03 November 2015

HMRC consults on changes to the Patent Box

The UK Patent Box was introduced from 1 April 2013 and applies a lower rate (10%) of corporation tax to profits that are attributable to patents and equivalent forms of IP. The benefit has been phased in, with companies not benefiting fully from the 10% rate until 2017/2018. Since being introduced, there has been a positive response from industry, with 639 companies having received benefits of £335 million in total to date. 

The G20-OECD Base Erosion and Profit Shifting (BEPS) project seeks to reform international tax rules so that substantial economic activities are undertaken in the jurisdiction in which the preferential IP regime exists, by requiring tax benefits to be linked to the level of R&D expenditure incurred to develop that IP (the ‘nexus approach’). Due to the UK Government’s commitment to this project, HMRC is now consulting on necessary changes to the Patent Box in order to apply the nexus approach.

The timing is relatively tight as nexus compliant IP regimes must be in operation from 1 July 2016. The consultation closes on 4 December 2015, but the Government intends to propose legislation in the 2016 Finance Bill in December 2015 to amend the current Patent Box rules (with effect from 1 July 2016). It will publish in Spring 2016 the response document to the consultation, together with any necessary changes to the draft legislation.

The consultation document explains how the nexus principle will work, how it might apply based on streaming (a method of calculation which is already used in the Patent Box) and the need for a company to ‘track and trace' turnover, expenses and R&D to an appropriate level. Where the outcome of the nexus fraction is not a result which reflects the true substance of the company's development activity, the taxpayer could seek to rebut this presumption. 

The Forum on Harmful Tax Practices (FHTP) 2015 Report requires that the current Patent Box regime be withdrawn completely by 30 June 2021; companies (and IP) already in the current regime can continue to receive the benefits of that regime until it is finally withdrawn. The Government states that it intends to use the full five year period. 

The new modified regime will apply to ‘new entrants’ from 1 July 2016 and the consultation sets out proposed transitional rules for companies that are already elected into the existing regime and those that have not yet done so but wish to make an election, or having elected out, wish to elect back in. There are also rules to prevent IP being moved between related companies after 1 January 2016 to take advantage of grandfathering: any IP acquired from a related party after that date must be excluded from the grandfathered regime (it will continue to get the benefit of the Patent Box until 31 December 2016) unless it already qualifies for benefits under the existing regime. 

The Government suggests that the immediate impact of the proposed changes will be relatively small, given the proposed transitional arrangements. However, it is clear that the changes to the substantial activity requirement will, in certain cases, result in a lower tax benefit. Businesses that have used and may wish to use the Patent Box in the future should scrutinise the consultation carefully, and in particular consider what changes may be necessary to their R&D strategy.

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