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If you are starting a new business based on providing a better product with new capabilities. New technologies or even revamping a design into something new. Using patent box to protect any inventions your business makes is worth bearing in mind.
Patent Box provides lower rate corporation tax applies to profits made from patented assets. Patent Box a Government Sponsored incentive. Noteworthy that taxes profits from patented interests at 10%(2016) which is considerably less than the standard rate.
In this Intellectual Property series, in the first article we discussed what it is and why you need it. In the second article we looked at copyright. In article three we discussed Trademarks and in today's article we will discuss Patent Box.
So let's get started with some basic understanding of what it is and how to calculate quantifiable profits
Patent Box -The government is proposing changes to the design of the UK Patent Box. Consequently, this will mean that the amount of profit from an IP asset which can qualify for the reduced 10% rate of Corporation Tax (CT) available through the UK Patent Box. Will depend on the proportion of the asset’s development expenditure incurred by the company.
Broadly, there are 3 stages in the calculation of Patent Box.
- Identify the profits attributable to income arising from exploiting patented inventions.
- Remove a routine profit.
- Remove the profit associated with intangible assets, such as brand or other marketing assets.
Use the 3 stages to calculate profits that benefit from Patent Box. In some cases, the streaming method applies.
Identify the profits attributable to income arising from patented inventions
Calculate the total gross income of trade
You must calculate the total gross income of the trade. This includes revenue receipts and any profits from the sale of intangible fixed assets or patent rights.
However, this excludes any finance income.
Establish IP Income
Establish the percentage of total gross income relevant to IP Income: Relevant IP income ÷ total gross income multiplied by 100 = percentage
Adjust the total profits
First of all, adjust the total profits of the trade by excluding finance income and finance deductions and any additional deductions for research and development expenses.
There is one other adjustment that may need to be made in respect of R&D expenditure. In many cases, the proportion of R&D costs from earlier years that is generating relevant IP income in the current year will be a good indicator of the proportion to use. However, where current year expenditure is lower than in past years (referred to as a shortfall in R&D expenditure) then it may be necessary to increase the R&D expenditure deducted in arriving at the profits benefiting from the Patent Box.
Make adjustments then apply the percentage at step 2 to the adjusted profits. then establish the profits attributable to income arising from exploiting patented inventions.
Remove a routine profit
This step involves the removal of a routine profit (referred to in the legislation as a ‘routine return’) from the result of step 3. Routine return is a profit a business might expect to make. If it does not have access to unique IP or other intangible assets.
The routine return calculated by:
- Aggregating routine deductions deducted in calculating the taxable profits of the trade and taking 10% of that figure.
- Applying the percentage (as calculated in step 2) to that 10% figure.
The amount given by this step is referred to as the ‘qualifying residual profit’ (QRP) and represents the part of the profits of the trade that relates to the exploitation of patented technology and other unique IP or intangible assets such as brand or other marketing assets.
Your company’s routine deductions are its tax deductible trading expenses that fall within one of the following categories:
- Capital allowances under Capital Allowances Act (CAA) 2001
- Premises costs
- Personnel costs
- Plant and machinery costs
- Professional services
- Miscellaneous services
However, the following tax deductible expenses are not routine deductions. Included in the above categories:
- Deductions in respect of loan relationships or derivative contracts debts
- Any deductible expenses which qualify for the R&D tax credit - this includes any additional tax deduction given by the R&D tax credit regime
- R&D allowances and patent allowances are given under Part 6 and Part 8 of CAA 2001
Remove profit associated with other intangible assets such as brand or marketing assets
Steps 5 or 6
Market asset return figure
The removal of the profits attributable to marketing assets - referred to as the ‘marketing asset return figure’ - from QRP arrived at the end of step 4.
If the nature of your company’s business is such that its marketing activities are minimal and its marketing assets make no significant contribution to the generation of profit, then it may be possible to assume that the marketing asset return figure is nil.
If at the end of step 4 your company has QRP of £3 million or less and hasn’t previously had to calculate a marketing asset return figure, it can elect to apply the small claims treatment. This allows your company to use a formulaic approach to remove the profits attributable to marketing assets. If you elect to apply the small claims treatment in step 5, you don’t need to make the same calculation in step 6.
Therefore the formulaic approach sets out that the profits that remain in the Patent Box after removing those profits attributable to marketing assets are the lower of either:
- 75% of the QRP
- The small claims threshold (£1 million)
The amount arrived at after step 5 is the relevant IP profit (RP) or loss. The amount of company profit taxed at the reduced rate. Then used to calculate the appropriate Patent Box deduction.
If the company generates a relevant IP loss. The profits are not eligible for a reduction in tax rate.
- IP loss Generated by the company.
- Generated profits in earlier periods that were from exploiting inventions. The patent application had been made but awaiting grant (known as the patent pending period), then the further adjustment to the relevant IP profit or loss is made.
If your company has QRP greater than £3 million or decides not to elect for small claims treatment. It may need to calculate marketing assets return figure then deducted from the QRP arrived at the end of step 4.
However, there are 2 situations where your company can conclude that the marketing asset return is nil:
- The company’s actual marketing royalty (AMR) is greater than its notional marketing royalty(NMR), or the difference between the 2 is less than 10% of QRP for the accounting period - this is intended to avoid your company having to undertake expensive evaluation of the value of its marketing assets when the contribution they make to overall profit is only small
- The company’s business is such that its marketing activities are minimal and its marketing assets make no significant contribution to the generation of profit - this is because any NMR is also likely to be less than 10% of QRP
Where it is reasonable to conclude from a high-level consideration of the business that either of these situations applies, a pragmatic and common-sense approach should be taken and it should not be necessary to undertake a computation of notional marketing royalty merely to prove that the 10% threshold is not breached.
However, if, for example, your company’s business involves the sale of well-known consumer ‘brands’ it will be equally evident that a significant proportion of profit is likely to derive from marketing activities and therefore there is a need to compute a notional marketing royalty.
Relevant IP profits and losses
The amount arrived at after step 6 will normally be the relevant IP profit or loss. But if profits were made in earlier periods from exploiting inventions for which a patent application had been made but the patent was awaiting grant (known as the patent pending period), the company may elect for those profits to be included when the patent is granted.
This is the amount of your company’s profit that will be taxed at the reduced rate and is used in calculating the appropriate Patent Box deduction.
If your company has generated a relevant IP loss then none of its profits will be taxable at the reduced rate.
If your company generated a relevant IP loss in an earlier period or has generated profits in then further adjustment to the relevant IP profit or loss may need to be made.
Calculating the marketing asset return
Therefore the marketing asset return figure is calculated by deducting any AMR your company incurs from an NMR that your company has to calculate.
Calculating the NMR
The NMR is an amount your company would pay for the right to exploit the relevant marketing assets that your company holds in the accounting period if it couldn’t exploit them without that payment.
This amount has to be calculated following Transfer Pricing principles and the legislation sets out various assumptions that your company has to make when calculating the NMR.
Relevant marketing assets
Your company’s relevant marketing assets are those marketing assets that it exploits in generating the relevant IP income.
Marketing assets are defined as:
- Anything in respect of which your company could bring proceedings for passing off
- Equivalent rights recognised under the law of another country
- Signs or indications of geographical origin of goods or services
- Information about your company’s actual or potential customers which your company uses for marketing purposes
The streaming method requires: you to identify your company’s relevant IP income. However, rather than using a formulaic approach to identify the profits associated with that income. Since streaming allows you to calculate the profit by allocating expenses to the relevant IP income stream on a just and reasonable basis. A routine return and marketing asset return will then need to be deducted from that profit using the same methodology as for the formulaic approach (see steps 4 to 6 above).
When you can choose the streaming method
If your company receives income in addition to that from exploiting its patented inventions then it may wish to elect to stream rather than follow the formulaic approach. In certain circumstances, it will be mandatory to stream.
Your company may wish to stream if applying the formulaic approach wouldn’t result in an appropriate amount of profit benefiting from the Patent Box.
A company which manufactures and sells a range of established products none of which are patented. Therefore do not give rise to relevant IP income has turnover from this activity of £900,000 but its net profits are only £50,000. However, the company also owns a patented technology which it developed many years previously and has licensed out to another business which takes care of manufacturing, marketing, distribution, and sales. Also, it receives an annual license fee of £100,000 all of which is relevant IP income.
The trade profits of £150,000 are apportioned by the ratio of relevant IP income to total gross income, the amount of profit that benefited from the Patent Box reduced rate would be:
£100,000 ÷ £1,000,000 × £150,000 = £15,000
But clearly, in this example, the company will want substantially all of the profits from licensing out its qualifying IP (ie £100,000) to qualify for the Patent Box.
Furthermore, you can read more information on the streaming method
When you must choose the streaming method
Therefore in certain circumstance, the formulaic approach may result in an unacceptably high level of profit benefitting from the Patent Box.
A company’s receipts from exploiting qualifying IP rights are £3 million in which it generates a profit of £600,000. It also has license income that relates to non-qualifying IP of £3 million all of which is profit.
Therefore trade profits of £3,600,000 are apportioned by the ratio of relevant IP income to total income. The result will be:
£3,000,000 ÷ £6,000,000 × £3,600,000 = £1,800,000
So £1,200,000 of profit from non-qualifying IP will potentially qualify as RP.
Where this is the case, your company must apply the streaming methodology. There are 3 conditions which if met by your company will mean you will need to stream.
Company A has a trading turnover of £1,000, of which £700 (70%) is from the sale of qualifying patented products. It's tax deductible expenses of £775 include £50 for R&D, all of which qualifies for R&D tax credits.
Corporation Tax Computation
|Tax deductible trading expenses:
- R&D (£50)
- R&D additional deduction (£50)
- Other costs (£650)
|Taxable trading profit||£250|
Patent Box Computation
Calculate the total gross income of the trade
|Total gross income||£1,000|
Establish the percentage of total gross income that is relevant IP income
|Total gross income from step 1||£1,000|
|Relevant IP income||£700|
Adjust the total profits of the trade and apply percentage
|Taxable trading profit||£250|
|Add back R&D additional deduction||£50|
|Pro rata trading profit used below (£300 × 70%)||£210|
Remove a routine profit
|Total routine deductions||£650|
|Mark-up rate 10% × total routine deductions||£65|
|Routine return figure (£65 × 70%)||£46|
|Apportioned trading profit from above||£210|
|Routine return figure||£46|
|Qualifying residual profit (£210 - £46)||£164|
Step 5 or Step 6
Company opts for step 5 (remove profit associated with other intangibles - small claims treatment)
|Qualifying residual profit||£164|
|Patent Box profit (RP) (£164 × 75%)||£123|
However, not all of your company profits may come from exploiting patented inventions. To be relevant it must include one of the following:
- Selling patented products
- Licensing out patent rights
- Selling patented rights
- Infringement income
- Damages, insurance also other compensation related to patent rights
Your company can also benefit from the Patent Box. The manufacturing process is patented or provide a service using a patented tool. In these circumstances, you will need to calculate a notional royalty.
Please make sure you have a Tax Adviser that can support and guide you.
Question- Have you already gained a Patent for your product? What process did you follow? Please leave your comments below