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Opening Pandora’s (Patent) Box

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  • Publish date: 29 February 2016
  • Archived on: 18 February 2017

March 2016; The UK’s Patent Box tax regime is changing in response to the OECD’s BEPS project, explains David O’Keeffe.

The Patent Box was introduced in the UK by Finance Act 2012 with effect from 1 April 2013. It has had a fairly rough ride so far with the Germans leading the criticism (to be fair, not just of the UK’s regime) and calling for a review by the EU. And it’s also probably fair to say that take up, certainly among smaller companies, has not been great.

Then came the OECD Base Erosion Profit Shifting (BEPS) project, which included a review of Patent Box regimes by the Forum on Harmful Tax Practices. The results of that review were included within Action 5 of the BEPS project, with the final report published in October 2015.

That report proposed a more restrictive structure for acceptable Patent Box regimes, with the key difference being that schemes should comply with the “nexus approach”. Following a consultation, initial draft legislation was published on 9 December 2015 as part of the draft 2016 Finance Bill.

The basic approach of the draft changes is to insert two new chapters into the existing Patent Box legislation in Part 8A of CTA2010. These chapters deal with the new, nexus-compliant rules.

New default

New Chapter 2A will become the new default provision going forward and will apply to all companies for accounting periods beginning on or after 1 July 2021. During the transitional phase, it will also apply to those companies whose first accounting period for which its most recent election into the Patent Box (under s357A(1)) has effect, commences on or after 1 July 2016 (“new entrants”).

Accounting periods straddling either of those dates are split into two for these purposes. Chapter 2A applies a modified version of the existing streaming rules, requiring companies to split their income and debits into “sub-streams” corresponding to IP assets (e.g. patents), products or product families for the purpose of “tracking and tracing” income and R&D expenditure.

Each sub stream is multiplied by the appropriate R&D fraction (the “nexus ratio” in the BEPS report), which is defined as the lower of:

  • 1; and
  • (D + S1)  *  1.3
    D + S1 + S2 + A


D is qualifying expenditure on in-house R&D.

S1 is qualifying expenditure on relevant R&D subcontracted to unconnected persons.

S2 is qualifying expenditure on relevant R&D subcontracted to connected persons.

A is qualifying expenditure on acquiring relevant qualifying IP rights.

LSCA Budget Breakfast 17 March 2016

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New chapter

New Chapter 2B will apply to all accounting periods beginning before 1 July 2021, where the company has both “grandfathered” intellectual property (IP) as well as a “new qualifying IP right”. A “new qualifying IP right” is defined in New S357BP as one meeting one of the following conditions:

  • that the right was granted or issued to the company in response to an application filed on or after 1 July 2016.
  • that the right was assigned to the company on or after the relevant date.
  • that an exclusive licence in respect of the right was granted to the company on or after the relevant date.

The “relevant date” is either:

  • 2 January 2016 in certain situations where the person who assigned the right or granted the licence was connected to the claimant (see below); or
  • 1 July 2016 in all other cases.

The relevant date will be 2 January 2016 in respect of IP rights that were assigned, granted or issued to the company by:

  • a non-corporate person that is connected with the company; or by
  • a company that is connected, where that company did not already benefit from a Patent Box regime (whether in the UK or elsewhere).

HMRC’s view of “benefit from” in this context is that there is a regime in place for which the company and IP could qualify. It is not necessary that the company has actually elected into such a regime. Note that the wording in the current draft legislation does not actually achieve this result and HMRC has confirmed that this will be amended.

Income from IP rights in this category will still be grandfathered until after 31 December 2016, essentially providing a deferred entry to the new regime.
Both new and grandfathered IP are streamed, as in Chapter 2A, but the grandfathered IP is all put into its own sub-stream separate from any new IP. No R&D fraction is computed and applied to that sub-stream.

The existing Chapters 3 and 4 remain in effect (until 1 July 2021) and apply to grandfathered IP where a company has no new IP.

David O’Keefe is a principal at Aiglon Consulting and a member of the LSCA Taxation Committee.

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