UK government plans a patent box regime
UK government plans for a ‘patent box’ regime has a number of distinct tax advantages for energy sector firms
In less than a year, the UK government is due to introduce a “patent box” regime to encourage companies with high-tech assets to locate their base in the UK. This is a significant and important move that offers substantial tax benefits to qualifying companies and, given the short time frame until implementation, now is the time to start considering how this proposed patent box regime could offer firms ways of gaining more value from their patent assets.
The patent box regime is relevant to companies earning profits from UK or European patents, provided that they themselves have originated or developed the technology. As oil and gas companies often use a portfolio of patent assets, it makes sense to ensure that businesses are sensibly structured so they can fully take advantage of the savings available from 1 April 2013.
The benefits are clear – while the regime is elective, it will allow companies to apply an effective 10% corporation tax rate to profits attributed to patents with effect from April 2013. The relief will be phased in over a five-year period, with 60% of the relief available in 2013/2014, rising by 10 percentage points each year until the full relief is available from April 2017. This allows the government to phase in the impact of the tax benefits granted without restricting the regime to “new” patents.
The regime will allow oil and gas companies to apply the reduced tax rate to profits from sales of patents or products which contain patented technology, royalties from the grant of licences, “notional” royalties in respect of patents used to provide services, and compensation gained from disputes over patents. The really good news is that a company does not have to hold all the patents covering a technology to qualify. Indeed, only one patent needs to be part of a product in order for the patent box regime to apply to the whole of the income from that product.
But identifying the patent box income is not the end of the story; once the income has been identified, a complex calculation is used to isolate the patent-related profits to which the 10% corporation tax rate can be applied. This means that the actual profits to which the reduced corporation tax rate is applied can be significantly less than the overall taxable profits of the company. Also, changes in the way groups and their patents are structured can have a considerable impact on the proportion of taxable profits eligible for the reduced corporation tax rate.
To qualify for the reduced tax rate, the company claiming the benefit must own the patent or have an exclusive licence to that patent in at least one country. Companies may need to review their existing licensing arrangements to check whether they would qualify and it’s worth knowing that special rules ensure that partnerships and cost-sharing arrangements can still benefit from the patent box regime.
To qualify for the reduced tax rate, the company claiming the benefit must own the patent or have an exclusive licence to that patent in at least one country
If all this sounds too good to be true, there is a big caveat. Crucially, tax legislation already protects the UK government’s corporation tax take from UK oil and gas extraction operations, with extraction activities and the acquisition, use and exploitation of oil and gas rights being treated and taxed distinctly (and at a significantly higher effective rate) from all other activities. The government is keen not to allow patents associated with such activities or rights from benefiting from tax relief, meaning that profit from such activities/rights will not qualify for the patent box. However, certain related profits may still benefit.
If, for example, a subsidiary that owns rights to software for monitoring drill pressure, or software used to find oil reservoirs, then licensed the rights to a drilling subsidiary, profits attributable to the patent would qualify. Thus there is still scope for exploration and production companies to benefit.
To maximise the benefit, royalty arrangements between companies may therefore need to be established so that the reduced tax rate can be applied to the royalties earned for licensing patents. All such royalties must be calculated on arm’s length terms in order to comply with the UK transfer pricing rules.
One important point to remember is that to qualify for the reduced tax rate, the owner or another group company must have been involved in the technical development of the patent. This effectively excludes companies that simply acquire and then license developed patents. Having said that, the development requirement may be met, for example, by acquiring patents and then participating in their ongoing development. In relation to group companies, the development work can be done by a separate group company as long as the company claiming the reduced tax rate manages the patent portfolio. To maximise the opportunity, oil and gas companies need to assess whether a subsidiary should manage the portfolio or whether a separate patent holding company arrangement should be set up.
As oil and gas companies as well as services firms will undoubtedly have a variety of qualifying patent box income and non-qualifying income, they may also wish to make a “streaming election”, whereby income and expenditure of a trade can be split. This is particularly useful where profit margins vary substantially in different areas of the business. But a word of caution: streaming will be mandatory in certain circumstances and any voluntary election should be approached with caution as the choice cannot be altered annually.
As with any new tax regime, there are some anti-avoidance provisions to ensure that the scheme is not abused. For example, the rules prevent commercially irrelevant patented items being included in a product solely to obtain the benefit of the reduced corporation tax rate.
Technical consultation on the regime finished in February, and the revised version of the Finance Bill 2012 was published at the end of March. With only a year to go until the tax benefits are available, the time is right for companies to audit their patents and to consider what alternative structures will need to be put into place to take full advantage of the patent box.
• Penelope Warne is head of energy at the international law firm CMS Cameron McKenna LLP