The Patent Box: can it help your business reduce its corporate tax bill?

In the recent UK Budget, the government has maintained the standard corporation tax rate at 25%, reflecting its commitment to fiscal stability and economic growth. Amid this backdrop, the Patent Box regime stands out as a strategic initiative designed to foster innovation and drive economic growth and technological advancement.

What is the Patent Box?

The Patent Box is a potentially generous tax relief, designed to encourage companies to keep and commercialise intellectual property in the UK, but one which is taken up by relatively few (current estimate of 1,600) UK companies each year. It reduces the effective tax rate on profits derived from qualifying IP to just 10%, compared to the current main rate of 25%.

Why isn’t Patent Box more popular?

One reason may be its previous reputation. In its original form, introduced in the UK in 2013, it was strongly criticised by the Organisation for Economic Co-operation and Development as a “harmful tax practice”. The UK was not alone in receiving their criticism, as many European countries also introduced lower corporate tax rates for income from IP. It was generally recognised that the intention of these regimes was to encourage global businesses holding valuable IP to relocate to lower tax jurisdictions, which was seen as unfair competition.  However new rules to address these concerns were introduced from 2016, in the UK and Europe, and the regime has been subject to further tweaks since.

Those frequent amendments probably contribute to another negative perception that Patent Box is very complicated. It is certainly true that making a claim, particularly for the first time, can be daunting, however once a company has developed an appropriate methodology for calculating its profits qualifying for relief, the process becomes more routine in subsequent years.

Why is it called a “Box”?

The regime works by identifying profits which qualify for the lower rate, and notionally ring fencing them in a “Box”.  Any profit that falls inside the box is subject to corporation tax at just 10%, but any that falls outside the box is subject to tax at the main rate of 25%.

How do I get one of these Patent Boxes

1. To take advantage of the Patent Box, your company must:
   Be liable to Corporation Tax
2. Own or have an exclusive licence in a patent granted by the UK Intellectual Property Office, the European Patent Office, or certain other countries in the European Economic Area including Germany, Poland, and Sweden
3. Make a profit from exploiting that patent, principally by either
   • selling products incorporating a patented invention
   • using that patent invention to provide a service
   • licensing or selling that patent to others
4. Have carried out either directly or via subcontractors at least some of the research and development involved in creating the patented invention.

So, are Patent Boxes just for technology companies that create new products?

Patents put simply are a means of protecting new ideas by registering them. You don’t have to invent an entirely new product.  You could patent a new component to improve an existing product or system. Further, a new process, for example a process to manufacture an existing product more efficiently, may also qualify. Provided you have a patent in respect of one essential element of a product or process, income derived from the entire product or process may qualify for tax relief.

In one example provided by HMRC, a patented razor blade is incorporated into a final product (having a non-patented handle designed to incorporate the patented blade). The product is sold as a single item for a single price and is also treated as a single item (incorporating a patented element) with all income from its sales relevant to IP income.

Another example provided by HMRC is where a patented printer cartridge is designed to be inserted into a printer and not removed until empty. Income from the sale of the printer, including the printer cartridge in a single saleable package can qualify as relevant IP income, even if there is no granted patent on the printer itself. Conversely, if the printer includes a patented invention but the printer cartridge does not, sales of the cartridges on their own may qualify as relevant IP income if they are designed to be incorporated into the printer and are bespoke to that printer.

Further, profits arising between the date of application for a patent and the subsequent grant of the patent (up to a limit of 6 years) can be included in the Patent Box claim once the patent is granted.

Patent Box sounds easy

While the Patent Box regime offers significant tax benefits, it’s important to note that the calculations involved can be complex. Essentially, the process involves identifying and separating income derived from qualifying patents, then allocating relevant expenses appropriately. There are additional adjustments to ensure that only the qualifying income benefits from the reduced tax rate. Although these steps require careful and methodical handling, rest assured that specialised professionals can manage these calculations for you, allowing you to focus on leveraging the benefits of the Patent Box to drive your business forward.

What about Research and Development?

There is a final step in the calculations which involves the application of what is known as the R&D Fraction. This is essentially the proportion of the R&D activity involved in the development of the IP which has been carried out by the company claiming the relief.  If this is less than 77% there is a further reduction in the amount of profit that can be put into the box. This fraction has to be calculated separately for each item of qualifying IP and should be recalculated every year based on all relevant R&D activity carried out to date.

The good news is that you can claim R&D tax relief or tax credits on the same R&D activity as gives rise to income qualifying for the Patent Box. Essentially R&D tax relief encourages UK companies to do R&D, whilst the Patent Box should encourage them to retain the resulting IP in the UK.

So, what should I do?

If your existing R&D activity is producing ideas which are capable of being protected with a patent, then alongside the other benefits of patent protection you should consider the additional advantage of reducing your corporation tax. If you have previously dismissed the benefits of Patent Box as being too marginal compared to the effort of claiming, maybe reconsider now that corporation tax rates have risen to 25% within the last few years?