Patent Box: encouraging innovation in the UK

Kevin Nicholson (Chair): Hello, my name is Kevin Nicholson and I am Head of Tax at PwC. One of the most exciting changes in the corporate tax reforms this year is around the introduction of the Patent Box regime. I’m delighted to be joined today by Ian Valentine, who led the development of the patent box regime with HMRC, and Diarmuid MacDougall, who is our R&D and Patent Box leader here at PwC in the UK. Over the next ten to fifteen minutes we’ll be talking about how Patent Box might impact your business and how you can take advantage of the new regime and the reliefs that are available. So Ian, at a time when the Government is looking to cut back and make savings, here we have a new regime introduced with potential investment in the UK of £1bn of tax relief. So, why is the Government doing this?

Ian: Well, the Government has embarked on quite an ambitious programme of corporate tax reform, including reductions in the headline rate of tax from 26% down to 22%, but it still lacks incentives for companies to develop and commercialise their patenting technologies in the UK. The UK is a world leader in patent technologies and the Government’s intention is that it should remain so, and the tax system needs to reform in order to get there. So the 10% rate of tax on patented profits is intended to be the mechanism by which we can encourage companies to invest in the UK, and to put the high value jobs that are associated with patents in the UK.

Kevin Nicholson (Chair): And can you just give us an idea of the sort of conditions that will apply?

Ian: Well, in order to qualify for the Patent Box, which gives you a 10% rate of tax on the profits that you derive, you have to own a patent and you have to satisfy some development and ownership conditions. The patents that will quality are those that are granted by the UK Intellectual Property Office, by the European Patent Office or by certain other national patented offices within the European Economic Area. You either own the patent outright or you can license it on an exclusive basis from the owner. And provided that you do that and provided that the company, or the group that the company is part of, has made a significant contribution to the creation of the patented invention or to the application of that patented invention, then it will satisfy the development conditions. And then if the company is a member of a group, and it has not itself developed the patented invention, then provided that it actively owns its IP - by which I mean it formulates plans related to that IP and it makes decisions associated with that IP - then it should qualify for the Patent Box.

Kevin Nicholson (Chair): OK well that sounds good. Diarmuid, come on, bring this to life. How will that work in practice with our clients and with companies out there?

Diarmuid: Well, for the companies that own the patents outright it’s relatively straightforward and I think for many businesses, particularly the foreign parented groups, they will be seeing whether they meet the ownership criteria under an exclusive licence. I think there the active management of the IP is critical, so it’s helpful to hear Ian describe exactly what active management of the IP is. Although I think it still remains a subjective area as to precisely how much activity or substance is required in the UK to meet that condition.

Ian: And that’s very deliberate. We didn’t intend to put a definition in that was going to be inflexible. We don’t intend companies in the UK to have to do things that they wouldn’t commercially do, but we do want to ensure that the Patent Box isn’t giving benefits to companies that don’t really do things in the UK. So that’s the basic test.

Kevin Nicholson (Chair): So Diarmuid, give us an example of how this will work in practice.

Diarmuid: If you sell a product such as a car, and you own a patent in one simple part of that product, the entire product profit can get into the Box. So that’s the level of generosity that I think I would want businesses to understand. Clearly you need to meet the conditions, but Ian, it would be nice to hear that from you!

Ian: Well, absolutely. People have been surprised when we say that. It’s quite a bold concept, isn’t it, that just one thing will qualify the whole product. But, there are very deliberate reasons for that. What we don’t want people, in general, to have to do is to try and establish a value for their patent. What we want people to do is use the patented technology, as the qualification for getting into the Box. Then, there is a calculation that you have to go through to calculate what profit will be eligible, and we will go through that in a minute. But yes, the basic proposition that one patent in a product is enough to qualify the product, provided that it’s really therefore a purpose, is absolutely right.

Diarmuid: And I think this is a key difference between the UK scheme and overseas Patent Box schemes, which clearly exist. In most overseas schemes, you have to value the patent and the profit that gets the 10% rate or the more attractive rate is the notional royalty associated with that patent value. The UK scheme is completely different. The patent is a switch, so you just need one patent to switch the entire product profit into the Box. And that is a very attractive part of the design. You also mentioned the other parts of the calculation and I think there is a bit of a sting in the calculation in taking back, or clawing back some of that profit.

Kevin Nicholson (Chair): Maybe explain that, in a little more detail, now then?

Diarmuid: So, the first part of the calculation is bring in the profit. If it’s sale of products it’s the entire product profit when you’ve got the one patent and you meet the eligibility criteria that Ian mentioned. The second part of the calculation, you say - well actually some part of that profit you would have earned anyway, had you got no patent into the product and you claw back 10% of pretty much all of your internal costs associated with manufacture and sale of that product. And that 10% claw back effectively means there is a sort of threshold, a hurdle you have to get over, before you are going to have a profit in the Box.

Kevin Nicholson (Chair): So does that mean, Ian, that if you’re a relatively low margin business and the profit rate isn’t particularly high, you’re just not going to be able to take any advantage of the Patent Box regime?

Ian: Well, I think it depends. Clearly, the Patent Box is intended to reward and incentivise companies that employ technological IP. So, to a certain extent, if you don’t do that, the Patent Box isn’t intended for you. But the reality is, many companies do employ technological IP and patent it, and we do want them to be in the Box. However, clearly what we have to try and do is establish what a reasonable profit from the IP is. So, yes, we take out a 10% mark-up on certain internal costs to reflect a routine return that companies that did not have that IP might make anyway. We also take off a return that companies might be earning from their brand; from their marketing intangible assets. And we need to value that. But, both of those are intended to get us down to a reasonable level of what profit is derived from the technological intellectual property in the item. Not necessarily, as we’ve said, the value of a single patent or a combination of patents. It’s the IP as a whole.

Diarmuid: I’ve heard from a number of businesses that because of the 10% hurdle, businesses think this is just for life sciences or pharmaceutical companies.

Ian: Far from it, and the results of our consultation have indicated that it is widely welcomed across a whole variety of sectors and should benefit a whole variety of sectors from pharmaceuticals to manufacturing, to defence to telecommunications and certain business services and retail businesses may well even come within the Box. So, it is very widely applicable and it’s applicable from the largest companies in the country down to the smallest companies in the country. And we’ve worked very hard to try and make the regime as accessible as possible to small companies. So, no, I think the first thing is don’t be put off by the 10%. You’ve got to look at your company profits and how they are made up before you can really work out what the effect of the Patent Box will be on your company.

Kevin Nicholson (Chair): I know both of you have been to seminars and seen many, many, companies. Diarmuid, you and the team have been out seeing lots – hundreds actually - of companies, but the rules don’t come in yet, so why think about it now? What should businesses be doing now to get ready for this new regime?

Diarmuid: The eligibility criteria have to be satisfied, obviously, and if you are eligible through ownership under exclusive licence you have to get the licence right. It either has to exist in the right form now or you might want to document it more carefully. But also, the size of prize - the benefit you get - could be very different depending on some choices you make. When to elect into the scheme. But also in the calculation to go for what’s called ‘streaming’ – allocation of the costs the patent product stream – on a just and reasonable basis, rather than just a pro rata mechanism. And so, there are some things like that that companies really need to get to grips with and they’ve got to do that now otherwise they will find themselves in the regime and it will be too late, and they will be getting less than they could have got.

Ian: Absolutely, and in fact some companies may already, in effect, be within the regime. It comes into effect for profits that are earned after 1 April 2013. So, for some companies, that might be a current accounting period. For other companies, they will wish very soon to establish what the likely benefits for them in the box will be, and as Diarmuid says, they really need to be thinking about what records they need to keep, how they can identify the products that they have that have got patents within them. And, they need to decide what choices to make within the regime. The regime is designed so that if you want it can work in a very formulaic way it will, and that can be simple. But, if that's not appropriate for you, then you can make some other choices which may be more tricky in certain respects but may enhance the benefits. And so you need to make those choices now.

Kevin Nicholson (Chair): There’s a basic assumption, Ian and Diarmund, that the patents are already there. But a lot of companies haven’t patented things because of the costs of protecting them or they just haven’t got round to it or because they are busy. Presumably, if you have something which qualifies you could patent that and take advantage of the new regime?

Diarmuid: You can and actually, another reason companies don’t patent is just wanting to maintain secrecy. But, remember you only need one patent so you might find some part that you’re not too worried about the secrecy of and you patent that bit, and it’s enough to switch the product into the box. I think companies do need to think about their patenting policy, quite carefully, and see whether they could have much more in the box as a consequence.

Kevin Nicholson (Chair): And then you talked earlier about the competitiveness of this regime versus overseas. Ian, do you see multi nationals choosing to come to the UK for innovation and development of product, as a by-product of these changes?

Ian: We’re certainly getting increasing numbers of multi nationals looking at the UK now as a preferred place to do their high value investment. I think the combination of changes that the Government has made in reducing corporate tax rates, to reforming some of the other tax rules and now the Patent Box, together make the UK a very competitive place to locate business.

Diarmuid: And I think that’s one of the reasons, again, to be thinking about this now. Because that combination of Patent Box, the promised much better R&D credit, the reduction in headline corporate tax rate, the other CT reform elements - if you take the package, I think the UK is much more attractive now but you need to plan. If you’re going to make those decisions, and change your business model, you need to be thinking about that now.

Kevin Nicholson (Chair): So, we’ve heard that Britain really is open for business, that the Patent Box regime is real and that businesses need to start thinking now about how it applies to them and how they can start changing to take advantage of the exciting new reliefs.

Kevin Nicholson (Chair): So, a big thank you to Ian and Diarmund for taking the time to explain this to us and I would really encourage you to think about how it can impact your business. As you’ve heard from the discussions here today, HMRC want this to be a success, the Government wants this to be success and, actually, it can work for you and your business. Thank you for watching.

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