UK to modify Patent Box scheme

Jamie Fraser | November 2015

Following pressure from Germany, the UK Government has announced that it intends to modify the Patent Box scheme to bring it into line with the recommendations of the multinational Organisation for Economic Cooperation and Development (OECD).

The Patent Box scheme, brought in on 1 April 2013, currently enables companies to apply a lower rate of Corporation Tax to profits earned after 1 April 2013 from its patented inventions. 

Companies that can currently benefit from the scheme are those liable to Corporation Tax and who make a profit from exploiting patented inventions.  For a company to qualify for the Patent Box scheme, the patented invention must be covered by a patent granted by the UK Patent Office, the European Patent Office, or one of the qualifying EEA countries, and the company must have either:

a) created or significantly contributed to the creation of the patented invention; or

b) performed a significant amount of activity to develop the patented invention, any product incorporating the patented invention, or any process incorporating the patented invention.

As a result of this scheme a number of multinational companies flipped their tax domicile to the UK in order to make use of the lower rate of corporation tax. 

Such behaviour by multinational companies caused the OECD to produce an action plan on base erosion and profit shifting (base erosion and profit shifting refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low, resulting in little or no overall corporate tax being paid). 

This action plan prompted a re-evaluation of the way in which IP-based tax benefits should be awarded.  The result is a new approach to allowing such tax relief, and is based on the principle that businesses should only be able to benefit from a preferential tax regime if they carried out the "substantial activities" that generated the income benefiting from that regime in the country offering the regime.

It is upon this principle that the UK government intends to base a new iteration of the Patent Box scheme.

When are these changes going to happen? And what does this actually mean?

The current proposal is to close the current patent box to new entrants in June 2016, and to stop operating under the current rules in June 2021.  Thus, if a company is enrolled in the patent box scheme before June 2016 then it shall be allowed to continue to benefit from the current scheme until June 2021. 

Under the new proposals, from July 2016 companies enrolling in the Patent Box scheme will only benefit from reduced corporate tax for income generated by patented inventions in the UK (i.e. income generated elsewhere would not benefit from the reduction).