Why is this topical?
The EU Code of Conduct Group met on 22 October to consider whether the UK’s patent box regime (alongside others) constitutes harmful tax competition.
The Code of Conduct for Business Taxation requires member states to refrain from enacting harmful tax legislation; while it is not legally binding it has political force. The Code of Conduct Group was established by ECOFIN, the Council of EU finance ministers, to monitor whether member states act in accordance with the code.
In advance of that meeting, a draft EU Commission report appeared in the media. The draft report, which was written to provide guidance to the Code of Conduct Group, raised concerns that certain aspects of the UK patent box could be harmful.
The Code of Conduct Group did not reach a majority decision about how to proceed. Accordingly, the concept of patent boxes generally will be referred up to ECOFIN, which will meet on 10 December.
What aspects of the UK regime did the EU Commission report find to be potentially harmful?
We understand that the draft report raises concerns over two elements of the UK patent box: its substance requirements; and certain elements of the computation of the patent box benefit itself.
However, it seems that the whole question of patent boxes generally is now a political one rather than a technical one. Some member states appear to be philosophically opposed to the concept of preferential regimes for intellectual property.
How is the government responding?
HMRC remains confident that the UK’s position, in terms of the technical issues raised by the Commission, is robust and defensible.
The first concern raised – that the UK patent box does not require sufficient substance in the UK for qualification, because patents don’t need to be developed in the UK – seems to overlook the fact that both the ‘active ownership’ test and the need for a company to be trading in order to fall within the regime at all require significant levels of substance in the UK. (And, in any case, requiring development of patents to take place in the UK would seem to infringe the fundamental freedoms set out in the EC treaty.)
The second concern considers the patent box calculation itself, and specifically that it does not apply OECD transfer pricing principles at every step. OECD principles guide the allocation of profits between entities; only one part of the UK patent box calculation involves a profit allocation, and that part of the calculation refers to income streams intra-company.
Is it only the UK regime which might be harmful?
The question now hinges on whether patent box incentives are a legitimate mechanism for governments to stimulate growth. Accordingly, ECOFIN will be considering patent boxes in the round, and certainly more widely than just the UK’s regime. The UK patent box regime is certainly not out of step with other European patent box regimes. Other regimes have no substance requirements (notably Hungary, France and Spain – although in the case of Spain only since it reformed its regime in July 2013). Equally, not all regimes apply transfer pricing principles to their patent box calculations.
What happens next?
The possible outcomes from ECOFIN include:
The decision reached has to be unanimous. The one thing that will not be allowed to happen is for the issue of patent boxes to remain unresolved in the long term. Some agreement will eventually be reached – it is more a matter of how long and what form that process takes. In the meantime, the UK patent box regime remains unchanged.
What changes to the UK rules do you expect to see as a result?
If ECOFIN concludes there is a problem, we do not believe that the UK patent box regime, along with all the others, will disappear. Politics could mean that the UK makes some small concessions, irrespective of HMRC’s views of their technical merits.
What action should affected companies and their advisers take?
Companies do not need to take any action yet. In the event that ECOFIN supports the Commission’s view, then we expect the UK government to consider how best to adapt the regime to meet their concerns. In the meantime, companies can rely on existing law until such time as it is amended, if at all. As the state aid rules are not involved, there will not be any recapture of benefits from companies; it is unlikely in the extreme that any changes would be made retrospective by the UK government.
For guidance on the operation of the UK regime, see ‘FA 2012 analysis: patent box’
