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FA 2012 analysis: Patent box

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The patent box is an elective regime, introduced by FA 2012 s 19 & Sch 2, that will effectively reduce the corporation tax rate to 10% on certain income of a company’s trade relating to patents. As the calculation assumes the claimant company is paying at the main rate of corporation tax, a company paying at the small profits rate may find that the tax rate on its relevant IP profits will be slightly less than 10%. The relief will commence from 1 April 2013 but will be phased in over five years, so that the relief is 60% of the maximum in FY 2013, 70% in FY 2014 and reaches 100% in FY 2017.

The legislation on the patent box is contained in CTA 2010 Part 8A ss 357A–357GE, as inserted by FA 2012 s 19 & Sch 2. The regime effectively reduces the corporation tax rate to 10% on certain income of a company’s trade relating to patents. The rules take effect from 1 April 2013 but the relief will be phased in over a five-year period, so that the relief is 60% of the maximum in FY 2013, 70% in FY 2014 and reaches 100% in FY 2017.

HMRC published a technical note titled The patent box: Technical note and guide to the Finance Bill 2012 clauses in March 2012 (see This is a recommended read for all advisers and is more detailed than the ‘guidance’ published on HMRC’s website in August.


For the purposes of this legislation, a group includes a company and all associated companies. A company is associated with another if any one of five conditions is met:

  • the financial results of the companies are consolidated;
  • the companies are connected (by reference to CTA 2009 ss 466–471);
  • one company has a major interest in the other (by reference to CTA 2009 ss 473 and 474);
  • companies whose financial results are consolidated are associated with any company in which any of them has a major interest; or
  • connected companies are associated with any company in which any of them has a major interest.

This extended definition of a group applies for all patent box purposes.

Qualifying company

A company is a qualifying company in an accounting period if it:

  • holds any qualifying IP rights or an exclusive licence in respect of qualifying IP rights; or
  • has held a qualifying IP right or an exclusive licence and is receiving income in the current accounting period which relates to an event in an earlier accounting period when the company was also a qualifying company.

Qualifying IP rights are:

  • patents granted by the UK Intellectual Property Office or the European Patent Office or similar rights granted under the law of specified EEA states (currently, only rights granted in certain EEA countries qualify);
  • supplementary protection certificates;
  • plant breeders’ rights and community plant variety rights.

Exclusive rights means rights to the exclusion of all other persons (including the licensor) in one or more countries or territories, including the right to bring infringement proceedings or to receive the greater part of any damages awarded in such proceedings. The licence does not have to cover all rights in respect of the particular patented information, but the licensee must have some degree of exclusivity, for example in a particular commercial field. See Example 1.

A qualifying company must also satisfy the development condition, whereby the company or a group company carries out qualifying development, by creating or significantly contributing to the creation of an invention or performing significant activity for the purposes of developing the invention or any item or process that incorporates it. This work could be carried out before the company acquires the right or licence.

If a company is a member of the group, it has to satisfy the active ownership condition too, either by satisfying the development condition itself (ie, not by another group member) or by performing significant management activity in relation to the rights, such as formulating plans and making decisions about the development or exploitation of the rights.

Both these conditions require ‘significant’ activity or contributions, which is to be determined by reference to all the relevant circumstances. But companies cannot qualify for the relief merely by acquiring a completed invention and selling it, without having made any contribution to the intellectual property.

Computation of relevant IP profits

To compute the profits of the company which relate to the patented invention, we apply a factor, X%, to the profits of the trade, where X% is the proportion that relevant IP income (RIPI) bears to total gross income (TI).

TI for the accounting period is the company’s properly recognised turnover (using GAAP) plus certain other receipts, if not already within turnover, such as damages, insurance proceeds or other compensation, adjustments on a change of accounting basis and credits under CTA 2009 Part 8 (intangible fixed assets) or CTA 2009 s 912 (sales of patent rights). Finance income is excluded from TI.

RIPI is income from the patented information under five ‘heads’: sales income; licences; sale proceeds from a qualifying IP right or exclusive licence; damages; insurance proceeds or compensation. RIPI includes worldwide income, even if the patent only covers a single territory.

Sales income is likely to be most important. This is income from the sale by the company of:

  • qualifying items: items in respect of which a qualifying IP right held by the company has been granted, such as the invention specified in the patent;
  • items incorporating one or more qualifying items, such as a patented printer cartridge which is part of a larger printer. The patented item must be an essential part of the larger item; and
  • items that are wholly or mainly designed to be incorporated into one of the above, such as spare parts. The spare parts themselves do not have to be patented.

There are specific exclusions from RIPI, such as packaging (unless an integral part of the item), income from oil extraction activities or oil rights, income from exploiting non-exclusive licences and finance income. Obviously, non-taxable income cannot be part of RIPI, either.

Apportionment of profits

We now calculate the proportion that RIPI bears to TI, X%, and apply this to the company’s profits to give the IP profits.

Notional royalties as RIPI

A company may use a patented invention or exclusive rights in a way that does not generate RIPI, perhaps because by providing services, not goods, or because goods are produced by a patented process but do not comprise or include patented items. In these cases, the company can compute a notional arm’s-length royalty for the exclusive use of the IP rights and treat that royalty as RIPI. See Example 2.

Streaming (alternative computation of IP profits)

In some cases, the previous method of computing IP profits may give an unfair result. For example, if sales of patented items are materially more profitable than other sales, the pro rata allocation of expenses across both income streams would suppress relevant IP profits. The converse may also be true. Furthermore, streaming is mandatory where:

  • substantial credits are brought into the taxable profits of the trade that are not recognised in accordance with GAAP, such as transfer pricing adjustments;
  • there is substantial licensing income that is not RIPI, such as income in respect of non-exclusive IP rights; or
  • there are conduit arrangements, where the difference between licence fees paid and received may be minimal, but the RIPI may be substantial.

If a company has either elected for streaming or is subject to mandatory streaming, it must determine its RIPI as described and allocate the appropriate accounts debits on a just and reasonable basis (in contrast to the pro rata basis).

Computation of relevant IP profits (RP)

The first deduction is the routine return, being the aggregate of capital allowances, costs of premises, personnel, plant and machinery, professional services and miscellaneous items, including utilities, post, etc. This aggregate is multiplied by 1/10 and by X% to give the routine return figure to be deducted from IP profits to give the qualifying residual profits (QRP).

Where expenses are incurred on behalf of a claimant company by another group company, those expenses are treated as having been incurred by the claimant.

Some deductions, such as loan relationship and derivative contracts expenses, and R&D expenses and associated capital allowances, are specifically excluded.

There are two methods for computing the marketing assets return. The small claims treatment allows a company to deduct 25% of the QRP as a deemed marketing return, leaving the remaining 75% as the small claims amount or relevant IP profit (RP), which can then benefit from the patent box deduction. The maximum RP under this procedure is £1m and only applies if the company’s total QRP does not exceed £3m.

Otherwise, the marketing assets return is computed by determining the notional marketing royalty, the amount the company would have paid for the rights to exploit the relevant marketing assets, if it did not own them. This is effectively a transfer pricing exercise. The notional marketing royalty is then reduced by any actual marketing royalty, which will have already been taken into account in arriving at QRP. If the actual marketing royalty is greater than the notional marketing royalty or the difference between them is less than 10% of the QRP, then the marketing assets return is nil. See Example 3. Deducting the marketing assets return from the QRP gives the RP.

Points to watch: Even if the small claims limits apply, consider a desk-top transfer pricing review for comparison. Smaller businesses may have less valuable brands, so the flat-rate 25% reduction may over-estimate the marketing intangible.

Companies considering claims for the patent box relief should start looking at their accounting systems immediately to ensure all the relevant information can be captured.

Profits arising before grant of right

Companies can claim relief for periods after the patent is applied for but before it is granted. The company must have elected into the patent box regime for those periods and computed what would have been relevant IP profits had the right been in existence. Relief is then available for accounting periods ending on or after the date six years before the patent is granted or, if later, the date the patent was applied for (but not for periods before 1 April 2013).

In respect of exclusive licences, if a company developed IP, applied for a patent, then entered into an exclusive licensing arrangement with another company, the second company may be able to claim patent box relief in respect of the licence for up to six years before the patent was eventually granted (as long as it was granted) or from the date of application.

In both cases the relevant IP profits for each period are aggregated and added to the claim for the period in which the patent is granted.

Relief for losses

If the computation of RP gives a negative figure, this is set against RP of any other trade of the company, then against RP of any group member that has elected into the patent box regime. A surplus is carried forward against future RP of the same trade, of the company’s other trades or of other group members within the regime. A payment for the set-off of IP losses in another group company does not create a tax deduction or charge.


The general anti-avoidance provision applies where a company is party to a tax advantage scheme in order to secure a tax advantage under the patent box legislation. Other rules apply if the main purpose, or one of the main purposes, of granting an exclusive licence is to secure that it qualifies as an exclusive licence for the purposes of this legislation (so commercially irrelevant exclusivity can be ignored), or if a patented item is incorporated into a larger item with the main purpose, or one of the main purposes, of securing that the income arising from the sale of the larger item is relevant IP income (to prevent technically irrelevant items being incorporated to secure the relief).

HMRC says that standard commercial choices will not be affected by the use of the anti-avoidance rules. So it is acceptable to formalise a previously informal arrangement, or to patent a previously unpatented invention, in order that a company can take advantage of the patent box relief.


Elections must be made on or before the last date on which the company’s tax return for that accounting period could be amended and specify the first accounting period for which the election is to have effect. Elections apply to all trades carried on by the company.

A notice to revoke an election must be made on or before the last day before which an amendment to the company’s tax return for that accounting period could be made and specify the first accounting period for which the revocation is to have effect. A company cannot then elect back in to the patent box regime for, usually, six years.

An election can also be made by a corporate member of a trading partnership and only applies to that member. There is no election for the partnership as a whole, so each corporate member of the partnership can decide separately whether to make elections (into or out of) the patent box.

Pete Miller, Partner, The Miller Partnership