Boosting innovation in the UK: benefits of Patent Box tax relief in a high-tax landscape

The UK government introduced the Patent Box regime in 2013 to encourage research and development in the pharmaceutical and biotech industries.

Companies exploiting qualifying patents which are eligible to elect into the regime can benefit from a lower corporation tax rate of 10% on profits derived from the patented technology. This is significantly lower than the standard rate of corporation tax, which increased from 19% to 25% on 1 April 2023. The original regime was amended with effect from 1 July 2016 following criticism from the OECD and introduced such concepts as streaming and the nexus fraction for research and development (R&D).

A product only needs to contain a single patent for all profits from the sale of that product to qualify for the 10% Patent Box tax rate. Income can be included from the sales of patented products, items incorporating a qualifying patented product, items mainly designed to be incorporated into patented products, licence fees or royalties, and other sources such as infringement income and damages.

Who is eligible for Patent Box relief?

To be eligible for Patent Box relief, a company must:

• Own or exclusively license-in patents granted by the UK Intellectual Property Office, the European Patent Office or certain other EEA countries.
• Have undertaken qualifying development work on the patented invention.
• Actively manage and exploit the patent.

Calculation of the relief 

To calculate the relief, a streaming method is used, which identifies and allocates qualifying income and deductions to each intellectual property (IP) asset or product. As part of the calculations, profits arising from routine and marketing activities are excluded to leave only the profits related to the underlying patented technology. A hypothetical royalty rate is calculated to determine the portion of the profits that can be attributed to marketing activities associated with the patented product or process.  The application of transfer pricing principals and techniques is required to establish an arm’s length price for this “notional marketing royalty”.

The nexus fraction (see below) is then applied to the qualifying IP profits to potentially reduce (in the event that it is less than 1) the amount of tax relief that a company may claim based on the level of qualifying R&D activity conducted within the UK on the patented technology.

Interaction with R&D tax relief – the nexus fraction 

Patent Box relief is designed to complement the R&D tax relief scheme, which provides tax incentives to companies that undertake R&D activities. The two schemes can be used in conjunction with each other to further reduce a company’s tax liability. 

The interaction between these two incentives is managed through the nexus fraction, which is used to determine the proportion of relevant IP profits that are eligible for the Patent Box relief. The purpose of the nexus fraction is to ensure that companies that invest more in R&D relative to their overall investment in developing the patented product will be eligible for a higher proportion of the Patent Box relief. 

To put it simply, the fraction is cumulative and represents qualifying “good” R&D as a proportion of total R&D and other expenditure on the patent. A fraction of 1 signifies that a company has historically conducted all R&D activities related to its qualifying IP and has not obtained the IP from outside sources. However, if the company has acquired the IP or hired a connected company to carry out R&D work on its patented technology, then any costs exceeding 30% of the “good” expenses incurred in-house or contracted to third parties may negatively affect the R&D fraction. Reference may be had to our previous insight explaining the difference between expenditure on externally provided workers and sub-contracted expenditure, respectively “good” and, if with a connected party, “bad” R&D expenditure in the context of Patent Box relief.  

Conclusion 

The Patent Box relief and R&D tax relief schemes are powerful tax incentives that can significantly reduce a company’s tax liability. By working together, they can provide even greater benefits to companies that are investing in innovation and commercialising their inventions in the UK. 

Where it is commercially feasible, companies should consider making patent applications on unprotected technology and review the terms of licence agreements to check whether there is scope to bring more profits within the Patent Box regime. Internal systems should be optimised to ensure that the relevant income and expenditure is captured so that it can be easily extracted for a Patent Box claim. 

How can Moore Kingston Smith assist me?  

We can assist you by: 

• Quantifying your R&D claims as part of the process leading up to the creation of potentially patentable technology; 
• Preparing an assessment of the potential benefits of electing into the Patent Box;  
• Reviewing your current operational structures and advising of opportunities that may exist to maximise the benefit of the Patent Box; 
• Gathering relevant information from your records and providing detailed advice on particular aspects of the calculations; 
• Performing the complex calculations to arrive at the Patent Box deduction and advising on any supporting documentation to be included as part of the claim.