By Sam Lo Ricco, Corporate and International Tax Partner, Nuwaru, Sydney
The Treasury Laws Amendment (Tax Concession for Australian Medical Innovations) Bill 2022 was introduced in the Australian parliament on February 10. The bill provides the long-awaited detail for Australia’s new patent box rules, which were first announced in the federal budget on May 11, 2021.
The proposed legislation is complex, and several unanswered questions remain, but the eligibility criteria is now clear.
Where the eligibility criteria are met, taxpayers will benefit from a concessional tax rate of 17%.
Medical and biotechnology patents only
The patent box rules only cover medical or biotechnology patents “linked” to a therapeutic good included on the Australian Register of Therapeutic Goods (ARTG). The patent does not have to encompass the entire therapeutic good and instead can be a singular component of the good.
While the government consulted on extending the rules to patents in the clean technology industry, no policy decisions have been made at this time and such patents remain excluded.
Qualifying patents
Only Australian standard patents, United States utility patents, and European patents granted or issued after May 11, 2021 qualify under the patent box rules. The exclusion of patents issued in other jurisdictions is not seen as significant as the government claims that 97% of medical and biotechnology patents are filed in these jurisdictions.
In any event, this is an overall improvement on what was announced in the budget last year, which had indicated only new applications after that date would qualify.
Qualifying entities
To qualify for the patent box rules an entity must be an “R&D entity” for the purposes of Australia’s R&D tax incentive and must hold the eligible patent.
An R&D entity is a corporate taxpayer that is either an Australian resident or a resident of a country with which Australia has a double tax agreement and who carries on business in Australia through a permanent establishment.
To be considered to hold an eligible patent, the entity must hold an eligible patent for the purposes of Australia’s capital allowance (depreciation) provisions – that is, they must be the legal owner. An exclusive licensee of a patent would not satisfy this definition, as they merely hold rights under a license arrangement as a licensee.
Where an entity acquires an eligible patent, the benefit of the rules is limited only to the extent of improvements the entity made to the patented invention after acquisition.
Electing to apply the rules
A qualifying entity will be required to make an irrevocable election to access the patent box rules. The election will apply prospectively to all qualifying patents, including for subsequent income years.
The income rules
This is where the rules get complex. This is because only the proportion of income derived from exploiting a qualifying patent that is attributable to the qualifying entities’ R&D activities in the development of that patent will be subject to concessional tax treatment.
This requires a taxpayer to, first, identify the income stream for each qualifying patent. This could include royalties, license fees, sales income of the therapeutic goods, income from the disposal of a qualifying patent, and damages or compensation payable arising from an infringement.
Second, a taxpayer must determine the proportion of the income stream that relates to the qualifying patent itself, in accordance with Organisation for Economic Cooperation and Development (OECD) guidelines. For example, the income derived from the sale of therapeutic goods must be apportioned between that part attributable to its marketing and manufacturing and the qualifying patent. Unfortunately, there are currently no safe harbour rules to assist in the apportionment exercise, meaning a full economic analysis is required.
Finally, once a taxpayer determines a reasonable apportionment for each income stream, the concessional tax rate only applies to the extent that the taxpayer conducted the R&D for the technology underlying the qualifying patent in Australia, referred as a “nexus” approach. Helpfully, the explanatory memorandum to the bill indicates that where a taxpayer undertook all the R&D themselves in Australia, the relevant R&D fraction is 100%. It won’t always be that simple.
When will the rules take effect?
The bill has been introduced in the House of Representatives, it needs to pass through both the House and the Senate before it becomes law and may be subject to debate and further amendments in each. While the bill has broad support in principle, with a federal election due in May, it may still be some time before it becomes law. Nonetheless, it is expected (hoped) that it will have effect from July 1 this year.
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Sam Lo Ricco is a corporate and international tax partner at Nuwaru in Sydney.
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