by Anne Fairpo
The UK released on Thursday its long-awaited proposal to update its patent box to make it compliant with internationally agreed limits on intellectual property regimes. The UK proposal sets out a series of questions for consultation, with draft legislation to come in December.
The OECD base erosion profit shifting (BEPS) standards require that patent box benefits be limited by the amount of economic substance/activity in the jurisdiction where the patent box is offered. While there are many ways that economic substance could be measured, countries opted to use research and development (R&D) activity as a proxy. Accordingly, patent boxes are required to limit the tax benefit in accordance with the proportion of R&D undertaken by the claimant in respect of the specific patent or product for which the patent box is claimed.
The UK will introduce the changes from 1 July 2016, but there are grandfathering provisions (see below) – the following will apply to IP that is not within the regime by 1 July 2016, and for other IP from 1 July 2021.
Proposals – nexus and tracking
The UK follows the nexus proposals exactly, setting out a ‘nexus fraction’ which must be applied to patent box profits to establish the deduction that will be available. As a result, patent box claims will effectively be limited where the company outsources a substantial amount of R&D to related parties – even if those related parties are in the UK. Groups could well need to rethink their R&D arrangements accordingly. The limitation relating to acquired/licensed IP costs may, in practice, be less of an issue – if the company is spending that much, comparatively, on the relevant acquired/licensed IP, it may well not meet the development condition.
Nexus must be calculated and tracked on a patent, product, or product category basis. The impact of this need to calculate on such a basis is that streaming (allocation of income and expenses) will be the only calculation option for the patent box, and it will be necessary to do the streaming calculation per patent, per product, or per product category, as appropriate.
A company cannot choose between patent, product, and category tracking as such – it will be required to track nexus at the patent level unless that is unrealistic, requires arbitrary judgment, or would track a category unrelated to innovation. Where it can be shown to be unrealistic, etc., the company will be required to track at the lowest realistic level of product or category.
The default R-based nexus calculation is rebuttable in exceptional circumstances where the company can show that it doesn’t reflect the real nature of the nexus of the company in the UK.
Grandfathering
If a company has elected into the current patent box rules with effect before 1st July 2016, the current rules will continue to apply to IP that exists at that date until 20 June 2021. The consultation asks whether this is too long a period, but I assume HMRC isn’t realistically expecting many companies to say that it is. IP will exist at 1 July 2016 where (effectively) the date of application of patent is before 1st July 2016.
Post–1st July 2016 products which use pre–1st July 2016 IP and post–1st July 2016 IP will need to apportion profits and R& D between the two sets of rules if the company is tracking at the product level.
Some anti–avoidance (there will be more)
IP acquired from a related party on or after 1 January 2016 will be calculated on the basis of the new rules unless it is already within patent box.
It looks as if there will be rules similar to loss buying/streaming (or a main purpose) to deal with the situation where a group acquires a company with IP & r&d histories, to ensure that the nexus calculation is not ‘enhanced’.
— Anne Fairpo is a barrister at Temple Tax Chambers and a lecturer at Queen Mary University of London. She specializes in taxation of technology business.
See:
Related MNE Tax articles:
Be the first to comment