What is the Patent Box?
The Patent Box is a Government regime that allows companies to reduce the rate of corporation tax they pay on profits generated by patented inventions from 19% (for the 2022 tax year) to approximately 10%. This relief recognises the value of innovation and of keeping new technologies and intellectual property (IP) within the UK.
The Patent Box was introduced in 2013 by the Finance Act 2012. The scheme was updated by the Finance Act 2016, which introduced alterations to the calculations involved in determining a company’s tax relief. Since 1 July 2021, the new rules have applied to all companies that have opted into the Patent Box. This guide deals with the new rules. For information about the ‘old’ rules, see the relevant sections of HMRC’s manual.
Who is eligible for the Patent Box tax relief?
To be eligible, your business must be a company that is eligible for corporation tax, and it must make profits from its patented inventions. The scheme applies to:
newly granted patents
patents that are pending registration
Patents that are eligible for the scheme include those granted by:
the UK Intellectual Property Office (IPO) under the Patents Act 1977
the European Patent Office (EPO)
the patent offices of certain individual states within the European Economic Area (EEA)
Some rights that are similar to patents may also be eligible. For example, certain rights related to innovative medicines and plant varieties.
To be eligible, a company must also meet the ‘development condition’ by having undertaken qualifying development for the patent (ie the company was involved in creating the IP, they didn’t just buy it). To meet this condition, a company (or another company in the same group) must have significantly contributed to developing the patent or to developing a product which uses it. For more information, read the relevant section of HMRC’s manual.
A company must also either own the relevant patent(s) or be ‘exclusively licenced-in' them. This means that, if it doesn’t own a patent, it must at least have a licence to use it to produce and sell the patented products, and it must have exclusivity (eg no other company has a right to do this within a given territory). To learn more about the complex rules for this eligibility criterion, read the relevant section of HMRC’s manual or Ask a lawyer for help.
Although you can only benefit from the Patent Box after your patent has been successfully registered, relief can be claimed for profits made between the application for a patent and its successful registration, for up to 6 years before your patent was granted.
How do I apply to the Patent Box?
You can apply to (or ‘elect into’) the Patent Box by writing to HMRC or through the calculations accompanying your company tax return.
For profits earned within a particular accounting period, election must be done within 2 years after the end of that accounting period. If you decide to elect out of the Patent Box, you cannot re-elect into it for 5 years.
How do I work out my Patent Box tax relief?
The real amount of tax relief a company is entitled to depends largely on what portion of its income is generated by its patents. The general steps that must be followed to complete this calculation are:
1. Work out your Relevant Intellectual Property Income (Relevant IP income)
Relevant IP income is a company’s global income due to qualifying patents, which includes income generated:
by selling the products which incorporate a patented invention
from the licence fees and royalties generated by the company’s patents
by the sale of a patent or of an exclusive licence to use a patent
as damages and compensation received as a result of legal action for patent infringement
Your total amount of income attributable to relevant IP income will be used during the following calculation steps.
2. Allocate your relevant IP income to sub-streams
Once you’ve determined which of your company’s income is relevant IP income, you must allocate your relevant income into income sub-streams. Income should be streamed (ie separated out) by either:
income generated by each particular qualifying IP right (eg a particular patent), or
if it’s not ‘reasonably practicable’ to stream income in this way, by groups or kinds of IP (ie ‘product family sub-streams’). This could be the case if, for example, multiple patents contribute to multiple products so that the income earned by each individual patent cannot reasonably be separated from that earned by others
Under the old streaming system, income generated by old patents would be separated out into separate sub-streams. Since 1 July 2021, separate streams for ‘old’ IP have not been used.
3. Allocate debits and make deductions
Debits (ie essentially costs for, for example, research and development or manufacturing or goods costs) should be allocated to the sub-streams to which they relate. Once debits have been allocated, they should be deducted from their relevant income sub-streams. This gives you a provisional figure for the relevant IP profits obtained from each sub-stream.
A routine return reduction should then be made from each sub-stream. To do this, calculate a ‘routine return figure’ by applying 10% to routine deductions that were included in your debits (eg capital allowances, personnel costs and premises costs). For example, if £500 of your debits (deducted above) qualify as routine deductions, apply 10% to this figure to get a £50 deduction. You can then deduct this £50 figure from the provisional relevant IP profits figure you worked out for the relevant sub-stream.
4. Deduct the marketing asset return from your provisional relevant IP profits
Your company’s marketing assets return is any profit attributed to the brand (ie marketing of your invention) rather than to the invention itself. You will only need to deduct the marketing assets return value from your provisional relevant IP profits figure if the brand is worth more than the amount your company has paid for marketing. Where the cost of marketing is higher than the brand, no further deduction is required.
If your company’s provisional relevant IP profits figure is less than £1 million, you can apply for Small Claims Treatment where your marketing assets return value will be assumed to be 25% of your provisional relevant IP profits figure. Although this may be simpler, it may be beneficial to do your own calculations, as this may result in no marketing assets return deductions, which would increase your Patent Box tax relief.
This step gives you a relevant IP profits figure.
5. Apply your R&D fractions to your relevant IP profits
Next, you must work out your R&D fraction for each sub-stream. The formula for working out this fraction for a given sub-stream is (D + S) x 1.3/ (D+S+A+R), where:
D is the in-house R&D expenditure accumulated on the particular IP within a stream
S is the costs of R&D subcontracted to third parties
A is any relevant patent acquisition (ie purchase) costs
R is the costs of R&D subcontracted to connected parties (eg other companies within your company’s group)
These figures refer to the total costs your company has spent over the life of a patent, for up to 20 years.
The fraction will be 1 if there’s no acquisition cost and all R&D is taken by your company alone or by third parties. The R&D fraction will always be between 0 and 1.
Once you’ve determined an R&D fraction for each sub-stream, this fraction must be multiplied by your relevant IP profits figure for that sub-stream. For example, if your fraction is 8/10, your relevant IP profits will be multiplied by 0.8 and, therefore, reduced. In effect, this is an extra deduction stage that reduces the tax relief you’re entitled to if you outsource (or are otherwise not directly involved with) a significant amount of the R&D related to a patent.
6. Determine your relief
At this point, you will have a relevant IP profit figure for each sub-stream, which has been adjusted by an R&D fraction. Add the relevant IP profits from each sub-stream together to arrive at the amount of your company’s income that is essentially regarded as being generated by your patents (ie the income figure that will be used to calculate your corporation tax relief.
Calculate the amount of your relevant IP profits you’ll have to pay corporation tax on using the formula: RP x (MR - IPR) / MR, where:
RP is your total relevant IP profits figure
MR is the main corporation tax rate
IPR is the 10% intellectual property rate of corporation tax
This will give you a proportion of your relevant IP profits that you do not need to pay corporation tax on. The regular corporation tax rate should then be applied to the remainder (eg if your relevant IP profits were £1000, and the formula gives you £444, you should pay corporation tax on £556 of this). This results in what is effectively a (near) 10% tax rate overall for your relevant IP profits.
How do I prepare my company for the Patent Box regime?
Since it’s crucial for your company to be able to provide specific data related to income and expenses for each relevant patent, you may wish to consider the adequacy of your existing accounting systems before entering the scheme.
audit your company’s income streams and determine which ones are generated by which patents
audit your company’s expenses to identify what they’re for (eg which are R&D expenses? Which are capital allowances?)
You should also make sure your company actively develops the patents you’re basing your application on. If your company belongs to a group, consider subcontracting R&D work directly to third parties rather than to connected parties. This can improve your R&D fraction and, consequently, your Patent Box tax relief.
Information and assistance
The rules for determining a Patent Box tax relief are complicated and full of quirks and exceptions. The description above provides a general overview of the calculations. If you’re applying for a relief, you should utilise HMRC’s detailed Patent Box manual and Ask a lawyer if you need any assistance. You can also contact HMRC’s Specialist Incentive and Relief Team for assistance.