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.