What next for the UK Patent Box regime?

John Moore, November 24th, 2015

In our previous post on this topic (The death of the UK Patent Box regime? – All is not lost) we said that changes would be coming for the UK patent box as a result of the increased interest by the OECD in this area. The OECD has recently published its final report from its Forum on Harmful Tax Practices (FHTP) on Action 5 of the Base erosion and Profit Shifting (BEPS) Project. In response to this HM Treasury and HMRC have now published a consultation document setting out the proposals for the changes in the UK patent box regime which will be legislated for in next year’s Finance Bill.

Whilst some companies may not be substantially affected by the proposed changes, others will be, and they should be aware of both the potential impact and the timetable for the introduction of these. Companies that have not yet elected into the patent Box regime and that believe that they will potentially be disadvantaged by the new rules should explore the opportunity to elect into the regime for profits from qualifying IP arising on or before 30 June 2016.

What is changing?

The Government has said in the past that the current UK Patent Box regime is more tightly defined and imposes tougher eligibility criteria than other similar measures in operation citing the regimes in France, Spain, Belgium and the Netherlands. However the broader review of such regimes by the OECD as part of the BEPS project has stated that the benefits afforded by IP regimes should be directly assessed by reference to a substantial activity requirement. The FHTP conclusion is that these substantial activities can be linked directly to the proportion of R&D expenditure incurred in developing the patent. R&D expenditure is therefore to be used as a proxy for substantial activities.

The Government has said that it is able to retain core aspects of the current patent box regime but that it will need to be modified in order to comply with this new “modified nexus approach”. Draft legislation is expected on 9 December as part of the draft Finance Bill 2016.

The consultation proposes a number of changes, a full discussion of which is beyond the remit of this article. However we will look in more detail at the application of the key concept of the modified nexus approach, which is dealt with by the application of the nexus ratio to each item of IP, or IP asset, qualifying for the Patent Box. The consultation envisages some flexibility in defining the IP asset. It may be the profits from a specific patent, a patented product or a family of patented products.

The Nexus fraction

This ratio defines the proportion of profit from the IP which may be included in a country’s IP regime. The nexus fraction limits the benefits granted under the Patent Box regime to a company’s proportionate contribution to the R&D activity underlying the company’s profits. It ensures that in order for a significant proportion of the IP income to qualify for benefits, a significant proportion of the actual R&D activities must have been carried out by the qualifying taxpayer itself.

The fraction (N) is defined as

N = D+S+U


The terms represent different kinds of expenditure by the company which contribute to the IP:

D = In-house direct expenditure on R&D

S = Expenditure on R&D subcontracted to third parties

A = Expenditure on acquisition of IP

R = Expenditure on R&D subcontracted to related parties

U is the uplift which if applicable is the lesser of A+R and 30% x (D+S) and is included in order to allow some otherwise non-qualifying expenditure to be added providing that these costs have actually been incurred. This is included in recognition of the fact that some companies which acquired a portion of the IP from, or outsourced it to, a related party may still be responsible for adding much of the value creation that contributed to the IP income and allows some relief for groups that have operated this way under the existing rules.

Tracking & tracing

The nexus fraction or percentage is then recalculated on a cumulative basis for the amounts representing D, S, A and R. In order to keep the fraction representing the development activity from which the profit comes, it is proposed that the expenditure is removed from the fraction once it no longer contributes to income. In order to remove some of the complexity the Government is proposing that expenditure is removed after 15 years. So there will be a requirement for companies to be able to track and trace the relevant expenditure, and this will introduce a new level of complexity. Our concern is that this may well lead smaller companies to concluding that the resources required are too great to make it worthwhile making a claim.

As mentioned above the Government proposes that the revised Patent Box rules should offer companies a choice of whether to track to individual IP assets or products, or product families. This in turn means that the current largely voluntary streaming calculations will become mandatory with income and expenditure allocated to each IP asset and then each one selected will then have to have its own nexus ratio computed and applied and then these will be aggregated to give the overall profit to be included in the Patent Box.

When will this take effect?

As we have highlighted before the current Patent Box regime will close on 30 June 2016 for new entrants. These are either those companies who have not elected to use it before then or for new IP with a an effective filing date after 30 June 2016. Under the grandfathering provisions any company already elected into the existing patent box regime will continue to benefit from the existing Patent Box rules for profits arising before 30 June 2021 from any IP that already exists at 30 June 2016.

Can I ignore the new regime until 30 June 2021 if the company is elected in before 30 June 2016?

Any company will be subject to the new IP rules arising at any time for IP that does not exist at 30 June 2016 even if already elected into the current regime at 30 June 2016. So far from being able to ignore the effects of the new regime for a company that elects in before 30 June 2016 the Government intends that companies will have to split the income from a product income stream between old and new IP in a situation where say, it has been upgraded with new technology post 30 June 2016.

Our view

Although the OECD requirements seem reasonable, and the changes proposed are simply the UK Government’s attempt to amend the current largely compliant legislation for the nexus requirement, there is no doubt that the proposed changes will add a significant layer of complexity for companies. For those companies that have developed the IP in house, without acquiring it or outsourcing it to related parties then the nexus fraction will not impact on their ability to claim as much as they do under the current regime. However it remains to be seen whether the increased complexity will impact adversely on the appetite of smaller companies to claim in the face of onerous tracking and tracing requirements, and after factoring in any potential reduction in the profits brought into the Patent box due to the nexus ratio being less than 1.

Companies that have not yet elected into the patent Box regime and that believe that they will potentially be disadvantaged by the new rules should explore the opportunity to elect into the regime for profits from qualifying IP arising on or before 30 June 2016.

Please do not hesitate to contact John Moore on 0207 292 8850 or at john.moore@kinglybrookesllp.co.uk if you would like to discuss the implications of this for your company.

This briefing is prepared by Kingly Brookes LLP, a limited liability partnership. For further information on any of the material contained in or referred to in the briefing, please contact us. This briefing note is intended to keep our readers up to date with the developments in this area, but it is a general guide only and is not intended to be a comprehensive statement of the law and practice in this area. No liability is accepted for the opinions it contains or for any errors or omissions.