HMRC consults on BEPS-compliant UK patent box regime

HMRC has published details of the consultation on redesigning the UK’s patent box regime giving companies a reduced rate of tax on their profits from patents and similar intellectual property (IP), which now has to be modified to ensure it is consistent with the new international framework for preferential IP regimes laid out in the OECD Base Erosion and Profit Shifting (BEPS) project

The consultation, which is being run jointly by HMRC and the Treasury, sets out the government’s preferred approach, and seeks views on how this will affect businesses. Where alternative approaches may be possible the consultation document also seeks views on these, which must be submitted by early December.

The document points out that the central issue identified by the OECD work was that for a business to gain the benefit of a preferential regime, it should have conducted the substantial activities which generated the income benefiting from that regime.

The agreed ‘nexus’ approach uses R&D expenditure as a proxy for substantial activity and links benefits to the requirement to have undertaken the R&D expenditure incurred to develop the IP.

The consultation looks at how the UK patent box should be modified to meet this requirement, based on streaming - a method of calculating profits already used in the patent box.

Under this method, companies would first attribute turnover and expenses to IP assets (eg patents), products or product families and calculate a profit for each, then modify this based on the nexus principle. Where, exceptionally, the principle did not give a result reflecting the true substance of the company's development activity, it would be able to challenge this (the ‘rebuttable presumption’).

To apply the nexus principle a company would need to ‘track and trace’ turnover, expenses and R&D to an appropriate level, which might be an IP asset, a product or a family of products.

The proposes methodologies for achieving this covering a range of different scenarios, including circumstances such as co-development between companies.

In addition, the consultation is seeking views on whether the same definition of R&D should be used for nexus as for R&D tax credits, and on whether the definitions of and rules for calculating direct and subcontracted expenditure should be aligned with the R&D tax credits.

It also looks at transitional issues, including provision allowed by the OECD rules for ‘grandfathering’, that is, allowing existing IP to continue to receive the benefit of the current patent box regime for a limited time which is yet to be determined.

Due to the OECD timescale, the government plans to publish draft legislation in December informed by the consultation process (rather than publish a response document and then draft legislation).

A response to the consultation will be published in spring 2016, along with any necessary changes to be made to the draft legislation, including changes responding to comments on the December draft.

The government will propose legislation in the 2016 Finance Bill to amend the current patent box rules (rather than replacing them completely) with effect from 1 July 2016.

In his introduction to the consultation document David Gauke, financial secretary to the Treasury, describes the patent box as ‘a key initiative in making the UK tax regime competitive for innovative high-tech companies’ and says 639 companies had received a benefit totalling £335m to date.

As regards the impact on the Exchequer of changes to the patent box regime, the consultation says that this will depend on the final policy design.

The document states: ‘The overall impact is expected to be relatively small particularly in the early years as a result of the proposed transitional arrangements. The changes to the substantial activity requirement may result in less tax benefit in cases where a company’s nexus fraction is less than one and it does not make changes to undertake more R&D in house.’

The consultation closes on 4 December and details are here

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Pat Sweet |Reporter, Accountancy Daily [2010-2021]

Pat Sweet was the former online reporter at Accountancy Daily and contributor to the monthly Accountancy magazine, pub...

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