'Thinking Inside The Box' To Encourage Innovation

Pharmaceutical companies with operations in the UK stand to benefit from the British government's plan to encourage innovation by 'thinking inside the box'.

The box in question is the Patent Box — a planned preferential tax regime that will reward innovative, intellectual property (IP) rich companies for the active patents they hold. Under the scheme, corporation tax on profits arising from products or services protected by patents will be slashed from the current 26% to just 10%. The Patent Box scheme (1) is currently at advanced stages of consultation, with draft legislation expected to be published in autumn 2011 and the scheme scheduled to go live from 1 April 2013.

(STHEPHEN WEBSTER/GETTY IMAGES)

Encouraging innovation and R&D

The scheme is part of the government's efforts to enhance the competitiveness of the UK tax system and to re-establish the UK as a location of choice for innovative, high-tech companies. One of the major supporters of the scheme is GSK, which has cited a number of its own important developments in the UK that the Patent Box would help facilitate, including:

• Securing new investment in the manufacture of GSK's next-generation respiratory inhalation device and further investment in its continuous tablet manufacturing technology.

• Ensuring that the UK is the location for GSK's next biopharmaceutical manufacturing plant; and development of a planned manufacturing centre of excellence to support its global dermatology franchise.

• Making a significant contribution to the construction of a new facility at the University of Nottingham focused on the development of 'green chemistry' technology.

• Launching a new €56.8-million UK Venture Capital Fund.

According to GSK, these new investments would create an estimated 1000 new jobs in the UK over the lifetime of the projects. The investments would also benefit the wider construction industry and the more than 10000 companies that supply GSK with services and facilities in the UK.

Boxing clever

To claim the Patent Box tax deduction, a business must actively hold a qualifying patent and receive income related to that patent. Income derived may be embedded in patented products; for example, it may come from patent licensing and royalties or from patent sales. It could also be income from damages paid by third parties for infringing a qualifying patent. The benefits of the Patent Box will be accessible both through legal ownership, including acquired patents, and through holding an exclusive licence to exploit a patent commercially. In addition, the scheme will apply equally to patents developed under partnership or joint venture.

The government proposes that the Patent Box should include patents granted by the UK's Intellectual Property Office (UKIPO) and the European Patent Office (EPO). Furthermore, it will include worldwide income earned by UK-based businesses from inventions covered by a qualifying patent, not just income that falls within the territorial limitations of the particular patent. Currently, the plan is for all active UKIPO/EPO patents to be eligible, including those that have been subject to supplementary protection certificates. However, the UK Treasury has said that it won't extend the 10% corporation tax rate to other forms of IP, such as copyright and trademarks, although businesses holding such IP rights will benefit from lower overall rates of taxation.

The scheme will be phased in over five years, starting at 60% of the potential benefit and rising to 100% in the fifth year.

Calculating patent profits

The proposed model for calculating patent profits is based on the premise that businesses that have developed valuable patents will produce additional returns compared with companies without such intellectual property. The amount of this extra profit, known as the 'residual profit', is a measure of the profit created by the patents rather than though routine business activities.

The proposed model operates on a company-by-company basis, but has three main steps:

• Businesses must allocate a proportion of their profits to 'qualifying income' (i.e., that which can be attributed to patents). To achieve this, the whole company's taxable trading profits (before finance costs and R&D enhancement) will be apportioned pro-rata based on the proportion of the company's total turnover that qualifies for the scheme.

• The company must calculate the amount of 'residual profit' they have achieved by deducting a simple fixed percentage return on routine activities conducted by the company from the profit allocated to 'qualifying income'.

• The business must identify how much of the 'residual profit' on a product or service is attributed to the patent and how much to other forms of IP, such as brands/trademark, copyright and artistic design. The government currently favours the use of a ratio of relevant costs to attribute the appropriate part of the 'residual profit' to patents, rather than requiring a valuation of patent and brand IP.

For the third step, the ratio of expenses incurred by the company that are classified as 'patent' or 'brand' expenses also needs to be considered. Patent expenses would include all R&D costs recognised in the statutory accounts (not only those eligible for R&D tax credits), as well as costs related to patent filing, renewal and protection. Brand expenses would include marketing, selling and promotional costs, expenses related to trademark development and protection, and design costs not classified as R&D.

Opening the box

The Patent Box represents an important incentive and innovative companies should be looking at ways to open the Patent Box to exploit its full potential. Firstly, companies should ensure they have the right level of patent protection in place at the IPO for the profits generated by their products and services to qualify for the proposed Patent Box regime. Second, it is important that companies are able to demonstrate that their patents are active and properly managed. Any company claiming a Patent Box tax deduction must "actively" hold the patent and remain "actively" involved in the ongoing decision-making connected with the exploitation of the patent. The Treasury does not want passive holdings to qualify, which would be contrary to its policy aims.

With the UK government taking such steps to encourage innovation, it will certainly raise the importance and value in companies' corporate management of maintaining and protecting intellectual property — and making it work more effectively for them by increasing profits, while reducing their tax burden.

Haydn Evans is vice president of intellectual property outsourcing at CPA Global, responsible for managing the company's IP outsourcing services across Europe. hevans@cpaglobal.com

References

1. HM Treasury, "Patent Box" (UK, 2010). www.hm-treasury.gov.uk, accessed 12 August 2011.