Can patent licensing reduce your tax bill?

By April 2017, tax on profits from patented products, processes or methods could be reduced to just 10 per cent. Intellectual property specialist Robert Pocknell explains the benefits of Patent Box tax relief.

Patent Box tax relief was introduced earlier this year to increase the attractiveness of the UK as a location in which to innovate, develop and manufacture new products.

If you have a patent portfolio or patentable intellectual property then, according to intellectual property specialist Robert Pocknell, the potential tax benefits are worth exploring.

Patent Box tax relief enables companies to have profits which arise from the use of a patented product, process or method taxed at significantly reduced rates. The current corporation tax rate is between 20 and 23 per cent, depending on the size of the profits. Patent Box tax relief is being phased in from April 2013 onwards and, from April 2017 100 per cent of the qualifying profits will be subject to a 10 per cent rate of tax (see Note 1).

It is a testament to the success of HMRC’s policy that multinationals are starting to bring their activities back to the UK so that profits can be taxed at globally competitive tax rates, and this is helping to build awareness of the Patent Box relief.

All businesses should be asking more questions about which processes, products and methods they have which may be patentable, and they should factor the tax benefit in as part of their business planning and intellectual property strategy.

The costs and time required to obtain a patent mean that a company’s intellectual property strategy needs to look at the tax savings on a medium term basis, even if the business does not already have a granted patent.

A particular attraction of the Patent Box regime is that it can also apply where a company is granted exclusive rights to exploit patents in a territory. This relief means that companies will be able to get the benefit of the 10 per cent tax rate on profits derived from the activities or products that are patented if they have exclusively "licensed in" the patent.

The terms of the exclusive license can be limited to a territory, for example the UK. It is also possible to limit the exclusive licence to a field of use, for example the sale of widgets in the beer market, but not in the wine market.

The ability to create defined fields of use is an opportunity for companies that want exclusive rights and can benefit from a reduced tax rate from their exploitation of the patent. But, it also creates opportunities for patent holders, as they can look to license their patents exclusively for a field of use in which they may not be operating and which is not a competitive threat – for example, a small brewery with a widget for alcohol could be licensed to a wine business or a widget developed for food preservation could be licensed a healthcare application.

Whilst there are opportunities for businesses to explore here, caution is needed as there are some specific requirements that are worthy of note.

First, the company acquiring the benefit of the license (the licensee) must still undertake some qualifying development by making a contribution to the invention or the product. This should be expressly provided for in the exclusive license agreement and they must perform a significant amount of activity to develop the product incorporating the patented invention.

Second, the licensee company must be able to bring infringement proceedings to defend its rights to the invention. If the patent owner retains control over any defence of the patent, then the licensee must be entitled to most of the damages from any successful proceedings. The licensee company needs to ensure that this right is not conceded as part of the negotiations of the license agreement. The advisers to the licensor will understand that these terms need to be agreed to secure the tax relief, so the tax justification may be useful in the negotiations if you are the licensee company.

Finally, companies should note that HMRC will look at the substance of the licensing agreement and the facts of the case, rather than the form of the license agreement itself. There are many anti-avoidance provisions in the legislation, so you should seek bespoke tax and legal advice before concluding the commercial terms of an exclusive patent license.

1. Note re tax rates

The main rate of UK corporation tax is currently 23% from 1 April 2013, which should reduce to 21% from 1 April 2014 and then to 20% from 1 April 2015.

The Patent Box regime is being phased in from 1 April 2013 until 100% of the qualifying profits will be subject to the 10% rate of tax from 1 April 2017.

In the meantime only a proportion of the qualifying profits are subject to the 10% rate with the rest being subject to Corporation Tax at the appropriate rate for your company.

From 1 April 2013 the percentage of qualifying profits subject to the 10% rate is 60%, rising to 70% from 1 April 2014, 80% from 1 April 2015, 90% from 1 April 2016 and finally reaching 100% from 1 April 2017.