7 tax breaks for IP companies
- John Deane
- Updated: Sat, 17th Dec 2016
Government departments and HMRC are increasingly acknowledging the value to our economy of companies trading on their intellectual property – IP focused businesses. Over the years, tax breaks have been introduced to help IP creators. However, HMRC have amended and varied the legislation and nothing stands still.
Our services for tax relating to IP creators include:
- Research and development tax credits;
- Creative industries corporation tax relief;
- Tax relief on investment into IP focused companies;
- Reduced capitals gains tax for directors and employees;
- Business property relief for inheritance tax;
- Capital gains tax deferral;
- Patent box corporation tax relief;
- Claiming IP tax reliefs; and
- Track record of recent cases involving IP creators.
1. Research and development tax credits
Tax reliefs for qualifying research and development expenditure are generous. What’s more, your business does not even need to be profitable to benefit from R&D tax credits. The definition of research and development is broad. R&D can include for example, activities aimed at new knowledge, the search for new findings, the formulation of designs, the testing of new or improved materials and devices, and the construction of products economically feasible for commercial production.
Our knowledge of the R&D tax credit system enables us to provide more focused commercial advice when dealing with your legal agreements.
How to claim R&D Relief
There are two schemes available for claiming the R&D relief; which one you use depends on the size of your business. There is the SME Scheme and the less generous Large Company Scheme.
SME Scheme for claiming R&D relief
For R&D relief tax credit purposes a SME is a business which:
- Has less than 500 employees; and
- An annual turnover of not more than €100 million or gross assets of more than €86 million.
The tax relief on qualifying R&D expenditure under the SME scheme is now 230%.
Loss making companies under the SME scheme
Where an SME makes a loss for corporation tax purposes, the total amount of the loss arising after the R&D claim can be carried back to the previous accounting period (assuming there is a taxable profit), can be carried forward to be offset against future profits (as and when they arise) and/or be surrendered to HMRC in return for an R&D cash payment to bolster cash flow.
You can only claim R&D Relief as a SME company if your company is a going concern when it made the claim i.e. it wasn’t in administration or liquidation. If your company ceases to be a going concern between making the claim and receiving the credit then HMRC will not pay the credit.
Larger than an SME
There is a regime known as Research and Development Expenditure Credit (“RDEC”) available for businesses too large to qualify as an SME.
Some SMEs are treated as a ‘large company’ for the purposes of the R&D tax credit calculation because they are a ‘linked’ or ‘partnered’ enterprise (for example; where 25% or more of the share capital or voting rights of the SME are held by another entity). When considering the SME definition a company must look at the aggregated amount for each of the qualifying criteria (i.e. employees, turnover and gross assets) on either an absolute basis (for linked enterprises) or on a proportioned basis (for partner enterprises). We do guide you through the rules and work with your accountants.
What is qualifying R&D expenditure?
Where the business and the project meet the necessary requirement to claim R&D relief qualifying expenditure gives rise to a tax saving. Qualifying expenditure can include:
- Software used by the R&D staff;
- Energy and materials consumed;
- Subcontracted R&D costs;
- Research and development undertaken by a contractor for an end user.
R&D relief is taken as an additional deduction for Corporation Tax purposes by reducing your profit or increasing your loss which is carried forward for offset against future profits.
HMRC advance assurance for R&D expenditure
HMRC will review actual or planned R&D expenditure for small companies and let them know if the expenditure incurred or about to be incurred will qualify for R&D tax relief.
Assurance available to small companies only
HMRC offer the service only to “small companies” and define small as:
- Companies claiming R&D expenditure for the first time; and
- Whose turnover is under £2m and who have fewer than 50 employees. The measure is at the point of application for HMRC advance assurance and approval is not withdrawn if turnover or employees subsequently increase beyond the limits.
Benefits of seeking advance assurance from HMRC
Successful companies will receive an assurance that HMRC will allow their first three years of R&D expenditure to be claimed without further enquiry. If the application for advance assurance is turned down, the business can still make a claim in the usual way via its corporation tax return.
2. Creative industries corporation tax relief
Creative and media industries can claim cultural reliefs to reduce their corporation tax bill. The system of relief is similar to, but not exactly the same as, the system of R&D tax credit relief. Broadly, the creative industry reliefs apply to the following industries:
- Film and animation;
- High-end TV and children’s programmes;
- Video games;
- Theatre; and
Creative industry tax reliefs are available for:
- Film production companies producing films
- Television production companies producing relevant animation or high-end television programmes
- Video game development companies
- Theatre production companies
- Orchestra production companies
Benefit of a claim to creative industry tax relief
Qualifying companies can claim either:
- an additional tax deduction (the enhancement) of up to 100% of enhanceable expenditure or,
- if a loss is surrendered: 25% of the loss up to the amount of enhanceable expenditure.
The rules are complex and some activities are excluded, such as promotional campaigns or advertisements. We can guide you on how to maximise your chances of claiming the relief.
3. Tax relief on investment into IP focused companies
Investors can enjoy income tax reliefs and capital gains tax savings on profits or losses generated from investments in qualifying SEIS and EIS companies. We regularly set up companies to meet SEIS and EIS requirements, which in turn improve their attractiveness to investors due to the associated tax reliefs.
Business angels and other investors not claiming SEIS or EIS relief may be eligible to claim investors relief. If the investor qualifies under the Investors Relief regime the rate of capital gains tax payable upon a disposal of shares is reduced to 10%.
4. Reduced rate of CGT for employees and directors
Employees and directors of IP based businesses can enjoy a reduced rate of CGT when they sell their shares under the regime known as “entrepreneurs’ relief”. If the business creating the IP awards EMI options the shares acquired on exercise of EMI options by the option holders will qualify for entrepreneurs’ relief.
5. Business property relief IHT exemption
Shares in an IP business can pass to your estate free of inheritance tax if it qualifies as a trading company. For an intellectual property asset to attract business property relief, the asset must:
- Be a business asset used in the course of a trade;
- Be owned by the holder for a minimum period of two years; and
- Must not be an asset in a holding company, deal in securities, stocks or shares or any other prohibited activity.
The business must not be in the process of liquidation or winding-up. With regard to the latter, the process can either be voluntary or involuntary – the relief does not distinguish between the two procedures.
6. Deferral of capital gains on re-organisations
Capital gains arising on IP assets and shares in IP businesses can be deferred and rolled over into new shareholdings. The acquisition and disposal costs of the shares are adjusted to reflect the deferral. Broadly, for a deferral of gains to arise, the asset-holder must:
- Transfer the business as a going concern and essentially the business must be carried on as the same business albeit with a change of owner; and
- All of the assets must be transferred, although cash is disregarded in this aspect. For example, you cannot retain part of the business – such as the retention of trade marks for licensing or copyright for merchandising.
HMRC do offer a service by which tax payers can obtain advance approval to the tax treatment arising under the planned transaction before it is implemented. We do prepare approval applications for clients.
7. Patent box deduction of corporation tax relief
If you have a product using patented technology, then the corporation tax on that product’s profits will be reduced if you satisfy the legislative requirements under the patent box regime. The use of the patent box regime requires a calculation to identify the company’s total gross income and then identify how much of the income is relevant to the intellectual property and the qualifying patents – this is where our accountancy expertise is crucial.
If you are the original owner you will need to patent your inventions to qualify for relief – this is an area where we can assist. We offer a network of specialist patent attorneys. You do not have to be the original owner of the patent to qualify for patent box deductions.
The patent box legislation permits relief if you licence the use of the patent from the original owner. We can advise on the HMRC rules to see if we can put you in the best position.
Solutions relating to patent box tax relief
The patent box regime is constantly changing. Below is our list of some of the problems that we are commonly asked to solve:
- Determining whether the patent qualifies for the regime;
- Looking at who controls the use of the patent;
- Calculating overall profits and business profits from the patent’s use;
- Identifying which entity should develop the patent.
Qualifying patents for patent box relief
To qualify for the reduced corporation tax rate, a company must hold a “qualifying patent”.
The following organisations grant qualifying patents:
- UK Intellectual Property Office;
- European Patent Office; and
- An EEA state with similar patentability criteria.
Some areas of high-tech innovation that cannot be patented for policy reasons (eg. nuclear technology) also qualify for reduced corporation tax.
Unique rights to the patent
To qualify for the patent box, a company must have some unique rights to develop, exploit or defend rights in the invention. Hence your company could benefit regardless of how you use the patent to exploit profits. Revenue streams can include those flowing from:
- License; or
- Included in patented products; or
- Used in internal processes; or
- Used to provide services.
When you licence the use of the patent from the patent’s owner, the licence must give you an exclusive right for the patent’s use and must at least cover the country of your business’s operations. Pending patent applications do not qualify. However, once a patent has been granted, companies can claw back relief for up to 6 years from the date of grant.
Qualifying income arising from the patent
Patent box profits are calculated using a concept of “qualifying income”. Qualifying income includes:
- Income from worldwide sales of the patented item, or an item incorporating it;
- Worldwide licence fees and royalties from rights the company grants to others;
- Income from the sale or disposal of patent rights; and
- Money received from parties that have infringed the patent.
To calculate the profits derived from the qualifying income, a company can:
- Apportion the profits using the ratio of total gross income to qualifying income, or
- Allocate expenses on a just and reasonable basis between two streams of income –the qualifying income stream and the non-qualifying income stream.
Patents must satisfy the “development condition”. This means a company must have been properly involved in the innovation behind the patent or the application of the patented invention.
Qualifying development requires the following criteria:
- Creating, or significantly contributing to the creation of the patented invention; or
- Performing a significant amount of activity to develop the patented invention; or
- Performing significant activities developing any product or process of a product incorporating the patented invention.
Warning – tax reliefs have to be claimed
HMRC do not give away tax credits. You must ask. There are complex procedures for claiming IP related tax reliefs, and often time limits. We can put you in touch with tax compliance specialists who will handle the making of any claim.
Track record of recent cases involving creators of intellectual property
We work with creators of a variety of forms of IP and patents. There can be hurdles to overcome to benefit from the tax reliefs. We guide our clients on the best approach.
- Acting for a consortium of high-net worth individuals on their individual investments into a mobile application company using EIS.
- Preparing case management documentation for executors acting on the administration of an estate for a high-net worth individual. We prepared business property relief documents and obtained clearance from HMRC before submitting the IHT400 form on behalf of the executors.
- Using the deferral of gains relief on behalf of an electrical component company seeking to establish an entity in the innovative technologies sector.
- Working with a developer of car safety mechanisms seeking to claim patent box corporation tax relief. The relief entitled our client to a reduced corporation tax bill at the end of the tax year.
- Structuring the sale documentation to maximise entrepreneurs’ relief for CGT purposes.
- Working with an electromagnetics group company operating in the UK seeking to satisfy the rules and requirements to claim a deduction from corporation tax under the patent box regime.