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Patent box tax changes effect multi-nationals

The government is consulting  on proposals to amend the patent box regime. It’s hoping to prevent multi-national enterprises shifting profits to the UK,  a low tax location, in cases where the multi-national has little economic activity.

The Organisation for Economic Co-Operation and Development (“OECD”) reviews tax reliefs. The OECD’s 2014 base erosion and profit shifting action plan, and the HMRC’s subsequent consultation paper, are pressuring the government to amend tax reliefs. The key issue in the 2014 action plan is for an MNE to gain a preferential tax regime, it should conduct the profit realising activities within the jurisdiction in which the preferential tax regime exists.

From 1 July 2016, to claim the 10% corporation tax rate under the patent box regime, multi-nationals will have to carry out or sub-contract substantial research and development within the UK to develop intellectual property (“IP”).

So for multi-nationals, patent box regime requirements will tighten.  Investors in multi-nationals also gain a degree of tax transparency.

Current patent-box position for multi-nationals

Currently, multi-nationals can incur expenditure in one EU jurisdiction and claim patent box relief within the UK.  This is because the patent-box regime allows two ways of calculating profits: a proportional split and streaming.  Thus multi-nationals choose how to stream profits i.e.: per product, per product category, or a mixture of both. Administratively this is relatively low-cost, there are minimal accountancy burdens.

The OECD’s 2014 “base erosion and profit shifting action plan” aims to eliminate this tax structure.

Multi-nationals patent box position from 1st July 2016

From 1 July 2016, multi-nationals must quantify their eligible profits using a nexus approach. The nexus principle is based on a connection or series of connections between activities, costs, and profits. This aligns R&D costs with the direct profits received from such R&D.

So multi-nationals will first attribute turnover and expenses to IP assets, products or product families. Next they will calculate a profit for each, using the nexus principle. Multi-nationals will maintain a paper trail showing product profitability and R&D costs. A multi-national must show that R&D activities and expenditures are conducted in the jurisdiction for which the resulting products are sold.

Procedural timetable for introduction of patent box amendments

On 22 October 2015, HMRC published its consultation for proposals.  The consultation closes on 4 December 2015. Then draft legislation will be published for parliamentary reading with a view to including the legislation in 2016’s Finance Bill.  It is planned the proposals become law on 1 July 2016.

Analysis

The concept of substantial activity within the jurisdiction is not new, being adopted by the OECD in late 1990’s. Now, multi-nationals must link the costs of developing IP assets to each stream to establish a profit figure.

The new requirements will come as a blow to multi-nationals. The patent box regime was an attempt to make the UK more attractive to pharmaceutical, engineering, and other R&D intensive industries.

Supporters  argue the new approach will bind multi-nationals to a consistent set of global tax rules. However, the proposals may provoke other EU jurisdictions to amend their corporation tax reliefs, to attract R&D intensive multi-nationals with generous reliefs and relaxed regulations.

Comment

Unfortunately for IP intensive businesses, the patent box regime is under constant scrutiny from OECD and HMRC.   Not all is lost. Fortunately, we keep our clients up to date with the regime’s requirements and our advice considers future amendments.

If the requirements are met, the regime ensures  IP focused businesses gain a reduced rate of corporation tax. We combine our tax and intellectual property teams to advise on the patent box regime, a service that few other commercial law firms can offer.

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