It is ‘all change’ in the world of Innovation taxes, with new rules shortly to be introduced on the Patent Box regime and a new clearance process recently introduced for small companies making their first R&D tax relief claim.
We take a look at the key changes to both regimes, how this might impact companies and actions that need to be taken.
A ‘smaller’ Patent Box
The UK Patent Box regime provides for a reduced rate of Corporation Tax (10%) on income derived from patents. This regime was identified as being potentially ‘harmful and open to abuse’ by the Organisation for Economic Co-operation and Development (OECD) as part of the Base Erosion and Profit Shifting (BEPS) review. This has resulted in the development of a new framework, such that the UK will need make some changes to its existing Patent Box regime in order to be compliant going forward.
It had previously been mooted that the existing regime would be closed down and replaced with a new Patent Box regime. In the latest announcement, however, the government has confirmed that this will not be the case and, instead, amendments will be made to the existing regime. This is welcome news, as although significant changes are ahead, the framework will be well known.
Nexus approach
As previously announced, the new rules will focus on a ‘modified nexus approach’ such that eligibility for IP tax benefits will only be available where substantial R&D activities tied to that IP have been carried out in the UK. Under the proposals, a ‘nexus fraction’ will be applied to the company’s qualifying IP profits to determine what should benefit from the reduced rate of corporation tax.
The ‘nexus fraction’ looks at expenditure on in-house direct R&D costs, plus expenditure on R&D sub-contracted to third parties as a proportion of total R&D expenditure. Any acquired IP or R&D subcontracted to related parties will result in a fraction of less than one. Therefore, any expenditure on R&D subcontracted to related parties, even those located within the UK, could result in a reduced claim under the new rules.
This could impact groups of companies which typically might have their R&D spread across more than one company. Groups should take an immediate action to review where their IP is held and their eligibility for patent box going forward.
Transitional rules
There will be transitional rules such that IP within the existing Patent Box regime as at 30 June 2016 can continue to be taxed under the old rules for a further five years. From 1 July 2016, any new patents would be dealt with under the new rules which could lead to different IP assets held by a company being taxed under different rules until 2021 when the tax treatment is aligned. To complicate things further, if say, a technology protected by a post 30 June 2016 patent becomes incorporated in a product which also contains technology protected under an existing patent, the old rules may only apply to part of the income from that product, leading to a very complex calculation!
In order to elect into the old rules of the Patent Box regime, the patent application would need to be filed but does not need to have been granted prior to 1 July 2016. Consideration should, therefore, be given to accelerating any applications prior to this transition date if possible.
“Track and trace” record keeping
Under the new Patent Box rules, companies will be required to track their expenditure on R&D activities to each product or patent with a separate ‘nexus’ calculation applied to each. Affected companies should consider undertaking a review of their accounting systems prior to 1 July 2016 to ensure that they are capable of reporting the required information.
The ‘track and trace’ requirement will even apply to companies falling under the old Patent Box rules as regards expenditure from 1 July 2016. This is because they will need to apply the new rules from 1 July 2021, and consequently they will need to be capable of applying the nexus fraction by reference to expenditure from the commencement of the new rules.
Although the new Patent Box regime undoubtedly involves more complexity, its importance in terms of potential tax savings should not be under-estimated; the increased complexity may well be a price worth paying for the continuation of this tax incentive.
Making R&D tax relief easier for SMEs
The Chancellor announced during the 2014 Autumn Statement that he would look to make it easier for small businesses to access R&D tax relief. A consultation was released in early 2015 and a follow up document was released in October 2015 setting out the government’s plans.
Definition of R&D for tax purposes
The consultation questioned whether the definition of R&D for tax purposes should be changed, potentially aligning it with the accounting definition. This proposal has not been pursued and was widely rejected by the respondents.
Advance Assurance
As part of the consultation it was agreed that advance assurance would be offered to small businesses. On 30 November 2015, HMRC published guidance in respect of the process and provided an online application form.
HMRC has confirmed that in order to be eligible to apply the company must not previously have claimed R&D tax relief, and it must have annual turnover of £2million or less and less than 50 employees.
If HMRC accept the application, the company will have certainty over R&D tax relief claims in the first three accounting periods without risk of an enquiry. HMRC have confirmed that a company will be able to make some changes to their R&D activities during the three year period without invalidating their claim but have not yet outlined the extent of these permitted changes.
Improved guidance
HMRC have also committed to bespoke guidance for smaller companies looking to claim R&D relief, better guidance for those looking to claim R&D tax relief but also receiving grants and a review of the treatment of subcontractors along with improved guidance in this area.
What next
If you would like advice on whether your company might be eligible to make an R&D tax or Patent Box claim or further information on how the changes highlighted above might affect you, please get in touch with your usual tax contact or a member of our Innovation team.