Is the UK patent box regime fair tax competition?

At the Stockholm conference there was a bit of a spat between Theo Keijzer and Will Morris over whether the new patent box regime in the UK was fair or unfair tax competition. References were made to the three wars fought between the Dutch and the English in the 17th century between (1652 – 1654, 1665 – 1667 and 1672 – 1674) but not to the fact that England subsequently accepted a Dutch monarch in the “Glorious Revolution” of 1685.

England has always competed with Holland, but now the question is whether there is a level playing field in terms of patent box regimes.

 

Netherlands introduced their regime as of 1 January 2007. The main goal of the patent box was to promote R&D activities in the Netherlands by introducing a low effective tax rate on income stemming from intangible assets developed and patented by taxpayers.

To increase the use of the patent box the effective tax rate decreased to 5% on 1 January 2010 and a number of restrictions were eliminated and the regime became the innovation box.

 

In summary:

1. the effective corporate income tax rate is 5% for the innovation box (instead of 10%), crediting foreign withholding taxes on licensing income can result in an even lower effective tax rate than 5%
2. losses from intangible assets in the innovation box are deductible against the regular corporate income tax rate of 25.5% instead of 10%
3. there is  no maximum or cap to the use of the innovation box, for patented intangible assets and for intangible assets which result from R&D activities for which an R&D certificate was received.

The innovation box is applicable to profits from intangible assets for which a patent was granted or which result from R&D activities for which a qualifying R&D certificate has been received. A R&D certificate can for example be granted for software development. Besides access to the innovation box, an R&D certificate also grants a reduction of wage tax costs linked to the R&D activities.

The income that can be taxed under the innovation box against the 5% tax rate should be reasonably linked with the self-developed intangible asset. It is specifically not limited to royalties and/or capital gains, because this would limit the different business models that companies may have. Before the revenues can actually be taxed against the reduced rate in the innovation box, the income should exceed the costs of development. A residual profit split method can be used to allocate income to the box and determine the overall income of the Dutch company.

The intangible asset must be self-developed by the company. However, practical solutions for acquired (existing) intangible assets and contract research are available. It can for example be considered to have the overall management and coordination of the global R&D activities of a multinational group in the Netherlands and have (part of) the actual R&D activities take place abroad.

The innovation box is included in the Dutch Corporate Income Tax Code and is not under review of the European Commission as state aid.

The UK started consideration of a patent box nearly a decade ago in the lengthy consultation on the reform of corporation tax for international transactions. This process (in which I was involved) moved to a territorial system of tax , with a fairly liberal regime for interest deduction and an updated controlled foreign company regime. This process started when corporation tax was charged at 30%, whereas now the rate is heading to 20%.

The tax rate context is important. Business sought a move to low rate and broad base and that is what has happened with the fall in rate, in this context, should the regime provide incentives such as the patent box? And what does it need to do in terms of competition?

The Patent Box enables companies to apply a lower rate of Corporation Tax to profits earned after 1 April 2013 from its patented inventions and certain other innovations. The relief will be phased in from 1 April 2013 and the lower rate of Corporation Tax to be applied will be 10 per cent.

It applies if the company owns or exclusively licenses-in patents granted by the:

  • UK Intellectual Property Office
  • European Patent Office
  • following countries in the European Economic Area: Austria, Bulgaria, Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia, and Sweden

The company or another group company must also have undertaken qualifying development for the patent by making a significant contribution to either:

  • the creation or development of the patented invention
  • a product incorporating the patented invention

To be relevant IP (intellectual property) income, it must come from at least one of the following:

  • selling patented products – that is sales of the patented product or products incorporating the patented invention or bespoke spare parts
  • licensing out patent rights
  • selling patented rights
  • infringement income
  • damages, insurance or other compensation related to patent rights

I have referred in my blog on incentives, (Protecting the Tax base through Incentive legislation), to the design of incentives and their character as government spending (as tax foregone). Is the patent box efficient government spending? How much tax is foregone and who are the beneficiaries? According to press reports the main beneficiary is Glaxo whose attitude to the UK as a good place to do business in has changed positively. Much has also been made of non UK companies transferring patents to the UK. The UK government has to assess whether the tax foregone is justified by the extra economic activity. Of course as the main tax rate comes down, the cost of the regime comes down as the arbitrage between the two tax rates declines.

So is this fair or unfair tax competition. Well the Dutch regime has been cleared by the EC. The new UK regime isn’t under review as far as I’m aware. Does it move activity to the UK which would otherwise not have moved? Or does it retain activity which might have moved from the UK? Are these two motivations on a par? Or is one acceptable and one not?

I’ve suggested to the EC that there should be guidance on where the dividing line between acceptable and unacceptable tax competition and patent box regimes would be a good place to start.

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