How to use the UK Patent Box regime for Corporation Tax

Developing new products and services that can go on to achieve commercial success when launched on the market is an essential part of driving economic growth. Governments want to create an environment for businesses to succeed in innovation and do so by various means, including offering tax benefits as incentives.

The UK Patent Box is a tax relief introduced in 2013 to incentivise companies to commercially leverage existing patents and develop product innovations. With it, you can lower the effective rate of corporation tax you have to pay on qualifying profits to 10%.

The Patent Box claim involves some reasonably complex calculations, so it is worth speaking to a tax expert in intellectual property (IP) and patent law about how you could benefit from tax relief in these areas. Check out the HMRC's guidance on the Patent Box.

Table of contents

• What’s the UK Patent Box?
• How does the UK Patent Box regime work?
• What types of patents are eligible for the Patent Box tax relief?
• How to calculate qualifying income from exploiting patented inventions
• What are the Patent Box calculation steps?
• Next steps

What’s the UK Patent Box?

The term ‘Patent Box’ describes the specific tax relief where you can elect to reduce the rate of corporation tax you pay to just 10%. This is a big reduction when you compare it to the usual level of Corporation Tax in the UK, which is currently 19% and set to increase to 25% from the 1st of April 2023.

These favourable tax rates from Patent Box relief are for profits attributable to qualifying patents and certain IP rights.  Since 2021, the way to calculate qualifying profits has changed to more accurately reflect the impact of using qualifying IP in generating income.

Excluded from the Patent Box are other profits attributable to activities such as marketing and non-patented tools or products. You will need to keep thorough records to calculate the final qualifying profit for the Patent Box accurately.

The aims of the UK Patent Box regime

Patent Box relief is designed to encourage the commercialisation of existing patents and the development of innovative products for patents. This helps contribute to growth in the economy and maintain the UK’s position as global leaders in technology and innovation.

The current Patent Box regime is designed to effectively identify the profits attributable to exploiting patents in commercialising a product and to take into account the amount of R&D you carry out, as well as its nature.

The Patent Box scheme incentivises companies to:

• Grow the levels of IP for patents developed and commercialised in the UK

• Produce and sell patented products from the UK

• Locate the high-value jobs needed to develop and manufacture innovative products in the UK

How does the UK Patent Box regime work?

You can elect to apply the Patent Box relief when completing your company tax return. You must have qualifying patents and IP rights to apply the tax relief and be able to attribute which parts of your profits are from your patents and qualifying IP. This involves ‘streaming’ profits to remove those that are not attributable to IP. Then following this with some R&D expenditure calculations that may reduce the Patent Box regime benefit for your company.

This section looks at what qualifies for inclusion in line with the Patent Box rules and how to make the calculation of qualifying Patent Box profits.

What is a Patent Box election claim?

An election into the Patent Box regime must be made within two years after the end of the relevant accounting period in which relief is claimed. You can elect in early so that the tax relief is available while a patent is still pending. So if you are waiting to hear the outcome of the patent application, you should consider going ahead and electing to the Patent Box in the meantime.

How to make an election:

• In your Company Tax Return’s computations

• Separately in writing

The way IP is often developed makes some of the Patent Box calculations difficult to do and you will, in these cases, need to consider engaging a tax specialist for advice.

What types of patents are eligible for the Patent Box tax relief?

You can benefit from the Patent Box regime if you have legal ownership of the qualifying patent or hold an exclusive licence to commercially exploit the patent. The regime can apply to existing, newly granted or acquired patents.

One of the following must grant the patent:

• The UK Intellectual Property Office

• The European Patent Office

• Several countries in the European Economic Area (EEA)

The regime excludes patents granted from certain countries, including some in the EEA. You should consult with HMRC for the latest list of qualifying countries.

If your company only uses patented IP for a small proportion of the product you sell and if that IP has a patent held by an external party, you can still look to benefit from the Patent Box regime. This is where accurate administration will be invaluable when defining exactly which proportion of income is attributable to patented inventions.

What types of companies are eligible?

The claimant company must meet certain conditions regarding its involvement in developing a patented invention or using a patented item in producing a product. Your company must hold or ‘exclusively licence’ an UK or European granted patent and satisfy the scheme's development and active ownership conditions.

Find out more about ‘qualifying companies’

What is an exclusive patent licence?

You can still elect into the Patent Box for the use of patented inventions developed by others. You must hold an ‘exclusive patent licence’ for these inventions. In these cases, you can still use the Patent Box where you have:

• Rights to develop, exploit and defend rights in the patented invention

• One or more rights to the exclusion of all other persons (including the licensor)

• Exclusivity throughout an entire national territory (rights to manufacture or sell in part of a country would not qualify)

The licensee must meet one of these conditions:

• Be able to bring infringement proceedings to defend its rights

• Be entitled to the majority of damages awarded in successful proceedings relating to its rights

How to calculate qualifying income from exploiting patented inventions

You can elect income to the Patent Box to apply the 10% rate of tax on qualifying profits, whether those profits are from royalties or part of the sale price of your products. In addition, a Patent Box claim can be made for qualifying IP rights such as regulatory data protection or supplementary protection certificates. 

Outside of these qualifying profits, the normal rate of Corporation Tax will be applied to your company’s profits. Again, it’s worth noting that the rate of UK Corporation Tax is due to rise from 19% to 25% in 2023, so planning for this and thus looking at how to use all available tax reliefs for business is a great idea.

Identify profits from intellectual property

Profits that qualify for the Patent Box may not make up the entirety of the profit you make for a product you sell. In these cases, you need to identify the income that you make from exploiting patented inventions from the following categories:

• Product and bespoke spare parts sales

• Royalties and licensing fees

• Patent sales

• Infringement income and other compensation payments

• Services income or income from patented processes

Once you have done this, there are several further calculations you need to make before you arrive at the final qualifying profit that is eligible for the Patent Box relief. We will look at this in the next section and, again, for more complicated cases, you will need to work with a specialist to make sure you arrive at the right final calculation. 

What are the Patent Box calculation steps?

The new Patent Box regime became mandatory for companies to follow from mid-2021. The main aim of the update is to accurately reflect what proportion of profits comes from exploiting qualifying IP rights and take into account the R&D expenditure for the product.

A series of calculations are necessary to remove non-qualifying profits that are attributable to routine business or marketing activity and so do not qualify for inclusion in the Patent Box.

Read more about the process of ‘streaming’

Five steps for calculating qualifying profits

1. Identify the relevant income and profits

2. Deduct the routine profit

3. Deduct profit derived from marketing assets

4. Apply the R&D fraction from 0 to 1 based on the level of expenditure

5. Obtain the final amount eligible for Patent Box tax relief

Routine returns and the R&D fraction

Routine returns are profits that your business would be expected to make without exploiting patented inventions and will be removed from the qualifying profit. Similarly, income attributed to your company’s marketing efforts must also be removed from the profit.

The R&D fraction is applied to those profits after the qualifying IP streams are identified.

The purpose of the R&D fraction is to link the beneficial tax rate on income from qualifying IP rights to the research and development expenditure incurred by the company.

Read more about how to calculate the R&D fraction

When your company has R&D expenditure from acquiring patents or makes payments to other parties for R&D services, this will restrict your level of relief from the Patent Box regime. 

Next steps

If you hold patents or qualifying IP rights, then tax relief from the Patent Box can be very favourable in reducing the level of Corporation Tax you have to pay to give you more to reinvest into your next innovative project. 

If you need additional capital to fund your project and accelerate growth, you can speak to us about a non-dilutive form of finance designed with entrepreneurial, innovative businesses in mind. We’re available to talk about your project and finance needs. Contact us today