The Patent Box regime, administered by HMRC in the United Kingdom, aims to incentivise companies to invest in advancing technologies. It offers a reduced rate of Corporation Tax on profits generated from patented products or processes.
Eligible companies benefit from a reduced tax rate of 10%. This lower rate is only applicable to profits derived from patented income.
How to claim Patent Box
Let’s examine how the process works and how companies can claim this valuable relief, provided they qualify.
The Patent Box is for businesses that profit from patented products or processes. To make a claim, these businesses must satisfy strict qualifying criteria.
You can learn more about whether your project may qualify using our free eligibility checker.
Once you’ve established that your project qualifies, however, what happens then?
Qualifying projects
Qualifying Income is divided into five headings, the main ones being sales and licensing income. A ‘catch-all’ provision covers IP-generated income that doesn’t fall under one of the five headings.
Heading |
Details |
Example |
|
Head One |
Sales of patented items, including items incorporating patented items and bespoke spare parts for either of the above. |
A patented printer cartridge is designed to be inserted into a non-patented printer. The patented item (cartridge) is incorporated in the printer; therefore, the printer's sale will qualify as income. |
|
Head Two |
Income from licence fees and royalties is derived from agreements granting rights over qualifying IP, qualifying items or processes. |
The patent owner over a silicon chip licences the right to manufacture and sell the chip to another company. The income received from this licence fee qualifies. |
|
Head Three |
Income from the sale or other disposal of a qualifying IP right |
The gross income from the sale is included under Head 3 – but does not include sales of non-qualifying IP rights, even if the qualifying and non-qualifying items are sold at the same time |
|
Head Four |
Income received with respect to an infringement of a company’s qualifying IP rights |
This can be relevant even if the income isn’t received until after the company has sold the qualifying IP – provided the company qualified at the time of the infringement. |
|
Head Five |
Income received by way of insurance, compensation or damages (other than directly in respect of infringement) |
This income must be regarding qualifying items whose sale would have fallen under Head 1 or an amount about lost income, which would have been relevant IP income. |
|
‘Catch All’ |
Income received by exploiting qualifying IP, which does not fall under Heads 1-5, usually deemed a “Notional Royalty”. |
*Typically, this is seen when a company has a patent over a process, but the item manufactured under the process is not patented. |
* Under this provision, the company must be able to determine the IP-derived income. In a patented process, the IP-derived income might be cost savings or efficiency gains before or after using the IP. Under the Old rules, a transfer pricing study was necessary to establish the percentage of the IP income that was eligible under the Patent Box. Under the New rules from July 2021, small companies can elect to take 75% of this income into the Patent Box.
Calculating profits for Patent Box
The calculation of profits to be attributed to the qualifying IP starts with identifying the IP income falling under the table Heads above.
Under the current rules, a company must stream its income on a patent-by-patent basis where possible. If this is not possible, then a product-by-product basis must be applied, failing that, a family of products. However, certain smaller companies can make a Global Streaming election, enabling them to calculate the relief by identifying just one IP stream under which all IP income is included.
This simplifies the calculation in many ways, but there can be drawbacks if a company has an R&D fraction of less than one for a specific patent.
What is the R&D fraction?
The R&D fraction is a calculation used in the Patent Box tax system. The fraction is used to determine the portion of a company's profits that qualifies for a lower tax rate based on how much the company invests in (R&D.
A full overview of the R&D fraction can be found on HMRC’s Corporate Intangibles Research and Development Manual.
Allocating expenses to each IP stream
The expenses deducted in arriving at the taxable trading profits are then allocated to each IP stream. The allocation must be just and reasonable, and this will vary by company.
Some companies maintain management accounts with separate P&L accounts for individual products, but many do not. It may be appropriate for certain companies to allocate costs based on the split of turnover.
Adjusting the IP profit accordingly
The IP profit is then adjusted to reflect profits that would have arisen even if the company didn’t have a qualifying IP, so there is a deduction for a routine return. This is essentially a 10% markup on standard costs, which HMRC believes all companies will look to make. It is also a marketing royalty (to reflect IP, such as trademarks, which does not qualify).
Additional steps post-2021
There is another step for companies claiming under the New rules (and all companies from 1 July 2021). This ensures that only companies undertaking the R&D giving rise to the IP benefit from Patent Box. Any companies that sub-contract R&D to connected companies or buy qualifying IP may find the proportion of IP profits subject to the reduced rate of Corporation Tax are modified.
Patent box fraction
Once a final profit attributable to qualifying IP is calculated, this is subject to a fraction, which is:
Profit attributable to qualifying IP x (the main rate of corporation tax -10%) / 10%
This gives the amount to deduct from total taxable profits.
Making the Patent Box claim
Your company must formally opt-in to benefit from the Patent Box scheme's lower corporation tax rate on qualifying profits.
You must inform HMRC of your intention to use the Patent Box within two years after the end of the accounting period when the profits were generated.
There's no specific form required. You can indicate your election within your company tax return calculations or submit a separate written notification.
Patent Box claims can be quite complex, and we strongly recommend consulting a Patent Box expert to guide you through the process. This will help you maximise your chances of success while reducing the risk of errors or penalties.
To get started, you are welcome to try our quick Patent Box eligibility checker tool below.
Darryl Hoy
Darryl is the Technical Director of the Radius team. He is a specialist in Research & Development tax reliefs, having previously worked at HMRC as an R&D Tax Inspector.
View my articles
