10 Years of Patent Box: A Brief History of the Scheme

In the ever-changing landscape of intellectual property (IP) and taxation, the UK Patent Box scheme has become one of the most significant incentives for companies investing in patented products, processes, and inventions. The scheme, introduced to encourage innovation and economic growth in business and industry, turned 10 years old in April 2023.

To mark a decade of the scheme in the UK, here is a brief history of Patent Box.

Patent Box scheme introduced in 2013

While discussions about creating an incentive based on intellectual property had been going on for several years prior, the Patent Box scheme was formally phased in from 1 April 2013, allowing companies to benefit from a reduced Corporation Tax rate on profits derived from patented inventions.

This reduced Corporation Tax rate of 10%, aimed to promote investment in research and development, drive technology advancements, and ultimately enhance the country's competitiveness on the global stage.

Updates to the scheme in 2016

A number of changes were made to the Patent Box scheme in 2016, following a report in October 2015, in which the OECD (Organisation for Economic Co-operation and Development) described it as a “harmful tax practice”.

In summary, the issues noted were:

• The original legislation allowed tax relief claimants without UK-based R&D.
• Some international corporations tried to exploit the scheme by moving their tax headquarters to the UK. This led some countries to suggest that the UK Patent Box program might create opportunities for tax evasion.

Introduction of the Modified Nexus

The result of this was the introduction of the “Modified Nexus” approach. This meant that the amount of tax relief available would depend on how much of the R&D carried out in the invention of the patented product or process was carried out in the UK.

The nexus regime is largely based on the old Patent Box regime with the qualification requirements remaining largely unchanged. The two main changes are to the calculation of a company’s relevant IP profits, with the streaming of profits becoming mandatory (as opposed to being elective under the old regime), and a new step called the “R&D fraction” having to be applied to those profit streams.

Although the Nexus changes were introduced from 1 July 2016 and applied to all new entrants from that date, existing claimants were allowed “grandfathering provisions” until 30 June 2021.

Streaming

Streaming requires a company to calculate patent box profits by ‘just and reasonably’ allocating costs to patented income sub-streams. Under the old regime, the default approach was formulaic and used the percentage of patented turnover to total turnover to apportion profits.

However, using a streaming methodology can be beneficial as it is not uncommon for a company’s patent income streams to command higher profit margins.

R&D Fraction

The R&D fraction links the beneficial tax rate on income from a qualifying IP right to the research and development expenditure incurred by the company. This is calculated against each sub-stream of IP income and takes a value between 0 and 1 and is defined as the lesser of 1 and then a calculation based on R&D expenditure incurred against each sub-stream of IP income.

Broadly speaking, if the company has historically undertaken all R&D activity in respect of its qualifying IP and has not acquired the qualifying IP, then the fraction is likely to be 1, as the company has only incurred ‘good’ R&D expenditure.

If the company has acquired the IP or subcontracted the R&D work for the patented technology to a connected company then, to the extent that the acquisition costs or the subcontracted connected company expenditure exceeds the 30% uplift on ‘good’ expenditure undertaken in-house and sub-contracted to third parties, this could have a negative impact on the R&D fraction.

Generally speaking, if the R&D fraction remains at 1, then there will not be any impact on the Patent Box relief claim. A requirement to track R&D expenditure was also brought in to help with the R&D fraction calculation.

To calculate the R&D fraction, it is necessary to track the relevant R&D expenditure. In some cases, all the data required to calculate the R&D fraction will already be collated for the purposes of preparing a company’s R&D claim and is calculated cumulatively from 1 July 2016 (in some cases it can be 1 July 2013).

The transitional period from 2016-2021

A transitional period was introduced, which allowed companies that had used the scheme before June 30, 2016, to continue with the older regulations. However, this transitional phase concluded on June 30, 2021, meaning all participants from July 1, 2021, onwards are bound by the revised “new” rules.

Increased uptake in 2016/17

In 2018, HMRC published its annual Patent Box relief uptake statement for the year 2016/17. This report showed an increase of almost 25% in total relief claimed through the scheme from £754m (2015/16) to £942m (2016/17). It's interesting to note that whilst only 25% of claimants were large companies, they accounted for 96% of the relief claimed. Companies in the manufacturing sector are the greatest beneficiaries.

Further growth in 2018/19

Further impressive uptake in the scheme was seen in 2018/19, with 1400+ companies engaging with the Patent Box tax relief scheme, resulting in a total of £1.129bn claimed by UK companies. 92% of this total was claimed by large companies.

Latest HMRC statistics for 2020/21

The last set of statistics released in September 2022 showed the projected number of claimants had increased to 1,535 companies with an estimated value of claims valued at £1,205bn. Again, 95% of these claims were made by large companies despite only being 28% of the total claims – the other 72% being SMEs.

735 of the total claims were made from companies that operate in the manufacturing sector.

Increased Corporation Tax rate in 2023

In 2023, the UK Corporation Tax rate was increased to 25% from 19%, the highest level for over a decade. While the Patent Box was unchanged by this tax increase, the news sparked renewed interest in the benefits of using the scheme, as the considerable incentive can significantly reduce the new Corporation Tax burden for eligible companies.

The benefits of Patent Box

The Patent Box scheme offers a considerable benefit to companies exploiting qualifying patents – it is an especially powerful tax relief when combined with R&D Tax Credits. However, unlike R&D Tax Credits, Patent Box is generally less understood across the wider business community, meaning many companies may be missing out on a reduced effective Corporation Tax rate of 10%.

To learn more about how Patent Box works, download our free guide.