BEPS: UK patent box under scrutiny

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The UK's patent box regime for taxation of intellectual property has become a “conspicuous sticking point” in negotiations behind the ambitious G20/OECD project to tackle base erosion and profit shifting (BEPS), according to reports.

George Osborne's “determination to retain controversial tax incentives offered to businesses with lucrative patents” is expected to “leave Britain out on a limb” at the meeting of G20 finance ministers on Saturday, The Guardian reported. The chancellor will not attend the meeting in Cairns, Australia but “his commitment to international tax reform is expected to be high on the list of topics under discussion”, the paper added.

Heather Self, a partner at the law firm Pinsent Masons, noted that the OECD’s focus on “harmful tax practices” could impact on the patent box. "The emphasis will be on ensuring that incentives are only given for real activity, and the UK may come under pressure to tighten its qualifying conditions to meet this," she said, responding to the OECD’s reports setting out progress on seven “2014 deliverables”.

George Bull, tax partner at chartered accountants Baker Tilly, said increased scrutiny of the patent box “will almost certainly come as a blow to the chancellor, who introduced the regime with a view to making the UK more attractive to pharmaceutical and research and development industries”.

Action 5 of the BEPS action plan published last year is titled: “Counter harmful tax practices more effectively, taking into account transparency and substance.”

The OECD had noted in 1998 that a “race to the bottom” would ultimately drive tax rates on certain mobile sources of income to zero for all countries, “whether or not this was the tax policy a country wished to pursue”. Last year the OECD said the “race” nowadays often takes the form of “across the board corporate tax rate reductions on particular types of income … such as [income from] the provision of intangibles”.

This week the OECD said “work has accelerated with significant progress on … consideration of intellectual property preferential regimes”.

But a Financial Times editorial today noted that “there are sharp differences on the definition of harmful tax practices”.

It added: “One country’s spur to innovation is another’s race to the bottom, as shown in the simmering row about the UK’s patent box.”

The paper reported in July that recent data “confirmed that the UK has continued to recover from a post-recession dip, helped by cuts in corporation tax and measures such as the patent box, which allows for a lower tax rate on some intellectual property”.

However, the FT’s tax correspondent Vanessa Houlder said this week’s announcement reflected disagreement on the design of the measure “aimed at curbing unfair competition for patent income”.

Houlder wrote: “Four countries – thought to be the UK, Luxembourg, the Netherlands and Spain – disagreed with 40 other states over how to stop governments poaching other countries’ tax revenues by offering reduced rates on the income generated by intellectual property. These ‘patent box’ schemes include Britain’s flagship tax break for intellectual property, forecast to cost nearly £1bn a year.”

This week’s OECD report said: “Action 5 … commits the Forum on Harmful Tax Practices (FHTP) to revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime. It will take a holistic approach to evaluate preferential tax regimes in the BEPS context.”

The first of three outputs to be delivered by the FHTP is “finalisation of the review of member country preferential regimes”.

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