Patent Box: How To Determine Income Derived From Patents
Getting a grip on the calculations
Do you know which of your income streams are eligible for the Patent Box? Don’t worry, if the answer is a resounding no you’re not alone.
Legislation in relation to the Patent Box clearly defines what income streams are classed as intellectual property (IP) income. The calculation of applicable IP income can then be used to determine the amount deductible from the company’s trading profits when calculating its UK Corporation Tax bill.
Before reading this article it’s well worth refreshing your memory about what the Patent Box is and how to works. Take a look at our recent blog: A Guide To The UK Patent Box.
So how is relevant IP income calculated?
Generally speaking, eligible IP income will fall into a couple of categories as follows:
- Revenue generated by the sale of a product that is protected by an eligible patent
- Revenue generated by the sale of a product where one or more parts of the product are covered by an eligible patent
Calculating IP income is a complex area, and this is just an outline for guidance. We therefore strongly recommend getting in touch with our team so we can advise you on your client’s unique circumstances.
One thing we want to point out here is just because a product is made using a method protected by an eligible IP right, it doesn’t mean that the product itself qualifies for Patent Box relief. However, if an item is built using one or more parts that have IP rights, then that whole item can attract Patent Box relief. So for instance, imagine the engine management system of a car is covered by eligible IP rights. When that car is sold it will generate income, and it’s this whole income that can be included for Patent Box purposes. Indeed, this makes the Patent Box rather attractive in many sectors.
Parts that are covered by relevant IP rights are known as being “incorporated”.
How does HMRC define “incorporated” parts?
An “incorporated” part, according to HMRC, is a physical component of another larger item (like the management system in our car example). This part must be intended to be part of the larger item for the entirety of its working life.
Another important thing to note is that packaging cannot be classed as “part” of an eligible item for Patent Box purposes. The only way to get round this is if the packaging is an essential part of the item and without it the item will not operate. An example of this might be the housing for an asthma inhaler, or a gas bottle for a barbecue.
As a rule of thumb, if the packaging for the product is something you’d throw away, then it won’t be eligible.
Income generated by the licensing of an eligible IP right
Applicable IP income can include any royalties or licence fees obtained by the company under an agreement granting rights in respect of any eligible IP right held by the company. These rights may be given to an individual or to another company.
Importantly, relevant IP income may also include any royalty or licence fee in respect of any other right regarding an eligible item or process. This is as long as the right is granted in the same agreement as an eligible IP right and for the same purpose. So, if the right to a design or trade mark (which is not an applicable IP right) is included in an agreement granting the right to a relevant IP right (such as a patent), the income related to design or trade mark rights will also count as qualifying IP income.
Income generated by the sale of an eligible IP right
If a qualifying IP right or an exclusive licence is sold or otherwise disposed of, it will still be considered as relevant IP income.
If a company decides to sell any eligible IP rights, and receives income in an accounting period different from that when the eligible IP right was transferred, then the company must have elected in to the Patent Box at the time the sale took place (not when it received the income).
Income received from payment of damages due to infringement
If a company pursues another entity for damages due to an infringement (or alleged infringement) of a qualifying IP right that it holds, then any money it receives by way of compensation for damages can be classed as eligible IP income.
As mentioned, the Patent Box and issues around calculating what your client can claim in respect of IP is notorious complicated. Even the most competent and experienced business accountants can fall down multiple rabbit holes, and any errors can have a hugely negative affect not just on your clients but on your firm’s reputation too.
R&D tax relief in general, and the funding of innovative new products, is also a highly complex area. Getting it wrong can not only be a massive hassle for both you and your client, but it can cost them dearly too. HMRC will scour your client’s application with a fine tooth comb, and any anomalies – however innocent - can lead to stressful enquiries and hefty fines too.
This article also acts as guidance but it’s not exhaustive. Neither is it tailored to your specific clients.
Over the years, we have worked with numerous accountants to help them achieve the Patent Box relief and R&D funding their clients so deserve. Plus, as we only deal with R&D funding and no other area of general accountancy at all, you know that we’re simply trying to help you help your clients - not muscle in on your business.
Our friendly, highly experienced team are available whenever you need us. So why not call us today on 0207 118 6045 or send us a message so we can call you back. We'll be pleased to assist in any way we can to make sure your clients receive the most up-to-date Patent Box advice possible.