Unlocking the UK's Patent Box

Introduced in April 2013, the UK Patent Box forms part of the government's growth agenda to create a more competitive tax regime. The Patent Box enables all profits attributable to patents to be taxed at 10%. The reduced corporation tax rate is delivered through an additional deduction in a company's corporation tax computation.

Only one component of a product needs to be patented; for example, if a product is manufactured from a combination of patented and non-patented components, income from the sale of the whole product will fall within the regime.

In order to take advantage of the regime, the company first needs to hold a patent granted by the UK Intellectual Property Office (IPO) or the European Patent Office (EPO). "HMRC sees the holding of a granted patent as the gateway into the regime. HMRC wants to reward innovation, but not audit innovation, which is the role of the patent office," explains Trudie Alder, senior tax manager at EY.

Alder points out that filing a patent is a significant commercial decision and clearly would not be done solely for tax purposes. "It can be expensive and there is a need to balance commercial protection with the fact that the application requires public disclosure of the innovation," she says. But as innovation and intellectual property increasingly become crucial value creation components, companies need to be looking more seriously at ways to protect IP in order to ensure value is retained and fully exploited.

According to Bridget Walsh, UK & Ireland head of private equity at EY, the asset class is often overlooking the Patent Box because portfolio companies appear unprofitable due to high levels of leverage. "If the group is loss-making, the regime can exaggerate the loss – the tax incentive becomes an extra deduction. So where there is lots of debt this can be an issue," explains Walsh.

"But, what is often overlooked or not understood is that the incentive is applied to trading profits, before accounting for leverage. So, although the company needs to have profits arising from its IP, the profit is assessed before the interest deductions," explains Alder. Therefore, if a company is profitable before debt, the regime is potentially very relevant.

Inside the box
The key attraction to taking advantage of the Patent Box is that it adds extra value to portfolio companies, especially when seeking an exit. "A real benefit of the regime is the extra value it can represent if preparing a company for exit. This is something that can be easily diligenced – it can be very clear if it's in or out of the regime. And you can be relatively certain of the value attached to the patent regime," explains Walsh.

Some of Walsh's private equity clients have already been digging though archives to find out if patents already exist in companies that have been acquired through a buy-and-build strategy, she says.

However, if there is no patent cycle in the business, then companies should now start to consider whether new innovations can be patented. "The holding of a qualifying patent is only a gateway into the regime; what is key is to meet the additional qualifying criteria connected to development and active ownership of the patents. If a company has acquired another company that has developed patents, accessing the regime is possible. But if a company has only bought the developed patent, that can be more difficult, particularly if the company makes no further contribution to the commercialisation or development," explains Alder.

Outside of the asset class, Alder has seen a lot of interest in the Patent Box coming from inbound investment, as companies look to locate IP in the UK because of the regime or use the UK as a platform for business expansion. Another swathe of interest has come from UK-headquartered groups, which have a very high patent density, or groups with a history of acquisitions that need to trace back and look at whether they can meet the conditions for the Patent Box to apply.

Filing findings
According to the World Intellectual Property Organisation (WIPO), China filed 652,777 patents in 2012 while Japan filed 486,070. Both countries significantly outperformed Germany, which filed 61,340 patents in 2012, and the UK with a lacklustre 23,235. These figures are highly indicative of the ever-growing importance of protecting intellectual property.

Despite the UK's weakness when it comes to filing patents, the country continues to sit at the top of the league tables thanks to its well-regarded patent litigation and for the ease and fairness in obtaining them, according to the Taylor Wessing Global Intellectual Property Index. Much of this success is due to the reputation of the UK's specialist patent judges, the report goes on to add.

With its patent-friendly environment, and a now fully operational Patent Box, private equity and venture capital firms would be wise to scour their portfolios in search of existing patents or patentable technologies to ensure they are making the most of this new value-creation tool.

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• UK / Ireland
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• United Kingdom
• Ernst & Young