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Out-Law News 2 min. read

UK government quizzed on Patent Box tax break regime

The European Commission has asked the UK government to provide it with information about the Patent Box as part of its assessment of intellectual property (IP) tax regimes in the EU.

The Patent Box allows companies to elect to apply a 10% rate of corporation tax on all profits attributable to qualifying patents, whether paid separately as royalties or embedded in the price of products. Qualifying patents are those granted by the UK's Intellectual Property Office or the European Patent Office. The main rate of corporation tax is 23% at the moment, although this will fall to 21% in April 2014 and then to 20% in April 2015.

The Commission, which confirmed to Out-Law.com reports first published by the Financial Times, is making inquiries in an effort to understand whether the tax advantages on offer comply with EU rules on state aid. The Commission's scrutiny of the Patent Box regime had appeared to have been sidelined late last year, but it now looks to have reignited its interest in it.

State aid is an advantage or incentive granted by a national or local government to commercial companies, and can take a variety of forms including grants, tax reliefs, guarantees, government holdings of all or part of a company or the provision of goods and services on preferential terms. To ensure fair competition across the EU, State aid is generally prohibited unless it can be justified for general economic development reasons.

Member states must apply to the Commission for clearance on a case by case basis before they can offer funding or incentives which amount to State aid, although some types of aid may fall within the General Block Exemption Regulation and there is a de minimis threshold under which aid is automatically exempted from the rules. Member states can be required to recover illegal aid from companies which have received public support in breach of the State aid rules.

"The EU review of the UK's Patent Box regime is part of a wider move to prevent 'harmful' tax practices, which governments fear could lead to a 'race to the bottom'," tax specialist Heather Self of Pinsent Masons, the law firm behind Out-Law.com, said.

"At present the UK government is robustly defending its position, but companies who have claimed Patent Box benefits should be aware that if an incentive is held to be illegal state aid, repayments will have to be made by those companies, and not by the government," Self added.

Last week the UK Treasury called for greater certainty on what can be said to constitute "a harmful tax measure" (45-page / 474KB PDF). One area it has sought clarity on is when businesses can be said to be engaging in 'substantial activity' within a country in order to qualify for preferential tax treatment.

"A better understanding of what constitutes substance is needed so as to effectively address those instances where preferential regimes do present an opportunity to shift profits," the Treasury said in a paper released alongside the Budget 2014. "This will give certainty to the operation of legitimate tax regimes, such as the UK’s Patent Box, which is currently under consideration in the FHTP (The Forum on Harmful on Tax Practices), and the government believes that most of the activities currently qualifying for the UK Patent Box would meet any such substance test." 

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