Out-Law News 2 min. read

UK proposes ending its patent box scheme after agreement with Germany

The UK has agreed to put forward a proposal to  close its patent box tax break, which allows income from the commercial exploitation of intellectual property (IP) to be taxed at 10%, in a concession to German concerns about artificial shifting of profits between European countries.

If the proposal is agreed by the OECD Forum on Harmful Tax Practices, the patent box will close to new entrants in June 2016 and will stop operating in June 2021. An agreement between the UK and Germany (2-page / 393KB PDF) mentions a "transition to new regimes" but does not give details of any replacement for the patent box.

The UK government has been seen as a promoter of attempts through the Organisation for Economic Cooperation and Development (OECD) to stop companies from shifting profits to countries with beneficial tax regimes, but the UK has had to defend the patent box scheme against accusations that it allows this kind of profit shifting.

Countries in the OECD and the G20 group of nations with developed economies have been working on base erosion and profit shifting (BEPS) to ensure that multinational companies are taxed in the jurisdiction in which their business activities take place. They have established proposed new rules based on what they call a 'modified nexus approach', which is designed to ensure that economic activity that actually takes place within the country that grants the research and development (R&D) tax break.

"[The UK and German proposal] aims to resolve the concerns countries have expressed about some features of the Modified Nexus Approach, and identify what further work is required in order to enable agreement to be reached on this issue during 2015," said the agreement. "Concerns have been expressed about how to calculate qualifying R&D expenditure, transitional arrangements between regimes and time allowed for this through grandfathering provisions, and the tracking and tracing methodology for R&D expenditure that will determine whether it qualifies."

“The UK appears to have given in to German pressure to limit – or even abolish – its patent box regime," said tax expert Heather Self of Pinsent Masons, the law firm behind Out-Law.com. "Given that the regime is being phased in over four years to 2017, it will have a relatively short life – particularly given how long the development process is for major pharmaceutical products in particular.”

“We are beginning to see the early signs of inter-country tradeoffs in relation to the BEPS project. Germany also chairs the working group on Action 4 in relation to interest deductibility and we must hope that the UK will not make similar concessions on its tax regime for interest.”

Self said that rules requiring a link to R&D work performed in the UK in order to qualify for new patent box treatment could be difficult to align with EU requirements for freedom of establishment. “The UK has been defeated on this issue in other areas, such as the CFC rules, in the past, so needs to ensure that its new rules comply from day one – having to make further changes in future would not be welcome," she said

Commercial secretary to the Treasury David Gauke has previously said that the patent box was having an impact on investment in the life sciences and pharmaceutical industries in the UK.

"GlaxoSmithKline has attributed to the patent box its additional investment of £500 million in manufacturing in the UK, along with the creation of 1,000 new jobs and the construction of a new factory," he said. "The UK economy will see a positive effect as a result of that."

The patent box regime came into force on 1 April 2013 and by 2017 allows a 10% rate of corporation tax to be applied profits earned from patented innovations and certain other IP rights.

The European Commission is currently looking into the patent box as part of an assessment of whether various tax regimes applicable to IP in the EU comply with EU rules on state aid. The state aid regime is intended to prevent the distortion of competition that could occur if national companies grant advantages or incentives to particular companies. 

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