Patents & tax reliefs – game changing growth opportunities for innovative companies

Patent Box Tax Relief 

Patent Box Relief (PBR) allows companies chargeable to UK corporation tax, that have undertaken qualifying development work, to benefit from an effective 10% tax rate on profits derived from patented technology or processes, compared to the standard corporation tax rate of 25%. This can result in significant tax savings, increasing capital for reinvestment, business expansion, or further research and development, for example. 

There are two usual mechanisms of claiming PBR:

1. Product Sale or Licensing Income – The PBR scheme is generous, as sales or licensing income generated from an overarching product or solution can be qualifying income for PBR, even if the patent only covers a small but integral part.  This relevant IP income is then subject to tax adjustments before arriving at the Relevant IP Profit, which is then charged to corporation tax at an effective 10% tax rate.
2. Notional Royalty Regime - Profits generated due to the use of patented inventions or processes that improve efficiency, productivity or output.  This method calculates a hypothetical royalty that an unconnected company would have to pay to exclusively license the patented solution. 

To qualify for PBR, a company must meet several conditions:

• The company claiming PBR must own or exclusively license the patent right.
• The claimant company, or in some cases another group company, must have undertaken qualifying development work in connection with the patent right.
• The company must elect into the PBR scheme.
• The company must have generated profits attributable to the IP income.
• The ‘Nexus’ or ‘R&D’ fraction must be positive.

The Nexus fraction is a key component in assessing the portion of profits eligible for the reduced tax rate. This element of the PBR calculations produces a percentage based on Qualifying R&D Expenditure plus 30%, divided by Total R&D Expenditure.

• Qualifying R&D Expenditure includes R&D costs directly incurred by the company in developing the patented solution or invention, including externally provided worker and unconnected subcontractor costs.
• Total R&D Expenditure includes the Qualifying R&D Expenditure (as above) but in addition, connected R&D subcontractor and qualifying IP right acquisition costs.

A positive Nexus fraction (i.e. a percentage above 0) indicates the company has materially contributed to the development of the patented invention or solution, aligning the tax relief with genuine innovation. The Nexus fraction cannot exceed 1.

Due to the complexity of the PBR scheme and the importance of structuring IP ownership and development activities and costs correctly, obtaining expert tax planning advice early in the development process is essential. Seeking the advice early in the patenting process is also a better idea than waiting for a patent application to grant.

Research & Development Relief           

R&D Tax Relief is a corporation tax relief available to companies undertaking qualifying R&D work aimed at significantly advancing science or technology.  R&D work will usually be the prequel to companies applying for patents. Innovative efforts across different industries may qualify.

To qualify for R&D Tax Relief: 

• A project must have sought to achieve a scientific or technological advance. This is an advance deemed by a competent professional in the relevant field as being significant in nature, when compared to the existing state of knowledge. It is important to note the project does not have to be successful, so R&D relief can often be claimed where no new solution has been achieved.
• There must have been scientific or technological uncertainty to overcome during the project. The uncertainty must be significant in nature and not minor or routine, in the opinion of a competent professional in the relevant field.
• The knowledge to achieve the advance could not have been acquired from a competent professional in the field or have been available in the public domain, at commencement of the project. Again, it’s important to note that if an advanced solution has previously been developed but the knowledge of how to achieve that solution is not available in the public domain, as it’s a trade secret for example, R&D relief may be able to be claimed for work attempting to recreate that solution, often using a different method.

The R&D schemes are complex and there are currently five different schemes in effect, each with their own criteria to navigate.  Structuring R&D activities and projects to enable R&D relief can be crucial for businesses, as the R&D relief can reduce the effective cost of undertaking the development work, thus derisking the project. 

In addition, qualifying for R&D relief provides evidence of the ‘development condition’ for the Patent Box scheme being met, and patent applications may provide evidence of qualifying R&D work, so submitting R&D claims and patent applications can be mutually beneficial for both of these highly valuable tax reliefs. 

With HMRC increasing its scrutiny of R&D claims, it is more important than ever that claimant companies develop their R&D strategy to capture evidence to support their claim and liaise with trusted and experienced advisors to navigate the nuances and complexities of the schemes. 

Seed (SEIS) & Enterprise Investment Scheme (EIS) Tax Relief

The SEIS and EIS schemes offer generous tax relief to individual investors in qualifying early-stage companies, reducing the effective cost and derisking the investment, so making the investment in these companies more attractive to investors. 

Tax benefits can include Income tax, Capital gains tax and/or Inheritance tax relief, depending on the investors’ tax position and individual circumstances. 

Not all companies can qualify for SEIS or EIS relief, as a company must meet the ‘Risk to Capital’ condition, amongst others, to potentially qualify. Innovative companies undertaking R&D activities will normally meet this condition, as by definition, R&D is risky as there can be no known solution at commencement of an R&D project, for a company to qualify for R&D relief. 

For innovative companies who are attempting to grow the business and achieve success by creating Intellectual Property, the tax relief benefits under the EIS scheme can be further enhanced, as the age of a qualifying company can be extended in some cases to more than 10 years, from the standard qualifying company age of 7 years.  This means investors may be able to benefit from investments in more established and less risky companies, whilst still being able to obtain significant tax relief across different tax areas.

For early-stage companies requiring cash and funding to develop, expand and grow, the SEIS and EIS schemes can be monumental, and can mean the difference between a company failing or becoming extremely successful. 

Concluding remarks

In many cases, companies can benefit from multiple innovative company tax reliefs, as Patent Box, R&D, SEIS and EIS relief, are not mutually exclusive. In fact, they often interlink. Qualifying for one can pave the way for others, amplifying the financial and strategic advantages and benefits. Conversely, missing out on one, may limit access to others.

Early-stage planning is critical. Structuring development activities, IP ownership, and investment strategies, with the aforementioned tax reliefs in mind, can unlock powerful growth opportunities and long-term competitive advantages, which can be game changing for qualifying businesses.