Patent reforms box clever

THE GOVERNMENT’S attempts to encourage innovation in the UK has been universally welcomed this week. The general consensus it that its “Patent Box” consultation – which proposes a 10% corporation tax rate for profits made on patented products – did what it promised to with few nasty surprises.

On the same day, and not unrelated, it published reforms to research & development (R&D) tax credits. Exchequer secretary to the Treasury David Gauke has said the point of the proposals is to “make the UK tax regime competitive for innovative high-tech companies” and encourage companies to “locate the high-value jobs associated with the development, manufacture and exploitation of patents in the UK”. But what companies are going to benefit from the reforms? And will they help the government achieve its aims of high value jobs?

The first point is that it is not just attracting jobs that is driving the Patent Box initiative. James Dyson’s report, commissioned by the Conservatives before they came to power, made the argument that the UK is great at coming up with ideas but not at commercialising them. The Patent Box (PB), initiated by the previous Labour government, had set about doing this.

But that was not its only purpose. “Britain has a long and proud history of great inventions and discoveries which have been made in this country,” Gauke said. “But in recent years, too many companies have been choosing to move their patents offshore.” Other countries, such as the Benelux countries, have “special regimes for patent income”.

The proposals have a wider purpose than simply encouraging innovation, however. Multinational companies had threatened to leave the UK because of uncertainty over controlled foreign companies (CFC) legislation and the taxing of intellectual property (IP) held overseas. David Mellor, tax partner at Crowe Clark Whitehill, says the original purpose of the PB was “as a way to retain multinational groups who had IP held in subsidiary companies elsewhere in Europe that might have been caught by the CFC regime”.

The Patent Box forms a double sided coin with the CFC reforms that are being proposed this month – on the one side, the government is allaying multinationals’ fears about how much their overseas profits will be taxed in the UK; on the other, it is telling them that our low tax rate on IP means they will not need to carry out R&D abroad, anyhow.

Their main target is the pharmaceutical companies, which are heavily patent focused. Indeed, Shire had already left the UK as a base and the industry was at the forefront of lobbying the government to introduce incentives for patented products.

This seems to have garnered an immediate pay-off. When the current government announced it was going ahead with the initiative, Glaxosmithkline – the biggest pharmaceutical company – said it would lead to the creation of 1,000 jobs in the UK. It would invest £500m in manufacturing projects, would establish a new £50m UK venture capital fund and new investment with academia on “green chemistry”.

In itself, this would be great news for the economy. But this week’s proposals have given an even greater boost to companies than was originally expected, tax professionals have said. Perhaps the main one was that the government confirmed that “process patents” – that is, those not incorporated in the products but in the industrial processes – would be included using an “arm’s-length” royalty accounting method. This is especially true for oil, gas, mining and farming companies.

But, as Sally Grimwood, tax director at Deloitte, says: “This will even apply to chocolate manufacturers who have created process to put bubbles in chocolate bars.” Indeed, the only sectors that will definitely not benefit are “financial services, leisure industry and pure retailers”.

That is not the only treat within the consultation. BDO tax partner Stephen Herring says, the sale of patents will be included. This is a surprise “as the earlier papers could have been read as only applying to the income generated from the patents”. The biotech sector is one that will benefit from this.
But, as always, there will be losers. Software firms are able to get patents in other jurisdictions but only copyright on their products in the UK. The consultation addresses this without referring to the industry by name. It says the government “does not propose to include other forms of IP such as trademarks or copyright, as these have a weaker or more variable link to high-tech activity and have no parallel process of independent examination which would allow the government to be confident that the resulting product is technologically innovative”.

There are practical considerations, however. The government’s focus on patents is understandable – getting a patent is a rigorous process and it is a tangible proof of innovation. By including copyright, it is potentially leaving itself open to creative industries. As Grimwood says, should the singer Adele be subject to 10% tax rates (however much she would like to be)? Or writers, artists and all the other professions that use copyright?

Not that these are not worthwhile pursuits, but they do not create mass high tech, high value jobs. The same cannot be said of the software industry, however. The consultation seems to suggest that patents will be the defining qualifying attribute.

But this is still in consultation stage and the software companies are likely to make strong recommendations. If the government is firm in its belief that the UK economy must be led by high tech, high value jobs then a failure to make some provision for software will be a black mark. It would not be entirely surprising to see ministers expand the qualifying products to include innovative software in the final legislation.

There will be cost implications, of course. The Treasury has said it is not policy to comment on costings of proposals that it has rejected. The Budget book did estimate the costings of the policy at £900m a year by 2015.

Although a large figure, there does seem to be value in it. The CFC reforms in the Budget were enough to persuade advertising giant WPP to come back to the UK. But, as Accountancy Age reported, this was a paper move. The company said no jobs were transferred to Dublin when it moved and no jobs will be moving to the UK when it moves back to the UK.

These reforms are different. The scale of the GlaxoSmithKline announcement is unlikely to be typical, but focusing on R&D, the government is ensuring that jobs would necessarily follow if and when companies choose the UK as the brainpower is what makes and protects the patent. The wording of the document means that paper moves are almost impossible – it is not enough to simply hold a patent, there must be an element of R&D performed in the UK too.

If the government’s aims are realised – and it looks likely they will be – there is nothing to stop software companies being included, as each pound lost in tax would be made up in the creation of jobs.

The consultation is focused on innovation. The government – and the previous Labour government – should be praised for their innovative thinking inside the box.