UK: consultation on IP tax reform published

HM Treasury have published the consultation document on IP tax reform, including R&D tax credits – quick thoughts below the cut, more details when I get back from the US next week.

There are some interesting points around the proposal that the patent box will cover “embedded” royalties in the profits from products manufactured using patents.  How the Govt proposes to define those is a good question – they are suggesting using a formula, but that seems to have the potential to be riddled with problems.
The patent box will also apply to net profits, after expenses (so that these, in effect, get relief at 10% and not 28%/24%)- including “pre-commercialisation expenses” but not, apparently, including R&D tax relief qualifying expenses (as there’s a commitment to retaining full rate relief there) which seem to remain deductible from regular rate profits rather than patent profits.  How this is all supposed to work is a bit of a mystery – businesses wanting the patent box rate are going to have to keep very detailed records if they want to ensure that they get full rate relief for certain expenses.  I’m not surprised that the patent box will be optional – the cost of compliance is not going to be cheap, as far as I can see.
The Govt has speeded up access to the patent box – it only applies to profits earned after 1 April 2013, but the proposal is that it wiull apply to patents commercialised (another definition nightmare) after today (Nov 29th) rather than patents granted after Royal Assent 2011 (the original proposal).
The focus is very much on patents – they are registrable and clear (copyright/trademarks etc are more nebulous and easier to acquire) – so this will be rather limited by comparison to (eg) Luxembourg and the Netherlands.  Interesting, given that the UK has a good film/sound recording/video game industry.  We are already well ahead with pharmaceuticals, which seems to be one of the main beneficiaries of this approach.  It’s questionable whether encouraging specialisation like this is all that helpful.
There will be the usual anti-avoidance – the patent box seems unlikely to apply to passive IP holding structures.  This may be tied to a requirement to have ongoing R&D, for example, or manufacturing activities.
Otherwise it all seems a bit early stages to tell.  Vaccine research relief may be for the chop – only 10 companies a year claim it (presumably the same 10 each year).
R&D tax relief does not seem to be for the chop, though – that had been rumoured to be in the firing line, but there is a statement that the Govt “is committed to retained full rate relief – not just patent box rate relief – for the additional deduction available from the R&D tax credit regime”.  There are requests for ideas for structural changes to make the scheme more attractive (without, presumably, costing anything).
On CFCs and IP, the idea to introduce an earn-out charge on exports of IP has – thankfully – been dropped.  The CFC rules appear to be focussing on what the Govt considers to be three high-risk areas:
1. IP developed in the UK and then transferred to a low-tax jurisdiction
2. IP held offshore but actively managed in the UK (or further developed in the UK)
3. IP developed with UK funds, where the UK doesn’t get a return on the investment
#2 seems to be the most contentious aspect of this: where UK activity increases the value of IP held overseas.  There could be transaction scenarios where this may be an issue, which are not an attempt to divert profits overseas.
There’s also whiff of retrospection about the idea that IP affected by changes to the CFC rules could include IP that has been transferred out of the UK in the past decade.

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