Legal Aspects. Tax Relief for Innovative Businesses Andrew Wilson and Michelle Andrews

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1 Tax Relief for Innovative Businesses Andrew Wilson and Michelle Andrews Biography Andrew is a Chartered Accountant and Chartered Tax Adviser and leads Magma s Corporate Tax team. He has extensive experience of advising large corporate and owner managed businesses on a wide range of corporate tax issues. Andrew has been a member of both the HMRC National Working Together Committee and ACCA Global Tax Forum, but is now fully devoted to clients affairs. Andrew Wilson Partner Magma Michelle Andrews is a Chartered Accountant with over a decade of experience in working with small companies through to major listed companies. Michelle has strong technical knowledge in all areas of Corporate and Business Tax, with experience including International Tax, company reconstructions and reorganisations, transactional work and research incentives. Michelle Andrews Senior Tax Manager Magma Keywords Taxation, Tax incentives, Tax relief, Research & Development, Patent Box Paper type Opinion Abstract With the UK economy having grown faster than any major advanced economy in the world last year, the Government will no doubt be quick to attribute this performance to its strategy for economic growth and tax reform. In this article, we look at two particular UK tax incentives available to innovative businesses. Introduction A major component of the strategy, to attract innovative companies to develop and exploit intellectual property within the UK, manifests itself through the tax system via two key company tax reliefs: Research and Development (R&D) tax relief; and Patent Box. Credit Control 1

2 Whilst there is a clear policy objective for these reliefs to attract multinationals, who are naturally adept at exploiting Government incentives, the benefits on offer to UK Small and Medium Enterprises (SME s) 1 are also significant. But are SME s really taking full advantage of this opportunity? R&D tax relief enhancements The most recent figures released by HM Revenue and Customers (HMRC) showed a 30% increase in the number of R&D claims made, taking the annual cost to the Exchequer to 600 million. Incremental improvements to the generosity of the regime have played their part in augmenting SME participation. Noteworthy historical enhancements have been: An increase in the rate of tax relief to 225% from 1 April 2012; equating to 45p of tax relief for every 1 of eligible R&D; Enabling R&D credits of almost 25p per 1 of eligible spend to be repaid in cash to companies, even where no corporate tax, PAYE or National Insurance has been paid over to HMRC; Elimination of the 10,000 minimum spend threshold to encourage smaller claims. These features are to be further augmented by the following enhancements announced in the Chancellor s December statement: From Autumn 2015, a voluntary advance assurance procedure to obtain HMRC approval for SME s making their first claims: (i) (ii) An increase in the rate of tax relief to 230% from 1 April 2015, equating to 46p of tax relief for every 1 of eligible R&D. An increase in the cash repayment rate from 25p to over 33p. Common misconceptions Notwithstanding recent and impending improvements, a decade of regular tinkering with the eligibility criteria by successive governments has left a legacy of common misconceptions, which continue to hamper SME s from pursing valid claims. Perhaps most commonly, SME s discount their eligibility as they assume that the relief is only available for ground breaking scientific research. In reality the scope of the relief is far more bountiful. Claims typically involve enhancements to existing products or processes to make them smaller, lighter, faster or more 2 Credit Control

3 environmentally friendly. A further misconception is that the R&D has to be successful to qualify. On the contrary, project failure usually provides better evidence of eligible R&D than success. Use of the forthcoming advance approval procedure should provide SME s with early reassurance as to their eligibility. Industry focus No specific boundaries exist on which industries are able to benefit from R&D relief. It is the nature of the R&D activities themselves which define eligibility. Recent HMRC statistics show that manufacturing companies led the way with 32% of claims. Companies within this sector who have yet to consider claims should review their position with the opening mind-set that they are likely to be undertaking some qualifying activities. The information and communications industries account for 26% of claims. Notably, this sector covers the development of software and integration of software systems; areas where we have seen HMRC become increasingly sympathetic to claims in recent years. SME s within this sector should therefore review their activities for potentially eligibility. The widely drawn professional scientific and technical sector takes the bronze medal in HMRC s league table. Whilst the scientific and technical categories lend themselves most naturally to the stereotype of R&D, the contribution from professionals to the R&D process, such as architects and designers is a potential further source of R&D which may often be overlooked. With the average size of a SME claim being worth over 20,000 and boundaries of the relief being far wider than generally perceived, companies which have historically not made claims should reassess their eligibility for R&D relief, particularly those in the manufacturing and IT sectors. Patent Box In contrast to R&D relief, the Patent Box is in its infancy, having only been introduced on 1 April Whilst this has meant it has not suffered from the misconceptions which have grown up around the R&D regime, it has yet to gain traction with SMEs. Time is of the essence with their relief, as following opposition from other EU member states that the UK parent box provides too generous a relief, it is to be closed to new entrants in June Thereafter it is anticipated that a less generous EU wide patent regime may be introduced. What is the Patent Box? The Patent Box regime enables companies to benefit from a lower UK corporation tax rate on worldwide profits generated from their patented inventions. Credit Control 3

4 How does Patent Box interact with R&D? The Patent Box is complementary to the R&D relief. Indeed, it is anticipated that many companies eligible for the Patent Box will also be undertaking qualifying R&D activity. Who can benefit? To benefit a company must: Hold an eligible patent (or an exclusive license to such a patent); and Undertake qualifying development work on them. Eligible patents are those which have been granted by: The UK Intellectual Property Office; The European Patent Office; or Certain other specific countries within the European Economic Area. A company will undertake qualifying development in relation to the patent where it makes a significant contribution to either: (a) (b) The creation or development of the patented invention; or A product incorporating the patented invention. What is the benefit? A lower corporation tax rate on Patent Box profits is being phased in from 1 April Starting at 14% for small companies, the rate graduates down 1% annually, reaching 10% in 1 April This rate represents a significant saving over the 20% corporation tax rate applicable to UK companies from 1 April The Patent Box regime covers worldwide income arising from: Product sales which incorporate the exploitation of qualifying patents; Licence fees and royalties from a right granted over a patent; and Proceeds from the disposal of a patent or exclusive licence. 4 Credit Control

5 The lower patent box tax rates apply to specified profits derived from these income sources. What should companies do to realise the benefits? Many companies are now due to file their first tax returns which can include a patent box claims. Companies must elect into the regime to benefit and should take action now to: Establish the potential Patent Box savings available; Determine the most beneficial claim methodology when computing claims; and Assess whether the Patent Box provides sufficient incentive to file new patent applications. Conclusions Whilst impossible to assess just how much of the UK s economic revival is underpinned by the Government s R&D and patent box reliefs, recent enhancements to the R&D regime can only be said to have supported SME s. Those SME s who have yet to make claims should take a fresh look at their eligibility and may be pleasantly surprised with the outcome. The Patent Box has potential to be an equally generous relief. SME s with existing patents should ensure they are now submitting claims and those companies which have potential to obtain patents should consider their strategy for doing so, factoring in the tax benefits. Reference 1 For R&D purposes an SEM is a company with fewer than 500 employees and either annual turnover not exceeding 500 million or a balance sheet not exceeding 43 million. Credit Control 5

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