Tax Reliefs That Work: Research & Development Tax Credits and the Patent Box regime

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1 Tax Reliefs That Work: Research & Development Tax Credits and the Patent Box regime

2 Encouraging UK innovation Introduction The Research and Development (R&D) tax relief scheme and the Patent Box are key parts of the Government s strategy to raise overall levels of R&D and to improve long term productivity growth rates in the UK. UK SMEs claim around 1billion of R&D relief each year from HMRC. R&D relief is a familiar part of the UK s corporation tax system and provides relief for eligible spend in different ways depending on the size of the business. The new Patent Box regime introduces an effective corporation tax rate of 10% on qualifying profits. Both reliefs are designed to work together to stimulate innovation and investment in the UK. No dilution of benefits occurs if both schemes apply. R&D relief What is R&D? R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology, resulting in advancement in the industry s overall knowledge or capabilities (not pertaining to only one company). This includes adaptations from other fields of science or technology. Eligible costs include staff salaries, national insurance contributions and pension costs, testing costs, overheads, such as heat and light, and also some subcontracted costs. Level of relief Relief can be given as a deduction against profits, or if a business is loss making, this can take the form of a useful cash refund. For example: An SME, spending 100,000 of its own money on qualifying R&D, would be able to offset 225% of the cost against its profits. This results in a tax deduction of 225,000, saving additional tax of 25,000 A loss-making SME, spending 100,000 on eligible costs, would receive up to 32,625 as an R&D tax credit In the case of R&D relief, the term SME covers a large number of companies, including many that you might assume to be large businesses. If your company has fewer than 500 employees and either an annual turnover not exceeding Euros 100million or balance sheet not exceeding Euros 86million, it will qualify for a more beneficial SME regime. For large companies, relief is either given at 130% of qualifying revenue spend or at the (marginally better) above-the-line credit rate of 10%. Both schemes run concurrently until 2016, when the credit scheme becomes compulsory. If your company also incurs capital expenditure through an R&D project, you may also be able to claim R&D capital allowances. If your company receives any subsidy or grant for the R&D project that might be deemed State Aid by the European Commission, the project will only be ineligible under the SME scheme. Any other subsidy or grant is deducted from the eligible expenditure.

3 Review of accounting systems When it comes to making claims under R&D and Patent Box, it s essential that accounting information is gathered both for historic qualifying income and costs and future projects. To calculate the Patent Box super deduction all profits from patents and intellectual property (IP) need to be identified using very specific methods, so we may need to review and adjust your accounting systems. Review of income streams Relevant IP income falls under five main categories: 1. Income from the sale of items protected by qualifying IP rights. This includes the sale of larger products incorporating smaller patented items. 2. Income from a licence of a relevant IP right. This includes any licence fee or royalty income. 3. Income from the sale of a relevant IP right. 4. Damages received for the infringement of relevant IP. 5. Notional royalties included in rental income from patented products or products manufactured using a patented process. The calculation of notional royalties is an inexact science and may require negotiation with HMRC. We have been working with HMRC to explore how this will work in practice. Review of IP expenditure Although the legislation provides a simplified method for analysing costs, all relevant costs need to be carefully captured for new claimants so that we can apply the streaming method explained above. This helps us to identify the best way of calculating the super deduction. If the streaming method is more beneficial, the accounting systems can be configured to extract the relevant costs, and then the routine costs from which a notional return is calculated. The routine costs fall into 5 categories: Premises costs Personnel costs Plant and machinery costs Professional costs Other relevant costs: this includes costs for computing, telecommunication and postal services Finally, companies with valuable brands or marketing operations may have to calculate a marketing return figure. This figure strips out the income attributed to a brand, reducing the amount of profit that can be taxed at the beneficial Patent Box rate. We are working with HMRC to protect small and medium sized companies from the impact of this adjustment.

4 R&D and Patent Box tax reliefs: how they interact The following examples show how the Patent Box regime interacts with the large company R&D reliefs. Profit and loss accounts No Claim 000 Small Super Deduction Claim 000 Large Above The Line Tax Credit Claim 000 Large Turnover 2,300 2,300 2,300 R&D Expenses (2,000) (2,000) (2,000) Patent box profits 1,000 1,000 1,000 Profits before ATL credit 1,300 1,300 1,300 ATL Credit 200 Profit/(Loss) 1,300 1,300 1,500 Patent Box super deduction 0 (500) (500) R&D super deduction 0 (600) Taxable profits 1, ,000 Tax computations Corporation tax ATL Credit 0 0 (200) Tax payable Rate of corporate tax 20% 20% 20% Effective cash tax rate 20% 3.1% 0% Note: In addition to reducing the tax bill by over 260K in this example, the ATL tax credit is incorporated into reported profits. This is intended to boost the value of research companies.

5 Patent box Patent Box is a complex area of tax, so our expert team works closely with UK-based patent attorneys to offer our clients the right blend of legal and business knowledge. If you re unsure of any area and would like help to see how much your business could save, please get in touch. Saving tax on patents The UK Government established the Patent Box tax incentive scheme to help companies maximise profits on their patents by setting a low tax rate of 10%. We have worked with the HMRC Patent Box team to agree a practical approach to Patent Box calculations for SMEs. Our IP review process described in detail below helps you to gather the right information from day one. Our work on Patent Box tax relief is aligned to R&D reviews, but we also offer this service as a stand-alone project in which we work with your existing advisers. Review of Intellectual Property According to Patent Box rules, not all Intellectual Property will qualify for reduced tax rates, so it s important to review your IP portfolio to check whether there are: 1. Qualifying rights: Does existing intellectual property qualify under the regime and where patents have not been granted, can further applications be made? 2. Qualifying companies: Is your company eligible to claim this benefit? This is particularly relevant to groups of companies, for which special rules apply. It s important to note that, despite the name, the Patent Box regime doesn t just cover patents supplementary protection certificates, plan variety rights and data exclusivity rights can also qualify. You don t even need to own the qualifying intellectual property an exclusive licence may be sufficient. How we can help Our success is based on our approach: we take time to understand your R&D projects and your intellectual property, and we know how HMRC assesses claims. To make a valid claim, you must meet a complex range of conditions. The key issue is the nature of the R&D project and the project boundaries. Although not all activity which a company classes as R&D will meet the criteria for R&D tax relief, our first step will be to work with your development team to establish the scope of your project and decide how we can legitimately maximise your claim. Once we have identified the eligible projects, we will check whether your company qualifies as an SME for R&D tax purposes, consider the other detailed conditions for the claim and finally list the qualifying costs. Claims for R&D relief are handled by specialist R&D units within HMRC, and we deal with these specialist teams on a regular basis. We have also met with the Revenue s senior team responsible for administering R&D tax reliefs across the UK, during which we have raised issues and pushed for improvements in the way the relief is administered. We use this experience to ensure that our clients claims have the best possible chance of success.

6 How do I find out more? If you would like a free assessment of how your business can benefit from R&D tax credits or the Patent Box, please contact either Susie Walker, Head of Tax, or Caroline Muir, Deputy Head of Tax, or one of our specialists listed below. Contact us Susie Walker Head of Tax susie.walker@jcca.co.uk Caroline Muir Deputy Head of Tax caroline.muir@jcca.co.uk

7 Our specialists David Dowell Aberdeen Callum Wilson Aberdeen Simon Burton Fiona Rigg Jennifer Brown Glasgow John McAuslin Glasgow Ian Lewis Inverness

8 Aberdeen Elgin Forfar Fraserburgh Glasgow Huntly Inverness Inverurie Perth Stirling jcca.co.uk Disclaimer: This update has been published for information purposes only. The contents of this document are not a substitute for tax, legal or professional advice. The law may have changed since this document was first published and Disclaimer: whilst all possible While care all possible has been care taken is taken in the in completion the completion of this of document, this document, readers no should responsibility seek tax advice for loss based occasioned upon by any their person own particular acting or circumstances. refraining from action as a result of the information contained herein can be accepted by this firm. Johnston Carmichael is a member firm of the PKF International Limited network of legally independent firms and does not accept any responsibility or liability for the actions or inactions on the part of any other individual member or correspondent firm or firms.