What is the Patent Box and could my company benefit?

What the relief actually does

The legislation contains no separate 10% rate of corporation tax. The Patent Box works by giving you an extra deduction in your corporation tax computation, so what remains is taxed at 10%.

The calculation set out below — the one built round the R&D fraction — applies to accounting periods beginning on or after 1 July 2021 for everyone, and from 1 July 2016 for companies that first elected on or after that date. An older calculation applied before then, and the relief itself has been available since 1 April 2013.

The deduction is your relevant IP profits multiplied by the difference between the corporation tax rate that applies to you and 10%, divided by that same rate. For a company paying the 25% main rate that applies for financial years from 1 April 2023, the deduction is 60% of relevant IP profits: the remaining 40%, taxed at 25%, comes to 10% of the original figure.

That mechanism has a consequence worth understanding before you spend money chasing the relief. The effective rate is 10% whether you pay the main rate or the small profits rate — but the saving is not the same. A main-rate company saves 15 pence in the pound on qualifying profit. A company paying the 19% small profits rate saves nine. The relief is worth appreciably more to a profitable company than to a small one, which is part of why HMRC’s own figures show 1,650 companies electing into the Patent Box in the financial year 2023 to 2024, of which the 28% classed as large took 95% of the £1,977 million of relief given.

Can your company elect?

You need to be a qualifying company, which means three things have to hold.

You hold the right, or an exclusive licence over it. Either you own a qualifying IP right, or you hold an exclusive licence in respect of one. An exclusive licence has to give you rights to the exclusion of everyone else, including the owner, in at least one territory.

The right is one the rules recognise. Patents granted by the UK Intellectual Property Office, the European Patent Office, and the national offices of certain EEA states qualify, as do some plant variety and medicinal protection rights. A patent granted only in the United States does not, however commercially important it is. This catches people out more than any other condition.

Your company, or its group, developed the invention. This is the development condition, and it asks whether you carried out qualifying development in relation to the right — creating or significantly contributing to the invention, or developing a way of using or applying it. If another company in your group did the development, that can satisfy the condition for you, but if you are a member of a group you also have to meet a separate active ownership condition: you must do more with the portfolio than just hold it.

The relief is not on all the profit from a patented product

This is the point that most often separates the expected benefit from the actual one. Relevant IP profits are calculated through an eight-step process, and three of those steps reduce profit.

First, your income is split into relevant IP income and everything else, and the relevant IP income is then divided into sub-streams. Relevant IP income covers sales of the patented item and of products incorporating it, licence fees, proceeds of sale of the right itself, and damages or compensation for infringement — but not, for instance, income from selling a service alongside it.

Then the costs attributable to each sub-stream are deducted, together with a routine return figure: a notional return the rules assume any business would make from its functions and assets without any IP at all, calculated as 10% of certain routine deductions. This strips out the ordinary trading margin, leaving the excess.

Then a marketing assets return figure comes off, representing the part of what remains that is attributable to your brand rather than the patented technology.

What survives those two deductions is the qualifying residual profit, and only then is the R&D fraction applied.

Where a company has one trade and its qualifying residual profit does not exceed £1 million — or, on a repeat basis and subject to conditions, a lower figure worked out by dividing £3 million between it and its associated companies — it can elect for small claims treatment, which replaces parts of that calculation with simplified figures. If the whole exercise looks disproportionate to the sums involved, look at this provision before abandoning it.

The R&D fraction: where this connects to your R&D claim

The final step multiplies each sub-stream by an R&D fraction, and this is the part of the Patent Box that ought to interest anyone already making R&D tax relief claims.

The fraction takes your qualifying expenditure on the relevant research and development and asks how much of it you actually did, or paid an unconnected party to do. In-house expenditure and expenditure subcontracted to unconnected persons go in the numerator, uplifted by 30%. Expenditure subcontracted to connected persons, and expenditure on acquiring the IP right itself, go only in the denominator. The fraction is capped at 1, so the 30% uplift is a genuine tolerance rather than a bonus — HMRC’s own guidance puts it plainly: “in effect up to 30% of R&D expenditure can be outsourced to a connected company, or on acquisition costs, without any reduction in the fraction.”

Two features of that calculation matter in practice. It is cumulative, measured over a relevant period that can run back up to 20 years, so decisions about where research sits still affect the fraction long afterwards. And it is exactly the same expenditure that your R&D relief claim is built from, which means the way a group organises contracted-out R&D has consequences in two different reliefs at once — and they point the same way. Work done by the company that will hold the patent is worth more in both.

Claiming both reliefs

The two reliefs are not alternatives, and electing into one does not compromise the other. R&D relief works on the spending side, reducing taxable profit in the years the research is done; the Patent Box works on the income side, reducing the rate on the profits that research eventually produces. Most companies with a Patent Box claim have an R&D claim as well — the architecture of the R&D fraction assumes as much.

They interact in the computation rather than competing. R&D expenditure is expressly excluded from the routine deductions used to work out the routine return figure, on the basis, in HMRC’s words, that such expenses “are likely to have a direct correlation to the creation and development of qualifying IP” — so R&D spending does not inflate the routine return that gets stripped out of your Patent Box profit. Research and development allowances and patent allowances are excluded from routine deductions for the same reason.

Timing, and the two deadlines that catch people

The election. You elect in your company tax return computations or by separate notice in writing, and it must be made within two years after the end of the accounting period it is to apply to. It then continues for subsequent periods until you revoke it.

Revoking is expensive. A revocation takes effect from the period you specify and every period after it, and having revoked, you cannot elect back in for any accounting period beginning within five years of the end of the period you specified. A decision taken to avoid an administrative burden in one lean year can cost five.

Patents pending. Where a patent takes years to grant, the rules let you bring in, in the period of grant, the additional profit you would have had if the right had been granted earlier — looking back up to six years from the date of grant. But that only works for accounting periods in which you were a qualifying company and an election was already in force. The practical consequence is that if you file an application and have not elected, every year you wait is a year of that six you cannot recover.