Companies often use Patent Box in order to save on tax. However, many times they can face a situation, where they receive income from qualifying intellectual property rights (QIPRs), but this income does not qualify as Relevant IP Income (RIPI) for the Patent Box.
This can be the case, for example, if the company receives income from a product, which itself is not patented, but the company developed (and patented) the process which is required to manufacture the product. A part of the income generated from such products can be treated as notional royalty (CTA 2010 s.357D). This does not apply automatically, but an election is needed (CTA 2010, s 357CD (3)).
Once the election is made an “appropriate percentage” of the income derived from the qualifying intellectual property will be treated as RIPI.
The problem with this “appropriate percentage” is that it has to be determined on an arm’s length basis and therefore it needs to be in line with Article 9 of the OECD Model Tax Convention and the OECD Transfer Pricing Guidelines (CTA 2010, s 357CD (8)). This means that the level of the notional royalty will be based on how much royalty the company would be willing to pay to an independent third party for the exclusive use of these intellectual rights.
357CD applies only to patents: it is not thought that qualifying data exclusivity and plant variety rights will be used in a way that generates income that is not RIPI. (Technical Note 29 March 2012, para 3.57)
The nature of the notional counterparty to the transaction is not prescribed. This is because
the notional royalty is intended to capture the full economic value of the patent to the business. (para 3.60)
The notional royalty should therefore be the full amount that the company would be willing to pay to be able to use the patent in an arm’s length situation. The company is not required to determine the price at which any particular counterparty would be willing to sell, and consideration of the relative bargaining positions of the two parties is not required. However, all other provisions of the OECD guidelines, including for example the circumstances of the company and the need to have regard to other options realistically available, should be considered in determining the level of the notional royalty. (para 3.61)
Some assumptions must be made in calculating this amount, to specify certain circumstances which would affect the level of royalty payable at arm’s length. These assumptions are set out in 357CD (6): (para 3.62)
To be continued…
Josef, Consultant, Leyton UK