Continuation from our blog post of July 24, 2017
When a company uses Patent Box and elects to bring notional royalty into the calculations, the level of notional royalty needs to be determined on an arm’s length basis. The assumptions, which need to be used, include (para 3.146):
- The company and the notional IP owner are dealing at arm’s length;
- The company have the right to exploit the marketing assets, to the
exclusion of all others including the notional IP owner;
- The right to exploit the marketing assets is conferred at the start of the
accounting period, or if later when the relevant assets were acquired;
- The rights to the assets being notionally considered are the same as in fact exist; and the appropriate percentage figure for the royalty, as a percentage of relevant IP income is determined at
- The start of the accounting period and it will be assumed that it will remain unchanged for the time that the company holds the rights in fact. In other words, as for the notional royalty, the marketing assets royalty is deemed to have an even profile over its life.
The royalty is only calculated based on income that is not itself RIPI, to prevent double-counting. It is not calculated on “excluded income” because no part of this income can qualify for the Patent Box. (para 3.67).
This means that certain types of income which might otherwise qualify as RIPI are excluded. These are (para 3.71):
- Any income arising from oil extraction activities or oil rights (as defined in part 8 of CTA 2010); and income from exploiting non-exclusive licences.
The notional royalty must take the form of a fixed-rate periodic royalty in order to unambiguously match payments under the licence to the accounting periods in which the IP-derived income is generated. The royalty must be calculated as a percentage of the IP-derived income from the patent rights for their remaining life. This precludes any lump-sum upfront or milestone payments, and tiered or front-loaded or back-loaded royalties which could distort the Patent Box calculation in particular years. (para 3.66)
The notional royalty can never be greater than the IP-derived income from which it is calculated. (para 3.68)
Any enquiries by HMRC into the computation and determination of the notional royalty will be subject to the transfer pricing governance process (of HMRC, para 3.69).
It can be seen that the calculation of the notional royalty involves transfer pricing calculations and will also require specialist knowledge in IP valuation. While the whole process might be complex, the tax benefit is often huge.
Josef, Consultant, Leyton UK