Bolstering UK Pharma with a Patent Box

Pharmaceutical Technology Europe

Pharmaceutical Technology Europe, Pharmaceutical Technology Europe-06-01-2012, Volume 24, Issue 6

Nick Beckett from the UK law firm CMS Cameron McKenna explains how the UK government's proposed Patent Box legislation may impact the pharmaceutical sector.

What is at stake in the proposed Patent Box legislation that has been unveiled in the UK?

Currently, companies in the UK must pay a corporate tax of 25% on taxable profits. The UK's new Patent Box legislation, however, will reduce the tax on patent profits to 10%. Although the government is still consulting on the finer details of the legislation, this change will give companies the chance to evaluate how best to apply the new tax rate to all profits attributable to qualifying patents, whether these are paid separately as royalties or embedded in the price of products.

Nick Beckett

The new tax regime will take effect in April 2013 and aims to encourage innovation across all high-growth industries in the UK, including the pharmaceutical industry, that rely heavily on cutting-edge research and development. It should provide an incentive for companies to retain and commercialise existing UK patents by making the UK more competitive with foreign regimes that already offer similar tax reliefs.

Unlike other tax regimes elsewhere in Europe, such as in Ireland, Switzerland and Luxembourg, the UK system will not apply to copyright or brands because the UK government does not consider these forms of intellectual property (IP) to be strongly linked to the high-growth, R&D heavy activities that it wishes to encourage. Companies will need to analyse the pros and cons of all of the available tax relief schemes in Europe to identify the best geographical location for their patents to be held.

It is not only UK companies that can benefit from the Patent Box—the legislation applies to patents granted not only by the UK's Intellectual Property Office, but also by the European Patent Office and some other EU national patent offices that have similar patentability criteria to the UK. Again, the government hopes that more international pharmaceutical companies will commercialise their patents in the UK to take advantage of the tax relief.

Why does the UK need a Patent Box?

The new legislation will encourage UK competition with other European countries, some of which have had similar tax-reduction systems in place for years. Previously, patent-rich UK businesses faced a higher overall effective tax rate compared with similar companies abroad, resulting in the emigration of intellectual property and its exploitation overseas rather than in the UK. Luxembourg, for instance, has had a Patent Box in place since 2008 that exempts 80% of royalties, damages and capital gains realised on certain intellectual property rights, creating an effective tax rate of around 5%, while Belgium offers a maximum effective tax rate of 6.8%.

Whilst the UK's existing system of R&D tax credits, which offers a tax deduction based on R&D spending in the UK, has provided relief for certain expenditure, there is no similar incentive for businesses to retain intellectual property in the UK once it has been created. At a time when low R&D productivity is a major challenge for the entire global pharmaceutical industry, the UK government hopes that the Patent Box will reestablish the country as a leader in patented technologies.

How effective is the Patent Box likely to be?

Although the tax relief will be welcomed, it may not be enough to help life-sciences companies in the UK. Even once the regime is in place, the UK's overall effective tax rate of 10% will still be higher than those of other European countries, such as Belgium and Luxembourg. In addition, the legislation will not apply to patents granted to UK companies in other major R&D centres, such as the US and Japan. What's more, because the scheme will be phased in over time, the full effect of the relief will not come into play until the financial year 2017–2018.

There are also anomalies in the legislation. In particular, for many companies, the Patent Box will not necessarily provide an optimal tax position because it is a 'one size fits all' model that has been designed to accommodate all sectors and industries in the UK.

In the pharmaceutical technology, patents are business critical and can be numerous. For medical devices, for example, there can be thousands of components that each have their own patent, but the number of patents embedded in a product is not directly taken into account when calculating Patent Box tax relief. In fact, without careful internal legal and tax controls, implementation of the Patent Box could be an extremely convoluted exercise as the calculations of tax relief become increasingly complicated. In Luxembourg, by contrast, tax relief is much easier to compute by applying a deduction from net positive intellectual property income.

The global pharma industry landscape is undergoing substantial change. E-health and medical devices are particularly huge areas of growth and development that require a convergence of technology with traditional pharma. Medical devices often gain market share based not on attractive design and brands, but on software, user interface and other functionality that are not necessarily protected by patents. Countries like Luxembourg that permit the inclusion of such nonpatent IP may therefore prove more attractive to companies planning for the long-term.

How can pharmaceutical technology companies maximise profits under the new tax regime?

To maximise the effect of the new tax regime, pharmaceutical technology companies— particularly those with international footprint or sales and those that have a choice of location for the development and commercialisation of intellectual property—will need to develop more sophisticated tax and transfer pricing structures. And they need to act now. It can take months to implement new structures, particularly as board-level decisions and legal input may be required. With the new legislation coming into force on April 1, 2013, little more than a year away, this should be a high priority for pharmaceutical executives in 2012.

Nick Bennett CMS Cameron McKenna