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HMRC internal manual

Corporate Intangibles Research and Development Manual

Patent Box: relevant IP profits: relevant IP income: notional royalties : calculation

How to calculate IP derived income

The first step (including in cases where the small claims treatment described in CIRD273100   applies) is to calculate the IP-derived income.    A company may calculate IP-derived income using any just and reasonable method such as:

(i) by considering profits from a previous year before the IP was added to the process; or

(ii) by identifying the profit margin difference between a patented process and a competitor’s unpatented process; or

(iii) by using cost projections for deciding whether it was worth investing in the IP.

Note that the IP derived income may be calculated as a royalty percentage but this should not be confused with the notional royalty referred to in the second step.

How to calculate the notional Royalty

The second step involves calculating the ‘appropriate percentage’ of the derived IP income. This is the notional royalty and this is required to be calculated under Transfer Pricing rules in accordance with S357BHA/S357CD (see  CIRD220260  and  CIRD220270 ).  The legislation allows a small claims election under S357BNA to be made to treat the notional royalty as 75% of the IP-derived income (see  CIRD273100 ) but in all other cases the facts will need to be considered in accordance with OECD transfer pricing principles to reach the appropriate percentage.

Examples are provided at CIRD220252

Streaming note

For new entrants (see CIRD270000 ) or accounting periods beginning on or after 1 July 2021, relevant IP income is separated into streams. The notional royalty calculated according to S357BHA and described above is likely to be treated as the relevant IP income for a process sub-stream in accordance with Step 2(c) of S357BF(2) , the calculation steps shown at CIRD275200 .