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HMRC internal manual

Corporate Intangibles Research and Development Manual

Patent Box: relevant IP profits: relevant IP income: notional royalties: transfer pricing principles

CTA10/S357CD and CTA10/s357BHA

The company must hold relevant ‘qualifying IP rights’ which means patent rights within (a), (b) or (c) of S357BB(1) (CIRD210150). Notional royalties cannot be calculated in respect of any other rights to which the legislation applies.

A company may elect that the notional royalty is to be treated as if it were relevant IP income. The notional royalty is the royalty that would be paid to an independent owner of the relevant qualifying IP rights for the company’s exclusive use of those rights to generate the IP-derived income.

The notional royalty is an appropriate percentage of the IP-derived income.

The notional royalty must be calculated in accordance with Article 9 of the July 2010 OECD Model Tax Convention and the OECD’s Transfer Pricing Guidelines, or any successor documents.

In a ‘normal’ transfer pricing case the relevant characteristics of each party to the controlled transaction, and hence their relative bargaining positions, are matters of fact which are sometimes difficult to establish in practice.

The determination of a notional royalty requires that a transacting party be hypothesised. The characteristics of the hypothetical transacting party (termed “P” in the legislation) are not explicitly prescribed. However, the legislation refers to the amount “…which the company would pay another person (“P”) for the right to exploit the relevant [assets]…”

In an arm’s length situation the bargaining range between the parties is determined by the minimum the seller/ licensor is prepared to accept and the maximum that the buyer/ licensee is prepared to pay. The relative bargaining strengths or positions of the parties merely determine where within that range the actual price finally ends up.

The practical effect of the wording of S357CD is to determine the particular point to be at the upper end of that range - that is, towards the maximum the company would be prepared to pay.

The notional royalty is for the right to exploit patents, and does not include amounts payable for any associated IP rights such as know-how, market forecasts, research data that the company holds from which in practice it obtains additional value. On the other hand, it does include IP such as technical detail as is necessary for the company to exploit the patents. The royalty rate takes into account all the qualifying IP rights held by the company. If these function holistically to create added value over and above the value of each individual patent (because the company’s trade exploits the patents as a single interrelated set of rights), then the appropriate royalty is that for the whole portfolio.

This approach prevents the following incorrect outcomes:

  • The aggregate notional royalty is treated as nil or negligible because each patent in isolation has little value even though the combined portfolio is extremely valuable.
  • The aggregate notional royalty is excessive because each patent in isolation is said to have a high value even though the package as a whole has a limited value.