Patent Box: streaming: example 3
Streaming can also be useful in situations where a company uses a patented process to produce items that are not in themselves patented or uses qualifying IP to provide a service. In these situations the income arising may not fall within any of the 5 heads of relevant IP income at S357CC (CIRD220150). The company may therefore wish to use S357CD to compute a notional royalty (CIRD220250).
In these cases it may be beneficial to use the streaming provisions to treat the notional royalty as a qualifying income stream, and apportion its expenses between the notional royalty and the balance of its income on a just and reasonable basis.
For example, consider a company that uses qualifying IP to provide armed forces with a service that transforms normal vehicles into specialised vehicles capable of withstanding harsh conditions.
The service costs £20,000 per vehicle. This is its only source of income and in the year to 31 March 2013 its total income is £20 million and its taxable profit is £6 million computed as below:
|Cost of goods||(10,000,000)|
|Other costs (all routine)||(2,000,000)|
|Profit before R&D costs||8,000,000|
The notional royalty computed for access to the qualifying IP used in the process is 10% of the income per vehicle which would give a total notional royalty for the year of £2,000,000.
If the company chooses not to stream its income, its relevant IP income will be £2,000,000 which is 10% of its total gross income of £20 million and its Patent Box computation will be following CIRD220110:
Step 1: Total gross income is 20,000,000
Step 2: £2,000,000 is 10% of £20,000,000
Step 3: Profits of £6,000,000 x 10% = £600,000
Step 4: Apply routine return of 10% to routine deductions of £2,000,000 = £200,000. Then apply the 10% from Step 2 to this. Deduct the resulting £20,000 from the £600,000 to give qualifying residual profit (QRP) of £580,000
Step 5: The company elects for small claims treatment, so its RP is 75% of QRP, or £435,000
The company’s Patent Box tax deduction is therefore £435,000x (22-10)/22 = £237,272
The company’s corporation tax profit is therefore reduced to £5,762,728; and its corporation tax payable is reduced from £1,320,000 to £1,267,800.
However, the company could opt to stream its qualifying and non qualifying income. In this instance the only expenses attributable to the royalty stream would be a proportion of R&D spend plus a proportion of overheads related to that R&D spend.
Assume that 25% of the R&D spend is attributable to pre patent research and 75% to non patent research and further development. 5% of other overheads are attributed to this R&D spend. The income streams are therefore split and the Patent Box calculation is as follows:
|Total||Notional Royalty||Other Income|
|Total Gross Income||20,000,000||2,000,000||18,000,000|
|Cost of Goods||10,000,000||10,000,000|
|Other costs (all routine)||2,000,000||100,000||1,900,000|
|Profit before R&D costs||8,000,000||1,900,000||6,100,000|
Step 1: RIPI is £2,000,000
Step 2: Total debits of £600,000 are allocated against RIPI (£100,000 + £500,000)
Step 3: Deduct debits from RIPI leaving stream profits of £1,400,000
Step 4: Apply routine return of 10% to routine expenses of £100,000 = £10,000. Deduct this £10,000 from the £1,400,000 to give QRP of £1,390,000
Step 5: The marketing asset return figure is nil because the notional royalty is only in respect of qualifying patents.
The company’s Patent Box tax deduction is therefore £1,390,000 x (22-10)/22 = £758,182
The company’s corporation tax profit is therefore reduced to £5,241,818; and its corporation tax payable is reduced from £1,320,000 to £1,153,200.