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HMRC internal manual

Corporate Intangibles Research and Development Manual

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HM Revenue & Customs
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Patent Box: streaming: example 3

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:

  Total £
   
Income 20,000,000
Cost of goods (10,000,000)
Gross profit 10,000,000
Other costs (all routine) (2,000,000)
Profit before R&D costs 8,000,000
R&D costs (2,000,000)
PCTCT 6,000,000

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:

Calculation

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:

    RIPI Non RIPI
       
  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
Gross Profit 10,000,000 2,000,000 8,000,000
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
R&D Costs 2,000,000 500,000 1,500,000
PCTCT 6,000,000 1,400,000 4,600,000

Streaming calculation

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.