R&D Relief moves ‘above the line’

Credit to 123dan321 at sxc.hu

We recently wrote about the proposed Patent Box and the tax deduction against trading profits it allows. But this is only half the story.

Research and development expenditure is itself subject to tax relief, currently in the form of a 225% ‘super-deduction’ for SMEs and a 130% one for larger companies. In other words, companies get a full tax deduction of 100% of qualifying expenses, then further deductions of 125% and 30% for SMEs and large companies respectively. Using the main corporation tax rate for 2012/13 of 25% these equate to payments of 31.25% and 7.5% of expenditure.

Generous though these reliefs are, they have not been particularly effective in spurring R&D in large companies. This, however, may be about to change.

A relief ignored

A report by PWC (premium content) in response to a public consultation has highlighted that the majority of large companies do not take R&D relief into account when making R&D investment decisions. This is despite the fact that the available relief means that the Government effectively subsidises companies to carry out qualifying research and development.

This seemingly strange state of affairs is due to a quirk of accounting. Currently, R&D relief is given as a deduction against corporation tax, so does not feature in companies’ pre-tax accounting figures. Unfortunately, most companies use this pre-tax figure in their investment decisions.

Moving on up

The solution (pdf), announced alongside the draft 2012 Finance Bill, is to move the relief ‘above the line’ in company accounts. Instead of treating the relief solely as a corporation tax deduction, it is proposed that it will be a payable credit and therefore will appear in the pre-tax accounting figures. This also means that loss making companies with no corporation tax liabilities will still benefit from R&D relief, providing greater certainty of its benefits when planning investment.

It is estimated that such a move will cost the Government around £205m but bring benefits of £665m. Whether that is considered to be enough of a payoff in the current climate should become clearer in March when a consultation on the design of the credit will be launched alongside the 2012 Budget.


As announced in the 2012 Budget, the ‘above the line’ credit will be introduced in the 2012 Finance Bill. This has now gone out for a further consultation. Notably this includes a question on whether an above the line credit should be available for SMEs as well.

Newsletter and RSS Feed

RSS Feed for Alvery Business Tax Blog

Liked the article? Then sign up for our monthly round-up of the latest tax news, or click the RSS icon to subscribe to our RSS news feed.

Patent Box – an important new incentive for innovation

After two consultations, the Patent Box has reached a near-final form in the draft 2012 Finance Bill. The Patent Box seeks to identify profits made as a result of ‘qualifying IP’ developed and owned by a company within the charge to UK corporation tax, and then to tax these profits at a reduced rate.

During the consultations, the Government has listened to companies and expanded the regime. The Patent Box has the potential to save innovative companies significant amounts of tax and should be closely examined by all those potentially affected as the scope for the reduced tax rate is greater than may be appreciated at first sight. Although the regime does not apply until 2013 you are urged to think about its application now as it may affect decisions that you are making today.

What is qualifying IP?

Intellectual property obviously incorporates much more than just patents, for example copyright and trademarks. However, the Patent Box is limited to patents issued by the UK IP Office and the European Patent Office, with a few patent-like additions aimed largely at the pharmaceutical sector.

The IP must have been created or developed by the company to qualify for the Patent Box. In order to claim relief for qualifying IP the company must hold the IP or an ‘exclusive licence’ for it in one or more territories. Relief may still be available if the company no longer holds the IP, allowing for deductions from income received from infringements of a patent after it has expired. However, patents must be held for trading purposes, so deductions are not available for passive IP holding companies that sue trading companies for infringements, colloquially known as ‘patent trolls’.

How is the relief calculated?

Effectively a reduced corporation tax rate is applied to the worldwide ‘relevant profits’ attributable to a particular patent or patents. This is done by allowing a deduction from the trading profits for corporation tax purposes:

RP x (MR – IPR)/MR

This means the effective rate of tax is 10 percentage points lower than the normal CT rate.

How are the relevant profits calculated?

This is where things start to get complicated. The full rules as laid out in the draft legislation (pdf) are beyond the scope of this article, but essentially it is a 3 stage process:

  1. Identify the profit arising from the patent by looking at the ratio of patent expenditure to overall expenditure;
  2. A ‘routine return’ percentage of 10% of certain costs is deducted to give ‘residual profits’;
  3. Deduct a notional brand royalty to take into account branding value to give ‘relevant profits’.

What about smaller companies?

Smaller companies can elect for simpler administration, for example by ignoring step 3 above and calculating their relevant profits as the lesser of 75% of residual profits or £1m. For smaller companies patents can be expensive, so they may wish to create joint ventures to spread the cost. In this case, they must be careful to maintain ‘active ownership’ for their IP by remaining involved in its development and/or management.

Given the significant benefits offered by the Patent Box, it may be worth companies patenting things they would not previously have patented to allow more of their profits to fall within the regime. Taken together with the improved R&D relief regime, the Patent Box has a real chance of ensuring innovative companies remain and thrive in the UK.


As announced in the 2012 Budget, the Patent Box will be introduced in the 2012 Finance Bill.

Newsletter and RSS Feed

RSS Feed for Alvery Business Tax Blog

Liked the article? Then sign up for our monthly round-up of the latest tax news, or click the RSS icon to subscribe to our RSS news feed.