Not all of your company profits may come from exploiting patented inventions. In order to calculate the Patent Box deduction, you will need to calculate the proportion of your income attributable to exploiting patents and innovations.
This guide explains how to make the calculation using two different methods - known as 'formulaic' and 'streaming' - and when to use them.
On this page:
Broadly, there are three stages to calculate the profit which can benefit from the Patent Box.
These are:
You can calculate the profit which can benefit from the Patent Box using a formulaic approach - this approach breaks down the three stages into six steps. Alternatively, you can choose to apply a streaming method, and in some cases you must use the streaming method.
Step 1
Calculate the total gross income of the trade. This includes revenue receipts and any profits from the sale of intangible fixed assets or patent rights, but excludes any finance income.
Read more about calculating total gross income and finance income
Step 2
Establish the percentage of the total gross income that is relevant IP income:
Relevant IP income divided by the total gross income multiplied by 100 = percentage
Read more about relevant IP income
Step 3
Adjust the total profits of the trade by excluding finance income and finance deductions and any additional deduction for research and development (R&D) expenses that qualify for the R&D tax credit relief.
There is one other adjustment that may need to be made in respect of R&D expenditure. In many cases, the proportion of R&D costs from earlier years that is generating relevant IP income in the current year will be a good indicator of the proportion to use. However where current year expenditure is lower than in past years (referred to as a shortfall in R&D expenditure) then it may be necessary to increase the R&D expenditure deducted in arriving at the profits benefiting from the Patent Box.
Once these adjustments have been made, apply the percentage at step two to the adjusted profits to establish the profits attributable to income arising from exploiting patented inventions.
More about R&D tax credit relief and additional deductions
More about calculating adjusted profits of the trade
More about shortfall in R&D expenditure
Step 4
This step involves the removal of a routine profit (referred to in the legislation as a 'routine return') from the result of step 3. A routine return is the profit a business might be expected to make if it did not have access to unique IP and other intangible assets.
The routine return is calculated by:
The amount given by this step is referred to as the 'qualifying residual profit' (QRP) and represents the part of the profits of the trade that relates to exploitation of patented technology and other unique IP or intangible assets such as brand or other marketing assets.
Your company's routine deductions are its tax deductible trading expenses that fall within one of the following categories:
However, the following tax deductible expenses are not routine deductions even if they're included in any of the above categories:
More information on routine deductions
Steps 5 or 6 involve the removal of the profits attributable to marketing assets - referred to as the 'marketing asset return figure' - from QRP arrived at the end of step 4.
If the nature of your company's business is such that its marketing activities are minimal and its marketing assets make no significant contribution to the generation of profit, then it may be possible to assume that the marketing asset return figure is nil.
See the section later in this guide for more information on marketing assets.
Step 5
Small claims treatment
If at the end of step 4 your company has QRP of £3 million or less, and has not previously had to calculate a marketing asset return figure, it can elect to apply the small claims treatment. This allows your company to use a formulaic approach to remove the profits attributable to marketing assets. If you elect to apply the small claims treatment in step 5, you do not need to make the same calculation in step 6.
The formulaic approach sets out that the profits that remain in the Patent Box after removing those profits attributable to marketing assets are the lower of either:
Find out more on small claims treatment
The amount arrived at after step 5 is the relevant IP profit (RP) or loss. This is the amount of your company's profit that will be taxed at the reduced rate and is used in calculating the appropriate Patent Box deduction.
If your company has generated a relevant IP loss then none of its profits will be taxable at the reduced rate.
If your company generated a relevant IP loss in an earlier period or has generated profits in earlier periods that were from exploiting inventions for which a patent application had been made but the patent was awaiting grant (known as the 'patent pending period'), then further adjustment to the relevant IP profit or loss may need to be made.
Find out more on profits arising in the patent pending period
Find out more on relevant IP losses
Step 6
Removing a marketing asset return
If your company has QRP that is greater than £3 million or decides not to elect for small claims treatment, it may need to calculate a marketing assets return figure that is then deducted from the QRP arrived at the end of step 4.
However, there are two situations where your company can conclude that the marketing asset return is nil:
Where it is reasonable to conclude from a high-level consideration of the business that either of these situations applies, a pragmatic and common-sense approach should be taken and it should not be necessary to undertake a computation of notional marketing royalty merely to prove that the 10 per cent threshold is not breached.
However, if, for example, your company's business involves the sale of well known consumer 'brands' it will be equally evident that a significant proportion of profit is likely to derive from marketing activities and therefore there is a need to compute a notional marketing royalty.
Find out more about calculating the marketing asset return
The amount arrived at after step 6 will normally be the relevant IP profit or loss. But if profits were made in earlier periods from exploiting inventions for which a patent application had been made but the patent was awaiting grant (known as the 'patent pending period'), the company may elect for those profits to be included when the patent is granted.
This is the amount of your company's profit that will be taxed at the reduced rate and is used in calculating the appropriate Patent Box deduction.
If your company has generated a relevant IP loss then none of its profits will be taxable at the reduced rate.
If your company generated a relevant IP loss in an earlier period or has generated profits in then further adjustment to the relevant IP profit or loss may need to be made.
Find out more on profits arising in the patent pending period
Find out more on relevant IP losses
The marketing asset return figure is calculated by deducting any actual marketing royalty (AMR) your company incurs from a notional marketing royalty (NMR) that your company has to calculate (see below).
The NMR is an amount your company would pay for the right to exploit the relevant marketing assets that your company holds in the accounting period, if it could not exploit them without that payment.
This amount has to be calculated following Transfer Pricing principles and the legislation sets out various assumptions that your company has to make when calculating the NMR.
More information on calculating the notional marketing royalty
Your company's relevant marketing assets are those marketing assets that it exploits in generating the relevant IP income.
Marketing assets are defined as:
Streaming still requires you to identify your company's relevant IP income. However, rather than using a formulaic approach to identify the profits associated with that income, streaming allows you to calculate the profit by allocating expenses to the relevant IP income stream on a just and reasonable basis. A routine return and marketing asset return will then need to be deducted from that profit using the same methodology as for the formulaic approach (see steps 4 to 6 above).
If your company receives income in addition to that from exploiting its patented inventions then it may wish to elect to stream rather than follow the formulaic approach. In certain circumstances it will be mandatory to stream (see the section later in this guide).
Your company may wish to stream if applying the formulaic approach would not result in an appropriate amount of profit benefiting from the Patent Box.
Example
A company which manufactures and sells a range of established products none of which are patented and therefore do not give rise to relevant IP income has turnover from this activity of £900,000 but its net profits are only £50,000. The company also owns a patented technology which it developed many years previously and has licensed out to another business which takes care of manufacturing, marketing, distribution and sales. It receives an annual licence fee of £100,000 all of which is relevant IP income.
If the trade profits of £150,000 are apportioned by the ratio of relevant IP income to total gross income, the amount of profit that benefited from the Patent Box reduced rate would be:
£100,000 ÷ £1,000,000 × £150,000 = £15,000
But clearly, in this example, the company will want substantially all of the profits from licensing out its qualifying IP (ie £100,000) to qualify for the Patent Box.
More information on the streaming method
In certain circumstance the formulaic approach may result in an unacceptably high level of profit benefitting from the Patent Box.
Example
A company's receipts from exploiting qualifying IP rights are £3 million on which it generates a profit of £600,000. It also has licence income that relates to non-qualifying IP of £3 million all of which is profit.
If the trade profits of £3,600,000 are apportioned by the ratio of relevant IP income to total income, the result will be:
£3,000,000 ÷ £6,000,000 × £3,600,000 = £1,800,000
So £1,200,000 of profit from non-qualifying IP will potentially qualify as RP.
Where this is the case, your company must apply the streaming methodology. There are three conditions which if met by your company will mean you will need to stream.
More information on mandatory use of the streaming method
Company A has trading turnover of £1,000, of which £700 (70 per cent) is from the sale of qualifying patented products. Its tax deductible expenses of £775 include £50 for R&D, all of which qualifies for R&D tax credits.
| Calculation step | Amount |
|---|---|
| Trading income | £1,000 |
Tax deductible trading expenses:
|
£750 |
| Taxable trading profit | £250 |
| Calculation step | Amount |
|---|---|
| Total gross income | £1,000 |
| Calculation step | Amount |
|---|---|
| Total gross income from step 1 | £1,000 |
| Relevant IP income | £700 |
| Percentage | 70% |
| Calculation step | Amount |
|---|---|
| Taxable trading profit | £250 |
| Add back R&D additional deduction | £50 |
| Adjusted profits | £300 |
| Pro rata trading profit used below (£300 × 70%) |
£210 |
| Calculation step | Amount |
|---|---|
| Total routine deductions | £650 |
| Mark-up rate 10% × total routine deductions | £65 |
| Routine return figure (£65 × 70%) | £46 |
| Apportioned trading profit from above | £210 |
| Routine return figure | £46 |
| Qualifying residual profit (£210 - £46) | £164 |
Step 5 or step 6 - Company opts for step 5
| Calculation step | Amount |
|---|---|
| Qualifying residual profit | £164 |
| Patent Box profit (RP) (£164 × 75%) | £123 |
