Australia Needs to Get Into the Patent Box

Australia currently has a tax offset scheme in place to provide an incentive for companies to engage in eligible R&D activities.  The R&D Tax Incentive program provides a 45% offset (equivalent to a 150% deduction) on eligible expenditure by small to medium enterprises, and a 40% offset (equivalent to a 133% deduction) for larger organisations.

This scheme has many merits.  It is broad-based, easy to access, and is available across all industries.  However, its drawback is that it is a one-off benefit.  Once the eligible R&D is concluded, there is no further incentive to maximise the commercial outcomes available from the resulting innovations.  More specifically, there is no ongoing incentive to conduct further commercialisation activities in Australia.

Increasingly, however, other countries are providing such incentives.  Countries that have introduced so-called ‘patent box’ regimes include the UK, the Netherlands, Belgium, France, Ireland, Spain, Luxembourg, Switzerland and China.  These schemes provide reduced tax rates (typically between 5% and 15%) on income attributable to patented IP.

The US is now contemplating its own patent box scheme, with legislation (the Manufacturing Innovation in America Act of 2013 [PDF, 280kB]) introduced into the House of Representatives on 28 June 2013.

These regimes do not apply only to locally-owned and operated companies, but can be accessed by foreign companies which engage in eligible activities (and pay tax) in the countries in question.  Furthermore, they are not necessarily limited to income derived under the protection of domestic patents, but will also apply to income earned on foreign patent rights in appropriate circumstances.

There are therefore two reasons why Australia needs to be looking at implementing its own 'patent box' regime.  Firstly, it is a good idea which could deliver real benefits to the economy, by assisting innovative local companies to achieve greater growth and to build markets both locally and overseas.  Secondly, as such schemes become more widely implemented by Australia's major trading partners in Europe, Asia and North America, failure to introduce a similar scheme could place the country at a significant disadvantage.  If companies can reduce their overall tax bills by moving lucrative parts of their operations to countries with more favourable tax regimes, why would they not do so?

The Principles of ‘Patent Boxes’

The specifics of particular patent box tax regimes are not trivial, and I am not going to attempt to explain them in detail here.  The requirements are set out in the relevant legislation, and presumably provide a steady stream of work for tax accountants and consultants in those countries where such schemes exist!

The principle, however, is fairly simple.  If a company invests, in some significant way, in developing and/or commercialising unique IP which is subject to patent protection, any profit which can be attributed specifically to that patented IP is eligible for a lower tax rate.

The complexities arise in working out just how much of a company's total taxable income can be attributed to the protected IP, i.e. can be placed in the 'patent box'.  In general, it is clearly the case that only products or services which actually embody the patented technology could contribute to the patent box.  However, not all of this income is entitled to the discounted tax rate.

‘Routine Return’

Existing patent box schemes recognise that companies would seek to operate at a profit, even in the absence of patent protection.  For example, the UK scheme effectively assumes that the first 10% of income above costs of production is ‘routine return’, which would be earned even in the absence of patent protection, and therefore should be taxed at the usual corporate rate.  The whole point of a patent, after all, is that it confers an exclusive right which should allow the patent owner to charge a premium price for a unique product or service.  So if a company is failing to capitalise on any ‘patent benefit’ (perhaps because the patent does not really add value), then it is not entitled to any reduced tax rate.

‘Marketing Asset Return’

Additionally, not all premium pricing can be attributed to patent protection.  In particular, a strong brand can differentiate a product, and enable the brand-owner to charge a higher rate for essentially the same product as is provided by less highly-esteemed competitors.  Thus patent box schemes, such as the one recently commenced in the UK, require additional profits attributable to such factors – called ‘marketing asset return’ – to be taken outside the patent box.

Conclusion – Why Australia Needs a Patent Box

The introduction of a patent box scheme in Australia is the logical next step up from the existing R&D Tax Incentive.  Once a company has conducted its eligible R&D, and claimed its tax offset, there should be a further incentive to protect any patentable innovations which may have emerged from the process, and to capitalise on that protection by bringing innovative new products and services to the market in Australia, and overseas.

Indeed, there already is such an incentive - if the company in question is willing to ‘offshore’ its commercialisation activities to somewhere like Ireland!

The Australian government has a duty to ensure that the country has a competitive innovation environment which supports not only the development of new IP, but also (and perhaps more importantly) its protection, development and commercialisation within the domestic economy, where it can create local opportunities and job growth.

Australia needs a patent box scheme.  In my view, this would be beneficial in its own right.  But even if that were not the case, being one of the few developed nations not to have one could be hugely disadvantageous!

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Tags: Government programs, Innovation policy, Public policy