13 May 2021

Australian Government Announces a (Sort of) ‘Patent Box’ Tax Incentive

BoxesThis week, the Australian government handed down its annual budget.  At the risk of sounding overly cynical, I am always sceptical about how many of the policy measures announced in the budget will actually come to fruition, given that their funding is often dependent on hazy forecasts of future economic performance, and their implementation may span many years during which future budgets – and potentially new governments – may come and go, bringing their own priorities and revised forecasts.  But even I cannot help sitting up and taking notice when patents get a mention, with all of the ensuing media coverage that brings during the budget frenzy!

So the ‘big news’ is that the government is going to introduce a ‘patent box’ tax incentive scheme in Australia… sort of.  If you are not already familiar with the concept, a ‘patent box’ – the name refers either to an actual box on a form, or to a notional box into which a company allocates a proportion of its income – is a tax incentive scheme under which income that can be directly attributed to the commercialisation of patented technology (as distinct from other attributes, such as branding, know-how, or manufacturing capability) is taxed at a reduced rate.  Other income continues to be taxed at the standard corporate rate.

The Australian patent box scheme is actually going to be somewhat limited, initially applying only to medical and biotech patents, with the possibility that it might also be made available to the clean energy sector.  The incentive will only be available on income generated from patents applied for after the budget announcement (i.e. pre-existing patents and application will not be eligible).  And it will not come into effect until 1 July 2022.  The tax rate on eligible income will be 17%, compared with the normal corporate tax rate of 30% for large companies, or 25% for small and medium enterprises (SMEs).  This discounted rate is higher than other countries that operate a patent box system, e.g. France 15%, Spain 12%, UK 10%, Belgium 6.8%, Luxembourg 5.84%, and Netherlands 5%.  Even taking into account that a number of these countries have a lower corporate tax rate than Australia, equal or larger discounts are also available elsewhere, e.g., in France (where the corporate tax rate is 32.02%), Spain (25%), Belgium (25%), and Luxembourg (24.94%).

So – true to form – the Australian patent box will be a very ‘middle-of-the-road’ affair, with limited eligibility, and relatively modest tax discounts, especially for SMEs that are already subject to a lower tax rate than larger corporates.  As it so often does, the government has decided to limit its exposure by picking winners – this time, medical and biotechnology industries – leaving other sectors (such as IT, where Australian companies such as Atlassian, Canva, Afterpay, Judo Bank, Zip Co, and AirWallex have been punching well above their weight) to fend for themselves.  Or, more likely, to move their R&D activities overseas, into more favourable jurisdictions.

On the other hand, the announcement is something of a turnaround for this government, considering that criticism among G20 finance ministers in 2014, and a 2015 review commissioned by the Office of the Chief Economist in the Department of Industry delivered negative conclusions that seemed to have killed off any prospect a patent box scheme being introduced in Australia.

What’s Wrong with Patent Box Schemes?

I am something of a fan of patent box tax incentives.  Australian taxpayers currently fund an R&D tax incentive scheme, to the tune of billions of dollars each year, which enables companies to claim a tax offset on eligible R&D expenditure (refundable in the case of small companies) that exceeds the corporate tax rate, i.e. higher than the benefit that would be obtained simply by claiming R&D expenditure as a tax deduction.  This is all well and good, but it has become Australia’s largest, and most costly, innovation incentive program, and it does not even guarantee that the R&D ever actually results in a commercial outcome.  A patent box fills this gap, by providing a benefit only when profits are made on the commercialisation of technology that is genuinely innovative, at least in the sense that it satisfies the patentability requirements including novelty and inventive step.

Of course, not everybody agrees with me!  The review commissioned by the Office of the Chief economist in 2015 noted that existing patent box schemes could have two different objectives: attracting mobile IP income (i.e. encouraging companies to shift activity into the jurisdiction, in order to minimise overall company tax); and incentivising innovation (i.e. encouraging domestic companies to conduct more R&D, and generate more innovation).  The review was unimpressed with either of these approaches, finding that:

  1. targeting mobile IP income is a ‘winner-takes-all policy’ that ‘requires an aggressive lowering of the headline tax rate’, and ‘opens the door to a fiscal race to the bottom as more and more countries seek to offer patent box regimes’; and
  2. ‘there are no solid theoretical or empirical grounds for claiming that patent box regimes induce more innovation.’

The review was also sceptical that any increase in patent applications encouraged by a patent box scheme would be associated with a net benefit to the Australian economy.  While conceding that ‘a patent box policy will certainly increase the number of patent applications filed at IP Australia’, the review concluded that ‘most of these additional patent applications are likely to be opportunistic (i.e., inventions that would previously have been kept secret will be patented) and will not be tied to real economic activity’.  At the same time, the ‘fall in tax revenues collected from innovative companies … is likely to exceed revenues collected from (re)allocation of IP income to Australia,’ such that ‘the overall return of a patent box regime is likely to be negative.’

Conclusion – a Compromise with the Critics?

While full details of the Australian patent box are yet to be hammered-out, the scheme that is being foreshadowed appears to be navigating a number of the objections raised in the 2015 review.

Firstly, it is clearly not a mobile IP income attraction scheme.  The headline rate is higher than many other jurisdictions, and comments in the budget papers indicate that the scheme will require Australian development, as well as patenting, to ‘encourage firms to develop their research and development innovations into profitable businesses in Australia’.

Secondly, in limiting the scheme to the medical and biotechnology sectors, the corresponding fall in tax revenues is contained (the cost is estimated at A$206.4 million over the forward estimates period).  Furthermore, these are industries in which the respective roles of patents and confidential information are well-established, and it is unlikely that any company would choose to patent (and therefore publish) valuable trade secrets in exchange for the possibility of a modest tax discount a few years down the track.

Finally, the government has apparently not forgotten the criticisms – in which the then Australian treasurer Joe Hockey joined – at that 2014 G20 meeting.  As part of the announcement, the government has stated that it ‘will follow the OECD’s guidelines on patent boxes to ensure the patent box meets internationally accepted standards.’  This is code for ‘we promise that we will not create an evil tax haven’!

In other words, this is a compromise all round.  But for many, and especially those in the Australian medical and biotech sectors, it will be seen as a step in the right direction.


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