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Help with Patent Box computations — GfC9

Published 7 November 2024

Purpose, scope, and background

These guidelines do not represent any change in the law or HMRC policy. They are not designed to be used in isolation, or to create an end-to-end process for businesses to comply with the rules. You should read these guidelines alongside our customer guidance for the Patent Box and HMRC’s technical guidance to help you to apply the Patent Box legislation in Part 8A of the Corporation Tax Act 2010.

The Patent Box encourages companies to keep and commercialise intellectual property (IP) in the UK. The Patent Box computation allows a company to apply a lower rate of Corporation Tax to profits earned from its patented inventions. The Patent Box can also be applied to profits from some rights to medicinal or botanic innovations.

HMRC find that some companies who elect into the Patent Box do not include enough detail in their tax computation. This leads to compliance checks that are often resolved when we see the missing detail. HMRC also find common areas where errors can occur in Patent Box computations.

These Guidelines for Compliance (GfC) set out the recommended information to include with your Patent Box computation. These GfC also tell you about problem areas that lead to tax adjustments. We want to share information to help you manage those risks.

Not all expectations or recommended approaches will be relevant to all businesses. These guidelines cover common scenarios and are not expected to be followed step-by-step. Some points may not apply to all customers and the links to technical guidance may cover subjects that do not apply to every customer. Customers with more complex tax affairs may need to provide more information.

Companies with a Customer Compliance Manager (CCM) may choose to discuss how to apply this guide with their CCM. Companies without a CCM who have specific questions about these guidelines may contact [email protected]. Include ‘Patent Box’ in the subject line.

If you are unfamiliar with the Patent Box, you may find our customer guidance for the Patent Box  a helpful starting point before reading further.

Who can benefit from the Patent Box

You may be able to elect into the Patent Box if all of the following apply to your UK company during an accounting period, the company:

• is a trading company liable to Corporation Tax
• makes a profit from exploiting qualifying intellectual property (IP) rights, including patents and some rights from medicinal or botanic innovations
• owns or has exclusively licenced-in the qualifying rights
• has undertaken qualifying development on the qualifying rights

The Patent Box may also apply to your company if your rights to qualifying IP stem from a cost sharing arrangement. Companies that are members of a group must also meet the active ownership condition.

Read more information on qualifying companies.

Recommended approach to your Patent Box computations

The Patent Box calculation flowchart helps you work through the steps to identify whether your company is able to elect into the Patent Box when commercialising qualifying intellectual property. You may find it helpful to follow the flowchart each year to help you complete your computation.   

We also recommend that you look at the following guidance:

• Patent Box technical guidance sets out HMRC’s view of each element of the Patent Box computation.
• step by step guides to calculations
• guidance on software, where appropriate

We recommend you check the ‘Information to include with your tax return’ section of these guidelines. You need that information to arrive at a correct Patent Box computation. HMRC need to see that information to understand your computation.

Avoiding common errors in Patent Box computations

HMRC see some errors when companies calculate their Patent Box computation. Many errors appear to arise because the customer makes assumptions rather than fully checking the facts. Fully checking the facts helps to show that you have met your obligation to take reasonable care to ensure that your computation is correct.

Here are some recommended steps to help avoid errors in Patent Box computations.

Check that rights are actually held

Including:

• rights have been granted for the relevant IP income
• profits arising before the grant of right qualify
• IP rights are still held by the company and have not expired

We see these issues when companies have not:

• fully read the Patent Box rules on eligibility
• kept track of the qualifying intellectual property they hold

We recommend you keep a clear record of qualifying IP you hold and the dates each expire, or you stop holding them. You should refer to this list when identifying relevant income streams.

Consider all of the steps of the Patent Box calculation

Considering all of the steps of the Patent Box calculation for each computation period can prevent errors such as:

• applying outdated rules
• incorrect deductions for routine returns
• incorrect deductions for marketing asset returns
• incorrect streaming calculations
• incorrect calculation of relevant IP profits

We recommend that you take care to identify and follow each applicable step.

Give full consideration to the facts and circumstances

Including:

• confirming you are a trading company within the charge to UK Corporation Tax
• identifying which group company owns the qualifying rights

• reviewing licence agreements to avoid problems such as including income from a licence that is not exclusive

• reviewing cost sharing arrangements to avoid applying incorrect assumptions
• fully considering the marketing assets return when calculating the Patent Box computation
• considering if a notional royalty computation is needed
• ensuring you include any relevant losses from previous years
• ensuring you track and trace R&D

Continued R&D and acquisition expenditure (or both) means that the R&D fraction will change each year. There needs to be an R&D fraction for each sub-stream.

It is not necessary for the expenditure relevant to the R&D fraction to be included in a claim for R&D credits or reliefs.

Information to include with your tax return

When you send us your Patent Box computation, supporting information helps us to understand it. You do not have to follow this best practice approach to supplying supporting information but following it may avoid HMRC opening a compliance check to ask you for missing details. We cannot guarantee that following this best practice approach will prevent HMRC from opening a compliance check or otherwise contacting you about your election.

Best practice can differ between different businesses and transactions. Every customer will not need to complete every computation.  We expect you to supply a level of detail that is reasonable and proportionate to the circumstances of your Patent Box computation.

The rest of this section sets out information we want to see. The information and the level of detail you provide will vary depending on the facts and circumstances. You should provide enough detail for us to understand your Patent Box computation. You or your agent will already have the information we need because you will have used that detail when you self-assessed the amount of your Patent Box deduction.

Qualifying company

It is good practice to briefly set out which conditions you meet to qualify for the Patent Box. We explain the three conditions in our guidance.

Companies that are members of a group will also have to show they have met the active ownership condition and provide a short explanation of how it has been met.

Here is an example of a short explanation.

Company A is a member of a group. Company A meets the active ownership condition because Company A staff actively participate as members of the group committee where decisions on how to develop and exploit relevant IP are made.

Qualifying IP rights

Read the meaning of ‘qualifying IP right’.

It is good practice to provide a list of the qualifying IP rights on which you have based the Patent Box computation, or the key qualifying IP rights if the company holds many IP rights. Details you supply should include the date of grant. We particularly need this information in cases where a search of public IP databases does not clearly show the company holds relevant qualifying IP rights.

It is helpful to note which qualifying rights arise though holding an exclusive licence or through rights similar to patents, such as:

• supplementary protection certificates
• medicinal and veterinary products with marketing authorisations and marketing or data protection
• plant breeders’ rights
• plant variety rights
• plant protection products with data protection benefits

Read more information on plant related rights.

The development condition

The development condition limits the Patent Box election to companies and groups which have been properly involved in relevant innovation.

The company must have engaged in qualifying development by either:

• creating, or significantly contributing to the creation of, the patented invention
• performing a significant amount of activity to develop the patented invention, any product incorporating the patented invention, or any process incorporating the patented invention.

Read about the four ways that a company can pass the development condition.

You should provide a short explanation of how you have met the development condition.

Here is an example of a short explanation.

The company meets the development condition for product X because it has developed and patented product X, patent number 123. Sale of this product gives rise to Head 1 sales income.   

The Patent Box computation

Computations will differ for every customer, consider which computations you need to carry out and only provide information relevant to your circumstances, which may not include all of the points covered in this guide.

Where they apply to your company, we would like your Patent Box computation to include the following.

Consideration of the steps

You need to provide a copy of the Patent Box computation, showing how you have considered all of the steps.

It is good practice to also provide:

• a summary list or explanation that gives a high-level view of which of the 5 heads of income your relevant IP income falls under.
• the different streams of IP income if not already clear from the calculation, but read section ‘Details of any election for small claims treatment’
• the level of streaming used, if not already clear from the calculation.

You should use the same level of streaming throughout the calculation.

R&D fraction calculation

You should provide a copy of the Research & Development (R&D) fraction calculation. This should show all terms and the details of tracking and tracing of R&D expenditure.

Read the following guidance to find out:

• what is tracking and tracing?
• records to keep for tracking and tracing
• when to start tracking and tracing

If, in exceptional circumstances, you have elected to use the value fraction instead of calculating the R&D fraction then you should provide the additional information required, including why the R&D fraction is considered to be incorrect.

HMRC will always consider the reasons behind the use of the value fraction and may ask for more information to support its use.

Details of any notional royalties

Notional royalties may be appropriate when all the following apply:

• a patented process or tool is used to produce a product or service which is subsequently sold to generate sales income of a company
• although a patented process was used, the product made as a result is not patentable in its own right
• the income does not fall under any of the 5 heads of IP income

A notional royalty is calculated as the percentage of IP-derived income which the company would pay another person at arm’s length value for the right to exploit the qualifying IP. The calculation must be carried out in accordance with Article 9 of the Organisation of Economic Cooperation and Development (OECD) Model Tax Convention and the OECD transfer pricing guidelines.

It is good practice to include a copy of the calculation used to arrive at each notional royalty. It should show each step of the calculation and the result, along with a brief but complete explanation of the methodology used and why the result is reasonable. There is a simpler method of calculating the notional royalty percentage if you are electing for small claims treatment. Read section ‘Details of any election for small claims treatment’.

Read further guidance on Notional Royalties.

Here is an example of a short explanation.

The company used a patented mechanical process in producing products which are not patented. Only part of the production process has been improved by the addition of a patented part. The IP derived income calculation only includes the appropriate percentage of the income. The appropriate percentage was arrived at using the profit-split methodology.

An explanation of the marketing assets return (MAR) figure.

You should exclude the profit from marketing assets to arrive at the relevant IP profits. This is simplified if you are electing for small claims treatment. Read section ‘Details of any election for small claims treatment’.

The nature of the business will indicate whether the marketing activities are likely to make a significant contribution to the generation of profit. Generally, you should take a pragmatic approach, as we set out in our guidance in calculating the MAR.

Broadly, the MAR is calculated by identifying the notional marketing royalty (NMR) and then deducting the actual marketing royalty (AMR). You should treat the result as zero when either of the following apply:

• AMR is greater than NMR
• the difference between NMR and AMR is less than 10% of the qualifying relevant profit (QRP) for the accounting period.

AMR will be nil in most cases. In that case, the MAR will normally be nil if NMR is less than 10% of the QRP.

The qualifying relevant profit is the figure of profit that remains after the removal of the routine return. It represents the:

• part of the profits of the trade that relates to exploitation of qualifying IP rights
• and ability to access other unique IP or intangible assets such as brand or marketing assets.

If you have treated the MAR as nil, then it is good practice to supply a brief explanation of why you consider that to be correct. This is particularly useful where marketing activities make a significant contribution to the generation of profit. 

Unless you have elected for small claims treatment, we would like to see:

• the NMR figure
• the AMR figure
• the MAR figure

It is good practice to show each step of each calculation and the result. It is also best practice to supply a brief but complete explanation of the methodology used and why the result is reasonable.

Here is an example of a short explanation.

The Marketing Assets Return figure is nil because the company doesn’t market its products. The company developed and supplied a product to fulfil a business-to-business contract based purely on technical specifications.

Details of any election for small claims treatment

The small claims treatment may apply if the company only has one trade. Further criteria to elect for the small claims treatment, including monetary thresholds, are set out in our guidance.

We would like to know which criteria the company meets along with a short explanation. We also need to know which of the three elections are being applied:

• that the small claims threshold has been considered and the marketing assets return calculation to be replaced by a 25% reduction
• appropriate percentage of IP derived income to be taken as 75%
• allowing a global stream

You must make any small claims elections in your tax returns for each period for which you are electing to the treatment.

Here is an example of a short explanation.

The company has a Qualifying Relevant Profit (QRP) of £500,000. Therefore, it can elect to use the small claims treatment. It chooses to make a global streaming election so it can include all of its relevant Patent Box income in one stream.

Profits arising before grant of right

An example may be where a patent is pending. An election into the Patent Box regime must be made to benefit from patent pending rights.

For each right, the company may be able to elect to add an additional amount of profits. This is the relevant IP profits had the right been granted on the relevant day.  These relevant IP profits will be included within the Patent Box computation in the accounting period the right is granted. We have published guidance on these rules and the conditions that must be met.

We recommend providing a list of any elections you have made and include a list of each item of qualifying IP, including:

• a brief explanation of why profits arose before the grant of right
• the date when profits began to arise and the amount of qualifying profit, for each item of qualifying IP, in each accounting period
• a copy of the calculation of the qualifying profits for each item of qualifying IP in each accounting period

Here is an example of short explanation.

The company applied for a patent in 2023, it was granted in year 2024. The company has provided Patent Box computations for both years. The company has made an aggregate deduction in its 2024 tax return.

Cost-sharing arrangements

A cost-sharing arrangement (CSA) is a commercial arrangement. It allows businesses to share the costs and risks of developing, producing, or obtaining assets, services or rights. Rules may apply to allow companies who are party to a CSA to qualify for Patent Box in the same way as other companies.  

Identifying the R&D expenditure and acquisition costs can be difficult. This is because of the various interactions within a CSA. We have published guidance on what is a qualifying CSA for Patent Box containing advice on applying the rules.

We want to see:

• brief details of each CSA relevant to your qualifying profits
• a copy of each relevant calculation, showing the steps you have followed to identify S1 and S2

Here is an example of detail we want to see.

B limited entered a CSA with C limited, an unrelated company. C limited owns the patent but, due to the cost sharing arrangement, B limited is treated as if it also holds the Patent. CSA costs are split equally as set out in the terms of the agreement.

Record keeping

Our recommended approach includes keeping good written records. HMRC do not expect you to create unnecessary records. We recommend that you keep sufficient records to evidence your Patent Box deduction.

Your records should show how the company qualifies for the Patent Box election and holds qualifying IP, including but not limited to, lists of the following:

• all IP rights held including patent numbers, dates of grant, dates of acquisition, dates of disposal, dates of expiry.
• details of any exclusive licence agreements and the supporting contracts
• any related acquisition costs and the supporting contracts
• related royalties paid or received and the supporting contracts

You should have evidence of the figures used in the Patent Box computation, including but not limited to:

• income streaming methodology and calculations for each period
• expenses and R&D tracking and tracing calculations for each period
• R&D fraction calculation and evidence to support each figure
• evidence and methodology to support MAR and NMR calculations for each period

This will help you to:

• have consistent accurate calculations for each period
• avoid common errors
• provide required information and evidence if requested
• comply with records keeping requirements for companies and avoid penalties

If HMRC open a compliance check into your Corporation Tax return, we may ask for anything reasonably needed to evidence your Patent Box computation. This may include, but is not limited to:

• seeing relevant documents
• talking to employees
• visiting the site

Further information and guidance

If you have any questions about Patent Box or how this guidance applies to your company:

• contact your Customer Compliance Manager (CCM) if you have one
• companies without a CCM may contact [email protected], including Patent Box in the subject line

Amending your company tax return

You can amend your tax return online to make or amend a Patent Box computation within 12 months of the statutory filing date. If you amend your Patent box computation after reading this document, state this in your amended computation. 

For all emails 

You should include the reference GFC9/2024 and copy in [email protected]. 

Sending information by email carries certain risks and HMRC will assume that by sending information by email you understand and accept these risks. 

Your obligations

Following the recommended approaches and good practice set out in these Guidelines for Compliance are not legal obligations. The law does require you to take reasonable care to get your Patent Box computation correct. Where customers fail to meet their legal obligations in relation to filing their Corporation Tax returns, they may be subject to: 

• penalties
• interest
• both penalties and interest

Read the HMRC compliance factsheets on penalties to find out more. 

Guidance and legislation

We have designed these Guidelines for Compliance to give you an understanding of some of the problems we see with Patent Box computations. This includes where insufficient information is provided in the tax computation for HMRC to have confidence in your self-assessment. The Patent Box regime can be complex and we recommend you read the legislation and all of our guidance before electing your company into the Patent Box.  

Read the Patent Box guidance and HMRC’s technical guidance.

Patent Box legislation is in Part 8A of the Corporation Tax Act 2010.