I recently blogged on the publication of Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, the final report on Action 5 of the OECD BEPS project. In that blog I suggested that any revised Patent Box regime in the UK was likely to be so complex – in order to comply with the OECD requirements – that SMEs in particular would almost certainly find it too complex.

Having read HMRC’s consultation document on the Patent Box (published on 22 October 2015), I am pleasantly surprised at how they have managed to minimise this complexity. Minimised but not avoided, unfortunately.

This current consultation is open for comments until 4 December 2015. The intention is to introduce legislation in Finance Bill 2016, amending the current patent box regime from 1 July 2016 in order to make it compliant with the OECD requirements. This will not be a wholesale scrapping of the current regime and the introduction of a completely new patent box; large parts of the existing legislation will remain unchanged.

There will, however, be important changes to the regime in order to make it compliant with the requirements of the OECD’s Action 5. I’m not going to discuss all of the proposed changes in this blog, just the most significant in terms of the likely impact on complexity.

The Nexus Ratio

Perhaps the biggest change will be the introduction of the Nexus Ratio. The core of the OECD requirements is that countries must only provide patent box incentives where the company has incurred expenditure on developing the IP. The nexus ratio will ensure that only profit, which is directly attributable to eligible R&D undertaken by the company, will be included within the patent box.

The nexus ratio is defined as




D is the in-house direct R&D expenditure

S is R&D expenditure subcontracted to third parties

A is expenditure on the acquisition of qualifying IP

R is R&D expenditure subcontracted to related parties


D, S and R will be determined in accordance with the existing R&D tax relief rules in CTA 2009.

U is an allowable uplift that is 30% of (D+S), subject to it not exceeding A+R

The nexus ratio is then applied to the appropriate profit attributable to that IP asset, product or product class (see below) to ensure that only that profit directly attributable to eligible R&D spend by the company can be included in the patent box.

For the purpose of the nexus fraction the costs above are cumulative, from the start of the R&D work to date. Once expenditure no longer contributes to income, however, the OECD requirement is that it be removed from the nexus ratio. The consultation recognises that this could be a difficult assessment and proposes that expenditure be removed 15 years after first being included.

Tracking and tracing

Companies wishing to take advantage of the patent box will have to implement procedures to track both expenditure and income at the level of individual IP assets. At least, that is the starting assumption. If the company can show that this would be unrealistic, would require arbitrary judgements or would entail tracking to a “category entirely unrelated to innovation or business practice”, they can track to a product or product class.

Each individual IP asset, product or product class (as appropriate) will then have its own nexus ratio. The overall level of profit to be included in the patent box will be the sum of the amounts computed for each category.

Whilst I understand the need for this type of tracking, I am concerned that it will lead many smaller companies to shy away from the patent box. Ironically, a small start-up company with only one patent and one product may actually find this fairly straightforward. The challenge will be to ensure that the records are kept!

I know that other countries – Ireland for example – already require R&D to be properly documented and recorded before R&D relief is given. I think this requirement to track and trace expenditure and income to the IP asset takes the recording to a slightly different level.

Transitional rules are proposed to cover IP assets where expenditure was incurred before 1 July 2016 and adequate tracking did not exist.


Given the quite strong opposition from some to the general concept of patent boxes, the OECD requirements are actually very reasonable. In the context of the implications for the UK’s patent box regime, however, I seriously question whether it is viable going forward. KPMG’s Annual Survey of Tax Competitiveness 2014 published last December suggests (at page 12) that 30% of all companies are using, or intending to use the patent box. This is a survey of 104 companies that are FTSE 100, FTSE 250 or foreign owned subsidiaries, so big companies. Actually, if only 30% of that sample are using or intending to use the patent box then I don’t really see that as a good take up rate. My own experience – both first hand and from talking with fellow advisers – is that the overall interest is pretty low. To be honest, I can only see these changes making that situation even worse.

We then have a situation where the patent box is really only of benefit to the larger companies in the economy, leaving the smaller innovators struggling to catch up.