Earlier this month the OECD published its final report on Action 5 of its BEPS project. The report – niftily titled Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance includes a section on the Substantial activity requirement in the context of IP regimes. In other words, the requirements for the design of compliant Patent Box regimes.

Having read through it – slowly, it’s not exactly light reading – my initial reaction is that HMRC is going to have a tough time designing a compliant regime that is not so complex as to be unattractive to all but the largest companies.

The basic principle of the Nexus Approach is pretty straightforward – income can only be included in the regime to the extent that the company has incurred the qualifying R&D expenditure on the creation/enhancement of the patent. This was a proposal designed by committee, however, so the reality is not quite so straightforward. The rules on what expenditure is included in the calculation of the “nexus ratio” are fairly obvious and unlikely to cause too much concern. Identifying the net income to be included in the Box is, perhaps, slightly more tricky but still not too controversial. No, where I fear that these proposals are going to cause SMEs (and probably some larger companies) to go off the idea, is around the tracking requirements.

To be compliant with these proposals, a Patent Box regime will have to require companies to demonstrate a link between expenditures, patents and patent income. The company will need to have systems in place that can track expenditure on R&D to the creation of specific patents, through to the qualifying income derived from those patents. The proposals do recognise that this tracking could be to individual patents or to products (or even product classes if appropriate) but this may still be too complex for smaller companies. Indeed, if the company wants to track to products rather than patents, it will have to provide documentary evidence to show that its IP business model is too complex for tracking direct to patents and justify tracking to products instead.

All in all, the ‘patent box proposals’ in the Action 5 report are pretty much as expected as far as the nexus approach itself. As I say, however, the problem for the UK Government – assuming it still wants to have a patent box regime – is going to be the challenge of designing a compliant regime that is not so complex that no one bar the biggest companies will actually feel confident to use it.