Unboxing the Australian PatentBox Scheme
Gordon Cottee, IP Solved (Australia)
From July 2022 Australia will join the pool of over 20 countries who have implemented various patentbox regimes. The Australian scheme will apply to companies operating in the medical and biotechnology sectors, and will provide for a concessional tax rate of 17% for corporate income derived from eligible patents.
At an estimated value of A$200M per annum, the proposed Australian scheme is relatively modest when compared with schemes in other jurisdictions. For example, the United Kingdom patentbox regime provides £1,100M per annum. in tax concessions.
For comparison by tax rate and leaving aside the particulars of taxation, the South Korean patentbox provides for a tax rate as low as 5%, the UK, French, and Spanish patentboxes provide for tax rates of 10%, and China provides for a 15% tax rate under its High and New Technology Enterprise (HNTE) patentbox.
The most common objects of patentbox schemes are to incentivise companies to base their R&D operations in the relevant country, and to encourage the onshore ownership and commercialisation of patents. Unlike direct R&D tax incentive and subsidy schemes, patentbox schemes are ‘output based’ meaning that they provide tax relief generally after successful outcomes have been realised from the R&D.
While the details of the Australian scheme are yet to be finalised, compliance with the OECD standards relating to Tax Base Erosion and Profit Shifting (BEPS) and the particulars of taxation would appear to be the foremost concerns of the Australian government in the discussion paper that has been released. There appears to be relatively little consideration given to tailoring the scheme to meet particular industry objectives. Apart from the exclusive focus on the medical and biotechnology sectors, the proposed Australian scheme would appear to be influenced to some extent by the relatively generic approaches adopted in Europe that stipulate few eligibility requirements.
Local objectives in implementing patentbox regimes and the associated eligibility requirements can vary significantly. For example the South Korean scheme is tailored to promote the more efficient exploitation of IP by SMEs. The scheme provides tax relief to SMEs who transact patents to a South Korean national, whether by assignment or by licensing. The applicable tax rate becomes more generous with decreasing size of the SME and is particularly generous for IP transfer arrangements.
On the other hand, the Chinese HNTE patentbox is tailored to encourage enterprises that have R&D as a core business focus. For eligibility under the scheme, the HNTE system stipulates that a minimum 10% of total headcount must consist of R&D personnel, a minimum 3-5% of turnover must consist of R&D expenses, and a minimum 60% of total annual revenue must be derived from the high and new technology products or services.
As an example of more traditional objectives, the French patentbox scheme is tailored to promote long term investment in local industry. In particular the scheme provides tax relief on royalties derived from patents that have been capitalised as long term fixed assets.
Such tailored objectives are not evident in the proposed Australian scheme.
Regardless of the objectives, recent years have seen a broad standardisation in patentbox schemes to accord with the OECD BEPS standards. In particular, the OECD standards impose a ‘substantial activity’ test and requirements for a nexus between the eligible patent and the revenue.
In most cases, including the proposed Australian patentbox, the substantial activity test will mean that the component of patent income that is eligible for concessional tax rates must be in proportion to the fraction of R&D expenditure that has been incurred in the relevant country on the relevant patent.
The OECD standards arose in response to the manipulation of differences in local tax practice across countries, particularly by large multinational enterprises (MNEs). Of particular concern was that large MNEs were separating their domicile, location of IP-related activities, location of manufacture, and revenue streams across countries to take advantage of differences in IP-related tax treatment and R&D incentive schemes.
Various countries were perceived to be responding with more favourable tax treatment, accelerating what was described by the OECD Forum on Harmful Tax Practices as essentially a race to the bottom.
The OECD recommendations were developed in order to limit the collective erosion of tax base in host countries, particularly by discouraging the separation of IP-related transactional revenue and R&D activities, by application of the substantial activity test.
To date, approximately 45% of OECD patentbox participants have amended their regimes to accord with the OECD standards with the remainder largely already in compliance.
In terms of the details of the proposed Australian scheme, granted Australian standard patents in the medical and biotechnology fields that have priority dates after 11 May 2021 will be eligible for the scheme. Prior filed patents and innovation (utility) patents will not be eligible. The extension of the patentbox to related foreign patents is under discussion.
Forms of revenue that are likely to meet nexus requirements in Australia are slated to include the traditional forms of patent royalties, damages or an account of profits awarded for infringement of a patent, and revenue derived from the assignment of a patent including capital gains.
Revenue that does not have a sufficient nexus to the patent, such as revenue attributable to the downstream activities of manufacturing and branding, will potentially be subject to the standard corporate tax rates of 30% or 25%, depending upon the company’s aggregate annual turnover.
Where licensing arrangements have not been used, for example the patent is exploited within the same company, revenue that is eligible under the proposed scheme may nevertheless be embedded in the sale of patented goods, the performance of patented services, or the use of patented processes in production. An apportionment mechanism will likely be required for such circumstances to separate eligible revenue and non-eligible revenue.
A patentbox scheme is certainly new territory for Australia. While the proposal may be rough around the edges and quite limited in scope, nevertheless it will be recognised as a welcome addition to Australian industry. Hopefully in response to its success a more comprehensive proposal will be put forward in coming years.