What is a patent
box?
A patent box is a tax regime that provides a lower tax rate for
some kinds of income derived from certain forms of intellectual property (IP)—typically patents but sometimes other forms of IP such as
designs and copyright material. The policy goal of patent
boxes is to promote research and development (R&D) and the
commercialisation of IP.
According to a United
States Congressional Research Service article, patent boxes get their name
from the box on an income tax form that companies check if they have qualified
IP income (p. 2). A patent box may also be viewed as a metaphorical box: patents meeting stated criteria—that is, patents
that are ‘in the box’—attract concessional tax treatment for the income they generate.
What is proposed
in the Budget?
In the 2021–22 Budget, the Government announced
it will establish a patent box tax regime in Australia for certain income
generated from Australian medical and biotechnology patents (Budget Measures: Budget Paper No. 2: 2021–22, p. 23). As part of the measure, the Government will
consult with industry to determine whether a patent box is also an
effective way of supporting the clean energy sector.
The patent box tax regime will provide a
17% concessional tax rate for corporate income derived directly from medical
and biotechnology patents. The usual corporate income tax
(CIT) rate is 30% for large businesses and 25% for small and medium enterprises
(for the 2021–22 income year onwards).
The proposed tax regime will commence on 1
July 2022, subject to legislation. The tax concession will apply to
patents granted after the budget announcement on 11 May 2021, with the
concessional tax rate to apply in proportion to the percentage of the patents’ underlying
R&D activities conducted in Australia.
According to the 2021–22
Budget’s tax factsheet,
the patent box ‘encourages businesses to undertake their R&D in Australia
and keep patents here’.
This measure will require legislation.
Figure 1: patent box’s concessional tax rate compared to corporate income
tax rate from 2021–22
Source:
Parliamentary Library estimates based on Australian Government, Budget Measures: Budget Paper No. 2: 2021–22, p. 23; Australian Taxation Office (ATO), ‘Changes to company tax rates’, ATO website, last modified 30 November
2020.
Who will benefit from Australia’s
patent box?
The proposal
has the potential to benefit the medical and biotechnology
sector, which includes pharmaceutical companies. It will be larger
companies that derive the most benefit because large multinational enterprises
(MNEs) tend to apply for and own more patents than local small and medium
enterprises (SMEs). For example,
UK government statistics shows that in 2016–17,
more than 95% of the tax relief claimed under the UK’s patent box regime came
from large companies rather than SMEs (pp. 2, 8).
Which income is
concessionally taxed?
The patent box tax concession will apply only
to income generated directly from patents, typically royalty
income or capital gains that arise from the licencing or sale of patents.
Income derived from manufacturing, branding, or other attributes
will be subject to the existing CIT rate at 30% or 25%, depending on the size
of the company. For example, if an overseas firm owns a patent and an
Australian manufacturer is licenced to produce goods based on the patent, the
Australian manufacturer would be unable to claim the 17% concessional CIT rate
because its income is not directly generated from the patent.
The concessional tax rate provided by the patent box could
potentially give rise to MNE tax avoidance behaviours. This issue is addressed
further below.
Where will the R&D activities
be required to take place?
The 2021–22
Budget’s tax factsheet indicates that companies will be eligible to benefit
from the patent box tax concession only if the R&D activities underpinning
the relevant patents are undertaken in Australia.
For example, if a company makes $100.0 million in net income
that is derived directly from its patent, and the company conducted 80% of the
patent’s research in Australia, then only $80.0 million income will be taxed at
the 17% concessional rate. The remaining $20.0 million income will still be
taxed at the 30% company tax rate.
Implementing the policy may present difficulties for the ATO
to accurately attribute a company’s ‘qualifying R&D expenditure’ to a
specific patent and income from that patent.
Why is the
Government introducing a patent box?
R&D activities are widely perceived to have positive benefits
(known as ‘externalities’) that spill-over to other parts of the economy and
benefit the rest of society. As such, some governments attempt to promote
R&D activities through a combination of direct investment and tax
incentives.
Currently, over
20 countries have some form of patent or IP box tax regime (p. 3). While patent
box tax regimes can differ widely in their scope, they are mostly designed to
achieve some or all of the following objectives:
- promote increased investment in R&D activities
- promote the commercialisation of research and
- prevent the erosion of the domestic tax base that can occur when
mobile sources of income are transferred to other countries.
The assumption underlying all three objectives is that IP is
highly mobile and companies that own IP can relocate these assets to
jurisdictions that provide favourable tax treatment.
Governments around the world have increasingly sought to
modify their tax regimes to incentivise the retention and acquisition of IP. This
competition between countries has resulted in ever more generous tax regimes
that enable large MNEs to access low tax rates for IP related income without contributing
significant amounts of R&D expenditures in the host country. The OECD
considers this type of competition to be a harmful tax practice (p. 14). In
other words, patent box tax regimes can potentially give rise to harmful tax
practices or lead to ‘a race to the bottom’ if they are designed or implemented
poorly.
For example, MNEs can file patent applications in low-tax
jurisdictions while undertaking manufacturing of the patented product in
another jurisdiction, even if their headquarters may be located in yet another jurisdiction.
This is particularly attractive where the patents have a high earnings
potential.
Furthermore, large MNEs are likely to possess the tax
planning expertise to relocate mobile sources of income such as IP income to
low-tax jurisdictions through transfer pricing or licensing agreements, including
with their subsidiaries. These types of corporate behaviours can potentially erode
the host country’s tax base and reduce the number of patents filed in ‘high
tax’ jurisdictions (p. 41).
OECD recommendations
The OECD/G20
BEPS (base erosion and profit shifting) project provides 15 Actions that
equip governments with the domestic and international instruments needed to
tackle tax avoidance behaviours.
BEPS
Action 5 recommends countries adopt the ‘modified
nexus approach’ for patent box tax regimes to ensure that patent boxes do
not give rise to harmful tax practices. BEPS Action 5 is endorsed
by all OECD and G20 countries (including Australia). The Australian Government
also said
it will follow the OECD’s guidelines to ensure the patent box meets
internationally accepted standards (p. 3).
The ‘modified nexus approach’ aims to ensure that the tax
benefits received by MNEs are commensurate with the level of R&D they
undertake.
What are the pros and cons of
patent boxes?
The debate around the benefits of patent boxes is highly
contested, with no consensus view emerging as to their overall effectiveness. The
following three questions are central to the debate on patent boxes:
- Do patent boxes promote economic growth and innovation?
- Do potential benefits of patent boxes outweigh their drawbacks?
- Are there better alternative policy tools to promote innovation?
In 2015, the Department of Industry, Innovation and Science
published a report titled, Patent
Box Policies. The report found that a patent box regime should lead to
an increase in the number of patent applications. However, this increase would
largely be the result of ‘opportunistic’ behaviour and would not reflect a
genuine increase in inventiveness (pp. 24–25). As such, the report concluded
that:
patent boxes are not a very
appropriate innovation policy tool because
they target the back end of the innovation process, where market failures are
less likely to occur. [emphasis added] (p. 24)
The conclusions reached by the 2015 report have been disputed
by industry stakeholders.
In 2016, the Joint
Select Committee on Trade and Investment Growth’s Inquiry into Australia’s Future in Research and
Innovation also cautioned that:
If a patent box is introduced, it should be subject to a
sunset clause after three years of operation. A review should be undertaken to
determine the effectiveness of the patent box scheme and whether it should be extended
and for how long. (p. xv)
Advocates
of patent boxes (e.g. medical companies and some industry stakeholders) argue
that the tax regime will promote the commercialisation of research in Australia.
They believe this is one of the key differences between patent boxes and
R&D tax incentives (pp. 2, 10).
Many countries (including Australia) have already introduced
R&D
tax incentives as a policy tool to encourage innovation. Australia’s
current R&D tax incentive program is ‘input‐based’—that is, the program
encourages companies to invest in eligible
R&D activities, and in return the companies receive a tax benefit
regardless of whether they ultimately commercialise their research.
Patent box tax regimes are ‘output‐based’ measures
that provide tax concession for corporate income generated from patents already
filed and registered—that is, after the R&D has occurred. If a patent is
not commercialised and generates no income, then the patent owner is unable to
claim the patent box’s concessional tax rate.
When a company develops a patent in Australia, it can choose
to commercialise the patent by licencing the use of the patent to Australian or
overseas manufacturers. The patent box regime is intended to incentivise the company
to commercialise the patent onshore in Australia by providing a concessional
CIT rate for the corporate income generated from the patent.
CSL
Limited, a biotechnology company, stated:
CSL welcomes the introduction of a Patent Box which will help
decrease the flow of intellectual property from local medical research going
overseas. It will drive the growth of advanced manufacturing jobs, capital
intensive investment and sovereign capacity in medical technology and
biotechnology manufacturing.
Table 1 provides an overview of the potential benefits and
drawbacks of patent boxes put forward by stakeholders and academics.
Table 1: Potential benefits and
drawbacks of patent box regimes
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Potential benefits of a patent box
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Potential drawbacks of a patent box
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Patent boxes
may incentivise firms to undertake more R&D activities as the cost of
doing so is reduced due to lower taxation (see Office of Chief economist,
Department of Industry, Innovation and Science, ‘Patent
Box Policies’, pp. 9-10).
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Due to the tax concession, patent boxes may lead to
a decrease in tax revenues collected from innovative firms (‘Patent Box Policies’, p. 10).
Furthermore, patent boxes may lead to a ‘the rich
getting richer’ situation because the tax concession could increase the
post-tax profits of large pharmaceutical companies that possess a large
number of patents (Institute for Fiscal Studies (UK), ‘Corporate
Taxes and Intellectual Property: Simulating the Effect of Patent Boxes’, p. 15).
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By providing a
concessional tax treatment, patent boxes may encourage firms to patent
inventions that would have otherwise been kept secret (‘Patent
Box Policies’, p. 10).
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Additional patent applications may be
‘opportunistic’ and not tied to real economic activity (‘Patent Box Policies’, p. 25).
Additional patent applications may also lead to a
‘patent gridlock’ situation, when miniscule aspects of a technology are
patented and new innovators lack the resources to access relevant patents to
start their research.
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Increased
volume of patents will mean increased revenues for the patent office, as well
as greater disclosure of technical knowledge (‘Patent
Box Policies’, p. 11).
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Increased patent volumes may not deliver purported
benefits where the patent office does not have the requisite resources to
process patents. Further, an inadequately resourced patent office may lead to
a backlog of applications, creating greater uncertainty and placing increased
pressures on start-ups who are looking to secure funding based on the patent
being processed (‘Patent Box Policies’, p.11).
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Patents boxes
could encourage the commercialisation of research as the tax incentives are
‘output based’ (Institute of Public Accountants, ‘2020-21
Pre-Budget Submission’, p. 35).
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Not
all R&D is patentable. As proposed, patent boxes provide tax concession
to patents only and this may discourage companies to engage in un‑patentable
research (Alstadsæter et al, ‘Patent boxes design, patents location, and local
R&D’, Economic Policy Journal, p. 138).
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Depending on
the specific design of patent boxes, they could reduce the erosion of domestic
tax base by encouraging firms to commercialise R&D activity which has
occurred locally (Australian Medical Manufacturing Exporters Coalition, ‘2021-22
Pre-Budget Submission’, p. 10).
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Depending on the design, patent boxes could
encourage multinational firms’ profit shifting activities (Tax Justice
Network, ‘Corporate Tax Haven Index 2019’, pp. 3–4). This is particularly pertinent given the
sensitivity of multinationals to patent box tax rates, and the difficulties
associated with accurately attributing revenue to a specific patent.
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