Patent box regime: Time for a market-oriented approach

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Updated: April 20, 2016 11:27 AM

The new patent box regime, despite its limited scope and a tentative beginning, will no doubt address multiple market failures

Government has brought a concessional tax regime for patent income, with a view to encourage indigenous research & development activities and to make India a global R&D hub. Under this concessional tax regime, any company, which has registered any patent, would be able to reduce the tax on the royalty earned out of that patent, from 30% to 10%, besides applicable surcharge and cess; the only condition being that the patent should have been developed and registered in India under Patents Act, 1970. These amendments will take effect for all the patents registered after April 1, 2016. The concessional tax regime for patent box, the budget memorandum states, is out of the OECD BEPS recommendations on nexus approach which prescribes that income arising from exploitation of intellectual property (IP) should be attributed and taxed in the jurisdiction where substantial R&D activities are undertaken rather than in the jurisdiction of legal ownership only. The downside of the new regime is that no expenditure or allowance in respect of such royalty income shall be allowed under the Act.

The new patent box regime is laudable and is in line with the Make in India effort of the government. For many years, the government had provided R&D tax credits and tax incentives to encourage companies to invest and attract R&D activities. But, the number of international patents filed in India continues to be very low—in 2015 as per the WIPO, 57,385 international patent applications were filed in the US, 44,235 in Japan, 29,846 in China, 18,072  in Germany, 14,626 in Korea, and only 1,423 in India; the story for trademark registrations also remains the same—with 7,340 in US, 6,831 in Germany, 4,021 in France, 2,205 in Japan, and 150 in India. In fact, as per the World Bank, India’s rank in 2012 in the Knowledge Economy Index was 100, and has remained largely unchanged for many years.

The concept of patent boxes, to serve as a tax incentive to companies to exploit their patented IPs, has not been uncommon. UK had also set up patent boxes, in 2013, to encourage companies to retain their IPs in UK and exploit through UK companies. But such patent box regimes came under criticism and this practice was seen as a means to artificially shift profits between European countries, and in various forums, in particular at the time of discussion on BEPS on harmful tax practices adopted by the countries, the UK has had to defend the patent box scheme against accusations. Later, the UK government had agreed to put forth a proposal to close its patent box tax break. But, that fear seems to have subsided particularly after the BEPS recommended new rules based on what is called a ‘modified nexus approach’, designed to ensure that economic activity that actually takes place within the country that grants R&D tax break. Indian authorities have taken cue from there and have announced the patent box regime. Such patent box regimes of the UK has benefited the economy. It is reported that the GlaxoSmithKline had attributed to the patent box its additional investment of £500 million in manufacturing, along with the creation of 1,000 new jobs and the construction of a new factory.

Another country, which had also introduced patent box regime was the Netherlands, in 2007. But, due to the restrictive nature and complexity of the regime, this was not embraced wholeheartedly, and later an improved version, called Innovation Box, was introduced in 2010. Under the Innovation Box regime, a tax rate of 5% was applied to the income generated by a qualifying intangible to the extent the income from the intangible exceeds the related R&D expenses, other charges and amortisation of the intangible. No doubt, this did lower the tax rate significantly, considering the normal corporate tax rate was 25%, and also any expenses or losses related to the intangible was deductible at the ordinary rate.

Other examples of patent box regime or its variations are: Ireland applies  zero tax with a graduated income cap that eventually reaches the statutory corporate tax rate of 10%, Switzerland applies a rate between zero and 12% depending on what is negotiated during the tax ruling process, France and Spain have the highest rate of 15%, but that is still considerably lower than their statutory corporate rates, and Belgium and Luxembourg allow 80% of qualifying gross patent boxes tax qualifying profits—those derived from patents or in some nations additional kinds of IP—at a lower rate in order to incentivize innovation.

So, question arises whether enough has been done to attract creation of IPs in India? Two issues being pointed out: why restrict the concessionary tax regime only to patents, why not make this also available to other IPRs, like industrial design, copyrights, trademarks, etc., and second, patents get filed in its early stages of development and later, further innovation is required to make it marketable, also patents need protection and other such issues relating to IPR creation, can the expenditure incurred on them be allowed?

In India, during 2013-14, a total of 4,227 were granted patents, which increased to 4,817 during the period, April 1, 2014 to December 31, 2014. On the other hand, 7,178 designs were registered during 2013-14, and 5,373 during the same period in FY 2014-15. Since industrial designs are gaining currency and India has of late woken up to that, it is important to consider it too for inclusion in the patent box (the new name could be, innovation box, to express the expanded scope). This regime could also include semiconductor integrated circuits layout-design, an IPR requiring registry and an important focal area for Make in India. So, it will be useful to include some of the important IPRs too.

Coming to the question on expenditure allowance, the new law does not provide for any expenditure, neither for patent creation nor for post-registration. While there may be some issues on pre-patent expenditure, as the innovator may be availing of the R&D expenditure, but post-patent filing expenditure can be considered for deduction under the regime.

The new patent box regime, despite its limited scope and a tentative beginning, will no doubt address the multiple market failures—including spillovers of the benefits to firms not making the investments in innovation—and the tax incentive will help correct these failures. It is also important to recognize that the process of innovation is now much more global, and countries have realized that they need a more competitive tax regime for innovation-based companies. India needs innovation regime in life sciences, electronics, chemicals, energy, aviation, etc. to emerge as a global R&D hub. It is time it presents a market-oriented regime. An impact assessment of the gains from this regime should, however, be made to make it useful. The results of the impact assessment could suggest any course correction, if so required.

The author is senior advisor, Deloitte India

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