Budget 2011 – Chancellor confirms details of “Patent Box” and other corporate tax reforms – further consultations in May

As we reported in the January issue of InFocus the long anticipated document entitled “Corporate Tax Reform” was published by the UK Government on 29 November 2010. The document outlined the intended changes to the corporate tax system in the UK over the next 5 years to deliver a more competitive and stable tax system. The most significant areas for reform and of particular interest to IP rich companies are the much criticised controlled foreign company (“CFC”) rules, the foreign branch profits exemption and the treatment of intellectual property rights.

In his budget on 23 March 2011 the Chancellor announced:

1. A reduction in the corporation tax rate to 26% would be applicable from April 2011 with a reduction in the corporation tax rate by 1% for each year until it reaches 23% in 2014;
2. Legislation relating to interim improvements to the CFC regime will be included in the draft Finance Bill 2011 which will be published on 31 March 2011.  The interim improvements are to have effect for accounting periods beginning on or after 1 January 2011, except for the extension to the transitional rules for holding companies (which is treated as always having had effect).  Following consultation, some changes were made to ensure that the interim improvements achieved their desired effect.  The interim measures focus on restricting the application of the rules to profits artificially diverted from the UK and:
• Introduce exemption for certain intra-group trading transactions with little connection with the UK;
• Exempt CFC's with a main business of IP exploitation where the IP and the CFC have minimal connection with the UK;
• Introduce a 3 year statutory exemption for foreign subsidiaries which, as a consequence of a reorganisation or change to UK ownership, come within the scope of the CFC regime, including subsidiaries that were formerly CFCs under UK headed groups where they return to the UK;
• Increase the de minimis exemption to £200,000 of profits per annum (increased from £50,000 per annum);
3. A consultation document detailing the full reform to the CFC regime will be published in May 2011.   Draft legislation will be published in autumn 2011 for inclusion in the Finance Bill 2012.  The Chancellor has confirmed that the regime will introduce a mainly entity based system operating in a more territorial way aimed only at bringing within the CFC charge such proportion of overseas profits that have been artificially diverted from the UK.  It is confirmed that the full reform will include a finance company partial exemption that results in an effective UK tax rate of 25% of the main rate on profits from overseas group financing arrangements.  This would result in an effective rate  of 5.75% on such finance company CFCs by 2014 (when the corporation tax rate reduces to 23%, and as compared with the effective rate of 8% previously proposed in the "Corporate Tax Reform" document);
4. A detailed consultation document the Patent Box will be published in May 2011.  The Chancellor confirmed that the Patent Box regime will be an optional regime involving a 10% tax rate for profits arising from patents (and not other intellectual property rights) on or after 1 April 2013 where the patents are first commercialised after 29 November 2010.  It has already been announced that this will be in the Finance Bill 2012.
5. A response will be published in May 2011 following consultation on R&D tax credits and in light of the recommendations of the Dyson review. 
6. The following changes to R&D tax credits will apply subject to State Aid approval:

• Legislation will be introduced in Finance Bill 2011 to increase from 75% to 100%, the additional deduction for qualifying R&D expenditure given to small or medium sized enterprises (SMEs) such that, for expenditure incurred on or after 1 April 2011, a total deduction of 200% would be available (although Vaccine Research Relief will be reduced to 20% of qualifying R&D relief on vaccines research from 1 April 2011);
• Legislation will be introduced in Finance Bill 2012 to increase the additional deduction by a further 25% giving a total deduction of 225% from 1 April 2012 (although SMEs will be prevented from claiming Vaccine Research Relief);
7. Subject to consultation, the inclusion of measures in Finance Bill 2012 to simplify the rules for R&D tax reliefs for SMEs such as:
• Abolishing the rule limiting a SME company's payable R&D tax credit to the amount of PAYE and national insurance contributions it pays;
• Abolishing for all companies the £10,000 minimum expenditure condition; and
• Changing the rules governing the provision of relief for work done by subcontractors under the large company scheme.

Lawyers Nikol Davies