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Box Clever

The start of April was a landmark date for patent-rich pharmaceutical businesses in the UK. Not only did it see the introduction of above-the-line R&D tax credits, but the government’s long-anticipated Patent Box also came into force, reducing UK corporation tax on patent profi ts. These new changes give a welcome boost to innovation and provide incentives to companies to retain intellectual property (IP) in the UK. But will this be enough to protect one of the UK’s most valuable sectors?

The life sciences industry is a key strength for the global economy, but even this once ‘recession-proof’ sector has not gone untouched by the current economic gloom. With new drugs typically taking 12-15 years to develop, at a cost of around £1 billion, and with no guarantee of success, a squeeze on finances all round has left the sector exposed.

Another blow is the devastating impact of the patent cliff on revenues, as high-earning blockbuster drugs lose out to generics. Gone are the halcyon days of the broken blockbuster model – instead, beleaguered pharmaceutical companies are cutting back on expensive and time-consuming R&D and diversifying into more gainful areas.

Industry Investment

The British government recognises the importance of overcoming these challenges. As the third-largest contributor to economic growth, bringing an annual turnover of £50 billion, the life sciences industry is strategically important to the UK. Just over a year ago, the government published its Strategy for UK Life Sciences to invest in growth for the industry, which included a £180 million catalyst fund to support biomedical start-ups, a consultation on opening up the NHS to life sciences companies, and a shake-up of the R&D tax credits system. The results are promising: in the first 12 months, this has generated more than £1 billion investment for industry and the private sector.

The government hopes the new Patent Box will help re-establish the UK’s position as a world leader in patented innovation. Introduced on 1st April, this preferential regime will reduce UK corporation tax on patent profi ts to 10 per cent, encouraging innovation across high-growth industries that rely on cutting-edge R&D, such as pharmaceuticals, and protecting these investments through the added benefits of IP ownership in the UK.

These changes are vital if the UK is to ward off competition from overseas. European countries such as Ireland, Switzerland and Luxembourg have had similar regimes in place for years, giving them a competitive edge over the UK, while many multinationals are now looking to emerging markets to recoup losses. China, for example, saw patent applications rise by more than 20 per cent this year – the fastest rate of growth anywhere in the world. More and more multinationals are looking to relocate R&D to the Far East.

While the UK’s existing system of R&D tax credits has given some relief for spending on R&D, it simply has not been able to compete against the advantages of other countries. What is more, until now there has been no similar incentive for businesses to retain IP in the UK once it has been created.

Far Enough?

While the move has been welcomed by the industry – pharmaceutical giant GSK, for example, showed its support by announcing a £500 million investment in Britain – the fact remains that the UK’s overall effective tax rate of 10 per cent will still be higher than those of Europe’s Patent Box trailblazers. Belgium and Luxembourg, for instance, offer maximum effective tax rates of 6.8 per cent and 5.9 per cent respectively. There are also anomalies – the UK Patent Box is designed as a ‘one size fits all’ model for all sectors and industries, and will not necessarily provide an optimal tax position for many companies. Phased in over time, the full effect of the relief will not be felt until 2017.

Luxembourg provides a great point of comparison. Introduced five years ago, Luxembourg’s Patent Box regime is now well-established among domestic and multinational companies. It exempts 80 per cent of royalties, damages and capital gains realised on certain IP rights, creating an effective tax rate of around five per cent – half that of the UK Patent Box.

The Luxembourg Patent Box also has other advantages over the UK’s offering. It applies not only to patents, but also to other forms of IP such as trademarks, designs, internet domains and software copyrights. These will not be covered in the UK, where they are not considered central to the high-growth, R&D-rich activities the government wants to encourage.

This might prove short-sighted. The global pharmaceutical industry is undergoing substantial change as struggling companies diversify into e-health and medical devices – fields that require a convergence of technology with traditional pharmaceuticals. Medical devices, for example, often gain market share based on software, user interface and other functionality that is not necessarily protected by patent. As a result, countries like Luxembourg, where the Patent Box encompasses non-patent IP, may have an edge over the UK in the long-term.

Even when it comes to patents themselves, the UK may find itself on the back foot. Luxembourg taxpayers developing and using patents internally (and therefore involving no licensing activity) may be entitled to a notional tax deduction equal to 80 per cent of what a third party would have paid for the use of such a patent. As it stands, the UK Patent Box will only apply to patents granted in the UK and some other European countries, and not to those granted to UK healthcare and pharmaceutical companies in other major R&D centres like the US and Japan.

Consequences for UK Pharma

As the case of Luxembourg shows, businesses and governments alike can reap huge rewards from an attractive Patent Box system, but the UK must keep pace. Even after Patent Box and above-the-line R&D tax credit beds in, Britain could still lag behind the regimes of European counterparts, opening up the risk that pharmaceutical companies will emigrate overseas – at a huge loss to the British economy, where much early stage R&D is currently invested.

Meanwhile, multinational companies will need to analyse the pros and cons of competing regimes to decide where best to hold their patents. To take full advantage of Patent Box, they must also review their tax and transfer pricing arrangements, as well as the terms of joint ventures, licensing arrangements, business disposals and acquisitions, and plans for group reorganisations. Despite anomalies, the Patent Box could create substantial savings for businesses and give a boost to UK innovation.

More broadly, the introduction of Patent Box may also have an impact on wider regulatory issues in the UK. In 2009, the European Commission suggested that strategies for secondary patents – those covering new products or processes that use existing ingredients already under patent – were often aimed at preventing generic companies from entering the market, rather than protecting new innovative products. Now, these strategies may also be driven by tax incentives: pharmaceutical companies may divert much-needed R&D investment towards quick-win secondary patents to boost their Patent Box relief. If this proves to be the case, competition authorities may consider stepping in to examine any excessive use of weak secondary patents for such tax benefits.

Watch This Space

It will certainly be interesting to watch the impact of Patent Box and above-the-line R&D tax credit in the coming months. While anomalies will almost certainly need to be ironed out, these measures are a welcome next step in the government’s strategy to attract investment and secure the UK’s foothold in the global life sciences market. That said, the jury is still out on whether this will provide the shot in the arm needed to keep life sciences businesses in the UK, and more will be needed in the coming months and years to keep what UK Prime Minister David Cameron has called “the jewel in the crown”.

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Nick Beckett is a Partner at leading law firm CMS Cameron McKenna, where he heads the Intellectual Property Practice and Lifesciences Industry Group. He represents high-profile companies in the life sciences sector, and also coordinates pan-European patent enforcement and other IP advice for a number of clients.
Nick Beckett
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