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IP and R&D Planning for Small or Medium Sized Enterprises
Small and medium sized enterprises (SMEs) can benefit from a research and development (R&D) tax incentives regime in the UK. In the past, it was a requirement that the intellectual property developed was owned by the UK company. Back in December 2009 the then Labour Government announced an intention to remove this intellectual property ownership requirement. As is normal in an election year, the Government did not manage to get all of their proposed changes through Parliament in the first Finance Act (this one is called the Finance Act 2010) which was passed by the Labour Government shortly before the country voted for change. Taxand UK and Taxand Luxembourg review international IP planning and the benefits for UK SMEs to claim R&D tax incentives in the UK.
Ignoring the debate about whether the change that the country voted for actually occurred, we did indeed awake one morning to find that we had a change of Government and we were now lead by a Conservative and Liberal Democrat coalition. It is highly unusual for the UK to have a coalition government and this is in fact only the second one in my lifetime. Who knows, perhaps we will learn from our colleagues and friends in Europe and have more coalitions in the future?
In any case, I digress; the point of this story is tax policy! The new coalition went to work almost immediately and put a second Finance Bill through the House to reflect the changes that they wanted to make with their own Emergency Budget. This Bill went on to become the Finance No.2 Act 2010 and is now law. Having put through the Emergency measures the Government decided to consult on the changes proposed by the former Labour Government, one of which included the proposed change to the R&D regime for SMEs.
The change has been included in the third Finance Bill for 2010 (which incidentally is called the Finance No.2 Bill 2010, but will eventually become the Finance No.3 Act 2010 - don't ask!). The proposed change is to drop the requirement for an SME to hold the IP that arises from qualifying R&D activity. The changes should apply for companies in accounting periods ending on or after 9 December 2009.
So what does this mean?
In the UK we have two different regimes that incentivise companies to perform qualifying R&D activity. The one that applies to SMEs is more generous than the regime that applies to large companies.
An SME can claim enhanced tax deductions on qualifying expenditure of 175% of the costs as compared to 130% for a large company. In addition, if the SME is making losses it can surrender them for a cash tax repayment of up to 14%. The cash tax repayment is not available to large companies.
The definition of an SME is taken from EU regulations. Broadly speaking a company will be an SME if it has less than 500 employees and either turnover not exceeding EUR100m or an annual balance sheet total not exceeding EUR86m.
One feature of the large company regime is that it is possible to have contract R&D being performed by a UK company and claim the additional deductions on the qualifying R&D activity. This means that such companies can use international structures for holding their IP (for example Luxembourg will exempt 80% of the royalty income on qualifying IP), benefit from a favourable regime in the IP holding jurisdiction and still claim a tax credit. Until now this has not been possible in the SME regime because of the requirement for the UK Company to hold the IP created as part of the qualifying R&D activity.
We believe that we are about to see a number of SMEs engage in tax planning to take their IP out of the UK tax net. Typical structures to be used could be variations of these below:
This outbound structure would need analysis from a controlled foreign company's perspective to ensure that the profits of the Luxembourg subsidiary are not taxed at the UK level. Nevertheless, at Luxembourg level, royalties received by the Luxembourg company from the licensing of the IP would, under certain conditions, benefit from the 80% exemption (in other words, they are taxed at around 6% in Luxembourg). Royalties should be fully deductible at the level of the licensee (including, as the case may be, the UK parent company). At the same time additional tax deductions from the R&D incentive regime should be able to be claimed by the UK Company.
Not interested? Then simply consider that the 80% exemption (yes, the 6% rate) would also apply to the capital gains realised on the sale of the IP. The profits thus generated by the Luxembourg IP Co (royalties and gains) could be distributed free of withholding tax to the UK parent where they will benefit from the UK participation exemption.
This inbound structure has all of the benefits of the outbound structure above but does not need any analysis from a controlled foreign company's perspective.
The door to tax efficient international IP planning is now open to UK SMEs that claim R&D tax incentives in the UK.
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