Patent box relief explained for founders: when the patent is worth filing

Patent box is an election. You claim it in the corporation tax return, and if you don’t elect, nothing happens, however well you qualify.

The election applies a 10 per cent rate to the slice of trading profit that comes from a patented invention, rather than the main rate of 25 per cent. That slice can come from selling a product with the patented part in it, licensing the patent out, selling the rights, using the invention in a service you charge for, or compensation for someone infringing it.

Three conditions sit behind that. Your company has to be liable to corporation tax. It has to own the patent or hold an exclusive licence over one granted by the UK Intellectual Property Office, the European Patent Office or one of the listed EEA offices. And your company, or another company in your group, has to have done qualifying development on the invention. Buying a patent and sitting on it doesn’t get you there.

The last point is the one founders miss: the relief lands on profit. A company still spending a seed round has no profit for a lower rate to bite on, so the election is worth planning for and worth nothing yet.

Two things usually stop it, and both are worth being honest about early.

The first is the patent. A computer program as such isn’t patentable in the UK, so a lot of software gets nowhere at the IPO unless there is a technical effect behind it: something the invention does to a process, a device or the way a machine works, rather than a better interface or a cleverer workflow. Founders building hardware, instruments, materials, diagnostics or control systems are in much better territory than founders building a web app.

The second is profitability. Patent application costs land years before the first penny of relief, and the grant itself is rarely quick.

If you are pre-profit with nothing filed, R&D is the relief that pays now, and it pays in cash or in a reduced tax bill rather than in a rate cut on profits you haven’t made yet. We would rather see a founder get the R&D claim right and revisit patent box once the product and the profit exist. Filing a patent purely for the tax rate is an expensive way to be disappointed.

If a patent does make commercial sense, the timing works more kindly than people expect.

Income earned while the application was pending can be brought into the calculation once the patent is granted, which means the filing date does a lot of work for you. A company that files early, grows revenue on the product while the application sits with the IPO, and then gets the grant can pick up those earlier years in the grant period rather than losing them.

What you can lose is the election. It has to be made within two years of the end of the accounting period the relevant profits fall into. So a company that becomes profitable, forgets about patent box for three years and then remembers has quietly written off the earliest years. I have seen that happen where the patent was handled by solicitors, the accounts were handled by somebody else, and nobody connected the two.

The practical move is unglamorous: tell whoever prepares your corporation tax return the day you file, and put the election on the year-end checklist from that point on.

Patent box profit is not your profit. The calculation splits your income into streams by IP right, product, or product family, allocates costs against each stream, then strips out a routine return for the ordinary business functions and a return for marketing assets. What’s left is the profit the 10 per cent rate applies to.

Two more things can cut it. If you bought the patent in, or paid a connected company for the research and development behind it, the R&D fraction reduces the benefit. And HMRC has said plainly in its own guidance that computations often arrive without enough supporting detail, which opens a compliance check that is usually resolved once the missing detail turns up.

All of which is an argument for coding your books properly from the filing date rather than reconstructing three years of product-level revenue and cost from bank statements later. In Xero or QuickBooks that means tracking categories or product codes on sales and on the costs that genuinely belong to them: direct development, production, support. It costs nothing to set up while the numbers are small and it is painful to retrofit once they are not.

These two reliefs are often sold separately and they shouldn’t be read separately. R&D reduces the profit you pay tax on now. Patent box reduces the rate on part of the profit later. The extra deduction from an R&D claim lands against the income stream it relates to, which is frequently the patented product, so it reduces the patent box profit in the same computation.

Run in isolation, by two different firms who never speak, the numbers come out wrong and the return takes longer to defend. Both sit in the same corporation tax return anyway: the CT600L and the additional information form for R&D, the election and the streaming computation for patent box.

We prepare both in house, and the same qualified person who does your year end does the claim. That is a deliberate choice. A claims shop that parachutes in, files a number and leaves has no view of your accounts, your group structure or what you did with the IP, and you are the one who answers HMRC’s questions. More on how we handle it on the R&D and patent box page.