Profits from the exploitation of patents: cost-sharing arrangements

Finance Bill – in a Public Bill Committee am 12:30 pm ar 19 Hydref 2017.

Danfonwch hysbysiad imi am ddadleuon fel hyn

Photo of Anneliese Dodds Anneliese Dodds Shadow Minister (Treasury) 12:30, 19 Hydref 2017

I beg to move amendment 31, in clause 23, page 32, line 45, at end insert—

(1) Within fifteen months of the passing of the Finance (No. 2) Act 2017, the Commissioners for Her Majesty’s Revenue and Customs shall complete a review about the effects of the changes to cost-sharing arrangements.

(2) In this section, “the changes to cost-sharing arrangements” means the changes to this Part of this Act made by section 23 of the Finance (No. 2) Act 2017.

(3) The Chancellor of the Exchequer shall lay a report of the review under this section before the House of Commons within three months of its completion.”

This amendment would make statutory provision for a review of the effects of the changes relating to cost-sharing arrangements on profits from the exploitation of patents or similar intellectual property.

With this it will be convenient to debate clause stand part.

Photo of Anneliese Dodds Anneliese Dodds Shadow Minister (Treasury)

As hon. Members will be aware, the patent box system in the UK was introduced following the Labour Government’s 2009 Budget, which committed to,

“consider the evidence for changes to the way the tax system encourages innovative activity and the relative attractiveness to global firms as they make decisions on where to locate their research and development and other innovation activities.”

As a result of that commitment, the patent box was created, intended to cover income from patents dating from April 2013. In 2010, before it came into practice, it was altered by the coalition Government.

The patent box rules reduced the corporation tax that accrues to profits from the development and exploitation of patents and some other forms of intellectual property. Our regime was identified during the OECD BEPS process, which we have already referred to this morning, as harmful and open to abuse. It was also identified as potentially harmful by the EU’s code of conduct group in 2013. It is therefore positive to see attempts to tighten the regime, following other measures that were discussed last year.

We have already seen a shift to the nexus basis for identifying the fraction of profits that will be allowed in a claim through the patent box as derived from R and D activities. That brings us in line with international best practice. It is good to see other countries adopting that approach as well. In this context, the British tax regime undoubtedly will have some impact on business investment decisions, but comparative evidence suggests that other factors, not least infrastructure and the availability of highly skilled researchers, technologists and other workers, are most significant to our overall competitiveness.

These provisions would ensure that companies that undertake research and development as part of cost-sharing arrangements are neither penalised nor advantaged, so in effect the provisions are designed to be more neutral as regards group structure. Having said that, the draft legislation is highly complex. Furthermore, the whole basis for the provisions is the approach agreed by the OECD that R and D spending is a proxy for R and D effort. We suggest that those provisions should be reviewed, because we think that more work is needed to ensure that those two concepts are aligned to prevent potential abuses. The provisions have put us under the international spotlight, so it is important that, as we continue to try to preserve and enhance research and development effort in the UK, we also live up to our international obligations. That is why we think that a review would be appropriate.

Photo of Mel Stride Mel Stride Financial Secretary to the Treasury and Paymaster General 12:45, 19 Hydref 2017

The Opposition amendment would require the Government to review the effects of the changes to cost-sharing arrangements made in clause 23. Before I set out why that review would be inappropriate, I will remind Committee members of the background of the clause and what it is designed to achieve.

The clause introduces provisions for companies undertaking R and D collaboratively under a cost-sharing arrangement that will ensure that those companies are neither advantaged nor disadvantaged compared with those undertaking R and D outside such an arrangement. Following the calling of the general election and subsequent wash-up negotiations between the Government and the Opposition, clause 23 was removed from the Bill that became the Finance Act 2017. The Government propose that the provisions in the clause will apply from 1 April 2017 as originally intended and announced.

The UK patent box was introduced by the coalition Government in 2012. It provides a reduced rate of tax to companies exploiting intellectual property, such as patents, to incentivise them to grow their businesses and to create jobs in the UK. The Finance Act 2016 included changes to the patent box rules in line with the new international framework agreed by the OECD for intellectual property regimes, as part of the BEPS action plan. The main change was the introduction of the R and D fraction, which connects the amount of profit from an item of intellectual property that can benefit from the patent box to the proportion of the R and D activity undertaken by the claimant company.

The 2016 Act did not directly address R and D undertaken as part of cost-sharing arrangements, as it required further consultation to ensure that, as the hon. Member for Oxford East pointed out, very complex collaborative arrangements are appropriately addressed. Following completion of the consultation, the clause now adds specific provisions to deal with cost-sharing arrangements.

Under a cost-sharing arrangement, typically companies agree to undertake a proportion of R and D activity as part of a collaborative project, therefore receiving a commensurate proportion of income if the project is successful. That means that the calculation of the R and D fraction must take into account how the company has discharged its proportion of the R and D costs throughout the life of the arrangement.

The arrangements create specific challenges in the application of the OECD framework. Over the life of the arrangement, the claimant’s R and D activity may fluctuate year on year and trigger additional top-up contributions—balancing payments—payable to and from the claimant company to other companies in the cost-sharing agreement. Although at the end of the project the claimant may have met its agreed proportion of R and D costs, the interim position can differ greatly. Without providing a specific mechanism to deal with the treatment of the payments, the claimant’s R and D fraction would be unduly depressed, putting it at a comparative disadvantage to claimants undertaking R and D outside a cost-sharing arrangement. The changes made by clause 23 are therefore exclusively focused on addressing that issue. Specifically, balancing payments made by the claimant will generally be treated as if subcontracted to the other member of the cost-sharing arrangement, so the impact on the fraction will depend on whether the two parties are connected.

It might be helpful at this stage to remind the Committee that under the revised patent box rules, payments to connected subcontractors reduce the R&D fraction, as does spending on acquired intellectual property, in line with the OECD guidelines. Balancing payments received by the claimant—that is, receipts—will be offset against outgoing payments, again depending on the relationship between the parties.

The hon. Lady raised the question whether that could be used for the purposes of tax avoidance. My comment is that the OECD base erosion and profit shifting project agreed an acceptable framework for intellectual property regimes that would address concerns about profit shifting, and the UK patent box regime was revised in the Finance Act 2016 to align with that framework. The changes ensure that the amount of profit and benefit from the patent box is restricted to the proportion of research and development undertaken by the company when compared with the total research and development. As a result of the changes, the payments and receipts should net out to ensure that, at the end of the project, the claimant’s R&D fraction reflects only the costs it has incurred to meet its agreed share of R&D activity.

Amendment 31 would impose a requirement on the Government to undertake a review of the effects of these changes to the patent box regime. However, the Government have carefully considered the regime and consulted extensively with stakeholders to ensure that the changes comply with the relevant international frameworks and provide no opportunities for abuse. The Government regularly publish statistics on the patent box and will continue to monitor the impacts of both the patent box and these legislative changes. On those grounds, I urge the hon. Members to reject the amendment.

Photo of Anneliese Dodds Anneliese Dodds Shadow Minister (Treasury)

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 23 ordered to stand part of the Bill.

Clause 24 ordered to stand part of the Bill.

Schedule 7 agreed to.

Clause 26 ordered to stand part of the Bill.

Clause 27