Australia: Patent box legislation introduced to parliament

Following extensive public consultation, the bill sets out the proposed design of the patent box which implements a concessional effective income tax rate of 17% for eligible income derived from medical and biotechnology patents with effect for income years starting on or after 1 July 2022.

The Morrison Government today introduced legislation to create Australia’s first Patent Box to drive more investment, create more jobs and back Australian companies to commercialise their cutting‑edge innovations in Australia.

The Bill implementing Australia’s highly anticipated patent box has been introduced into the Australian Parliament (the Treasury Laws Amendment (Tax Concession for Australian Medical Innovations) Bill 2022), following the Australian Government’s announcement in the 2021-22 Budget (see our prior alert here ).

Following extensive public consultation, the bill sets out the proposed design of the patent box which implements a concessional effective income tax rate of 17% for eligible income derived from medical and biotechnology patents with effect for income years starting on or after 1 July 2022. Australia’s current corporate income tax rate is 30% or 25% for certain small business entities.

Patent Box legislation introduced into Parliament to support investment and jobs

The Patent Box is a part of the Government’s economic plan, announced as part of the 2021‑22 Budget, which will increase investment by ensuring innovative Australian businesses are incentivised to commercialise their research and development in Australia.

This new concession, provided through Australia’s patent box regime, will support research and development for decades to come, as well as help retain Australian innovations in Australia during commercialisation and complements the Government’s additional $2 billion investment in the Research and Development Tax Incentive announced in the 2020‑21 Budget.

Following consultation, the Government has made two significant expansions to the patent box:

• allowing patents issued by the United States Patent and Trademark Office or granted under the European Patent Convention to access the regime; and
• allowing patents granted after Budget night to be eligible, rather than only those applied for after Budget night.

In welcome news, the Australian Government has adopted two of the key improvements raised by Baker McKenzie in our submission on the proposed regime and by a range of stakeholders:

• The patent box applies to patents granted or issued after 11 May 2021, not just those patents applied for after 11 May 2021, recognising that the patent lifecycle involves long lead times from application to ultimate grant of a patent.
• Eligibility for the patent box is no longer limited to owners of Australian patents, but has been extended to owners of utility patents issued by the United States Patent and Trademark Office and European patents granted under the Convention on the Grant of European Patents. The Government states that 97% of medical and biotech patents filed by Australian entities are filed in at least one of these three jurisdictions, and consequently almost all Australian medical or biotechnological inventions should be caught.

Although other suggestions made in consultation have not been implemented, the patent box is a welcome development in improving Australia’s tax competitiveness for medical and biotechnology commercialisation decisions.

The key prerequisites companies must meet to take advantage of the patent box

• Patentee of an Australia, US or European patent.
• Make an irrevocable election to access the patent box by the time the income tax return is due for the first income year in which they wish to access the patent box.
• Patent linked to a therapeutic good that is on the Australian Register of Therapeutic Goods maintained by the Therapeutic Goods Administration.
• Derive income from the exploitation of the qualifying patent(s).

As the patent box relies on a combination of existing transfer pricing rules and the R&D tax incentive, it will be critical that taxpayers prepare robust transfer pricing documentation to support how eligible income has been calculated. Taxpayers should carefully consider the compliance work required and other tax impacts before opting in due to the irrevocable nature of the election.

R&D fraction

The R&D fraction acts as a measure of the taxpayer’s involvement in the R&D conducted to develop the eligible patent. Consistent with OECD requirements, this ensures a link between the benefits of the concessional patent box regime and the R&D activities undertaken in Australia.

The fraction is applied for each patent box income stream (following the reasonable apportionment in step 2) to limit the income that can benefit under the patent box.

Very broadly, the fraction is equal to the taxpayer’s R&D expenditure with respect to the eligible patent as a proportion of the taxpayer’s total expenditure with respect to the eligible patent, including expenditure on R&D activities conducted outside Australia by the taxpayer’s associates, with certain adjustments. A 30% uplift is then applied to the fraction to ensure taxpayers are not excessively disadvantaged for acquiring intellectual property or outsourcing activities overseas to related parties.

“R&D expenditure” is defined by reference to the R&D tax incentive and consequently only captures the R&D expenditure incurred by the taxpayer for R&D activities undertaken in Australia. A taxpayer who solely undertook the R&D themselves in Australia to develop the patent would have an R&D fraction of 1.

Conversely, a taxpayer who outsourced the R&D activities to a related party overseas (even if those activities qualified for an Overseas Finding under the R&D tax incentive), or acquired intellectual property developed by another party, would have an R&D fraction of less than 1. As such, outsourcing clinical trials to a related party overseas may reduce the patent box income that qualifies for concessional tax treatment.

Only R&D expenditure incurred for the purposes of actual R&D activities (as defined in the R&D tax incentive) in the development of an eligible patent can constitute qualifying expenditure for the purposes of the R&D fraction. This link to the R&D tax incentive means that taxpayers accessing the patent box are already subject to existing record-keeping obligations to substantiate their R&D expenditure and R&D activities.

Holding the patent

The entity must “hold” (i.e. own) rights over an eligible patent, and for the purposes of the Patent Box, the patent owner is the patentee. An exclusive licensee of a patent does not satisfy this definition.

Further, if a taxpayer acquires the patent from an “owner” rather than developing the patent itself, the patent may still be eligible for the patent box, but only to the extent of improvements to the patented invention that the taxpayer made after acquiring the patent.

Accordingly, the patent box will provide the most significant advantage where the technology underlying the patent is developed and commercialised by the original patentee. 

Patent box election

The taxpayer must elect for the patent box regime to apply, and it then applies to all of the taxpayer’s eligible patents on a prospective basis in respect of income years starting on or after 1 July 2022.

Patent box income stream

The Explanatory Memorandum comments that the patent box regime has high ongoing compliance costs.  The taxpayer is required to identify each patent box income stream, which is the ordinary or statutory income derived from exploiting an eligible patent. This includes the sale of linked therapeutic goods; royalties, licence fees or milestone payments; a balancing adjustment event derived from the sale or assignment of the eligible patents; and damages or compensation payable to the taxpayer in respect of the eligible patents.

Determining apportionment of patent box income stream that relates to the patent

Only the proportion of a patent box income stream that is attributable to eligible patents is subject to the concessional 17% tax rate in accordance with Organisation for Economic Co-operation and Development (OECD) guidelines. For example, income or value relating to marketing, branding or hardware of a device that is not directly attributable to the underlying patent is excluded. 

Determining R&D fraction

The taxpayer only benefits under the patent box regime to the extent that the taxpayer conducted the R&D for the technology underlying the patent in Australia using the so-called “nexus” approach. The Explanatory Memorandum indicates that where a taxpayer undertook all of the R&D themselves in Australia to develop the patented technology, the R&D fraction is 100%. 

Patent box income rules

The full calculations and explanations associated with determining the proportion of the patent box income stream that is subject to the concessional tax treatment can be found in the Explanatory Memorandum. Briefly, however, the proportion is determined by:

• identifying all eligible patents that underlie a patent box income stream;
• determining a reasonable apportionment of the income that is attributable to those patents; and
• reducing that amount by applying the R&D fraction.

A portion of this remaining amount is then made non-assessable and non-exempt income to achieve an effective tax rate of 17%.

What’s next?

While it is promising that the bill is now before the House of Representatives, it needs to pass through both houses of parliament and may be subject to debate and further amendments. With an upcoming federal election, it may still be some time before the bill comes into law.

Concluding remarks

In short, the patent box as now proposed will provide a concessional corporate tax rate of 17% to a portion of income received from the exploitation of Australian, United States or European patents granted after 11 May 2021 that are linked to therapeutic goods listed on the ARTG, where the income is attributable to the taxpayer’s development of the technology underlying that patent in Australia.

***Other Articles***

– You could see the Procedure of Trademark in Australia here.

– You could visit here to see the Required documents of filing trademark in Australia.

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