Australia’s proposed patent box regime

November 2021  |  SPECIAL REPORT: CORPORATE TAX

Financier Worldwide Magazine

November 2021 Issue

In the federal budget announcement on 11 May 2021, the Australian government revealed its intention to introduce a patent box regime for corporate income associated with patented inventions in the medical and biotech sectors (and potentially the cleantech sector) with effect from 1 July 2022.

Eligibility for the patent box is to be limited to inventions in the eligible sectors claimed in standard patents granted by IP Australia (or inventions protected by foreign patents that would fall within the scope of Australian standard patents), which are applied for after the budget announcement (i.e., they have a priority date after 11 May 2021).

A discussion paper on the policy design of the proposed patent box regime was released in July 2021 with submissions due in early August. The next steps will be further consultation and the issue of exposure draft legislation for public comment.

The regime will introduce an effective concessional tax rate of 17 percent to encourage companies to base their medical and biotech R&D operations, commercialise innovation and retain the ownership of eligible patented inventions, in Australia. There are, in our view, quite a few challenges and issues that need to be addressed if these objectives are to be achieved.

Clearly, the concessional tax rate is a critical aspect of the regime, and it is imperative that it is set at a sufficiently low level to be attractive to companies to locate, or relocate, their R&D activities to Australia in preference to other jurisdictions. In this respect, the proposed concessional rate of 17 percent is significantly higher than rates offered in other jurisdictions (e.g., Ireland (6.25 percent), the Netherlands (9 percent) and the UK (10 percent)). Of course, if the G20 ‘global minimum corporate tax’ rate of 15 percent is ultimately implemented, other regimes may eventually need to lift their rates but, in the meantime, we believe Australia should consider a lower patent box tax rate if it intends to compete with other jurisdictions.

A further concern is that other patent box regimes are not restricted to patents in selected business sectors as it is proposed Australia’s regime will be. It is not readily apparent why Australia has chosen to impose this limitation, and, in our view, it could act as a serious disincentive to locating R&D activities in Australia as compared with other jurisdictions without any such limitations. For example, a company’s R&D might cover multiple complementary sectors – that is, it may be the case that there is complementary research being undertaken that might lead to a patent in multiple sectors. If only one patent, and not all patents, registered in consequence of that research qualify for the concession, there will be an incentive to conduct the research in those jurisdictions where all the resulting patents are eligible.

In addition, there might be a risk that the research a business conducts will not (despite the initial hypothesis) ultimately lead to a patent in the medical and biotech (or cleantech) sector, but may lead to a different path of discovery and a patent registered in another sector. This exposes businesses to a serious risk that R&D undertaken in Australia will not qualify for the patent box, despite the initial purpose of the research.

We therefore believe that serious consideration should be given to opening up the patent box to all sectors, or else Australia risks being seen as an unattractive place to locate R&D in comparison with other jurisdictions without similar limitations.

Another issue with the current proposal is that only inventions claimed in standard patents applied for (i.e., with a priority date) after 11 May 2021 will be eligible for the regime. The application process for a patent is lengthy, and we expect that if in order to qualify, the priority date must be after 11 May 2021, it will take one to three years before the first standard patents that can take advantage of this regime will be granted. If instead the regime was to apply to patents granted after 11 May 2021, there would be a more immediate benefit as it would cover currently pending applications.

A related matter not addressed in the discussion paper is whether the concessional tax rate should apply to profits earned while a patent application is pending or only once the patent is granted. Other regimes, including in the UK and the Netherlands, permit pre-registration profits to qualify for regime benefits. Given the length of time that can be taken for a patent to be granted, it is in our view imperative that profits earned during the application phase are eligible for the concession. Similarly, to provide certainty for business, it is also imperative that the regime does not ‘unwind’ the benefit of the concession should a patent, once registered, be successfully revoked through litigation.

It is also proposed that the regime would apply to profits derived from inventions protected by foreign patents that would fall within the scope of Australian standard patents. Determining whether the scope of claims in a standard patent granted overseas would be substantially similar to the scope of claims that would have been (but have not been) granted in Australia is not a straightforward exercise.

Patent laws are territorial and there is considerable variance in the law from one jurisdiction to another. In this context, determining the likely scope of claims in a hypothetical Australian patent based on reviewing an overseas granted patent would require an expert opinion and any opinion obtained would likely be heavily qualified. Therefore, this requirement would make electing into the patent box scheme on the basis of a foreign patent costly and potentially risky – for example, if the Australian Taxation Office took a different view on the scope of the claims of the foreign patent. In our view, there would be considerable merit in Australia adopting a similar approach to that in the UK, by ‘white listing’ those countries with sufficiently comparable patent regimes to Australia such that registration in these jurisdictions would be considered to meet the Australian patent box registration requirements without the need for obtaining costly expert opinions.

Another challenge will be getting the interaction between the patent box regime and other parts of the Australian tax law right. For example, Australia operates an R&D tax offset regime, providing tax credits (refundable to certain taxpayers), the amount of which are pegged to the company’s standard corporate tax rate (either 25 or 30 percent). If the R&D tax offset becomes pegged to the lower 17 percent patent box rate for companies that elect into the patent box, it may be that companies will not elect into the patent box as they will prefer the more immediate benefits of the higher R&D tax offset.

A similar issue arises in relation to tax losses, in that profitable companies incurring R&D expenditure may prefer to stay out of the patent box regime to utilise losses more immediately against other income taxed at the higher corporate tax rate, rather than carry forward patent box losses, potentially for a considerable period of time, in the hope that they can be offset against patent box income. We also expect the interaction with Australia’s tax consolidation regime will be very complex.

Finally, the interaction with Australia’s dividend imputation system will require careful thought. Very broadly, Australia operates a full dividend imputation system, which effectively eliminates double taxation of company profits in the hands of Australian resident shareholders. This is achieved by corporate distributions carrying imputation (or franking) credits representing the tax paid on the corporate profits underlying the distribution.

Australian resident shareholders can claim an offset against their personal tax liability for any franking credits connected with the distributions they receive. The shareholder will pay ‘top up’ tax where their personal tax rate (up to 47 percent) is higher than the company rate or, in some cases, may receive a refund of the offset if their tax rate is lower. Franked dividends are highly valued by Australian investors.

Take up of the new patent box regime may be hindered if the benefits of the lower effective tax rate on a company’s eligible patent box profits is effectively unwound when those profits are distributed to Australian shareholders because the lower level of franking of such distributions results in higher tax payments by those shareholders. That is, taking into account the overall tax burden on Australian shareholders, there will be no tax savings resulting from participating in the patent box regime, unless the imputation system is modified.

Further, unless this issue is addressed, there will be an inherent bias in favour of foreign resident shareholders who may not suffer the same increase in tax burden when receiving partially franked dividends (e.g., under many Australian double tax agreements, there is a nil or very low rate of dividend withholding tax on certain unfranked dividends paid by an Australian company to a foreign parent).

In conclusion, the public response to the announcement of the Australian patent box was muted and this may have been caused by recognition of some of the issues we have identified above. The government really needs to turbocharge the Australian patent box if it is truly committed to getting it off to a flying start on 1 July 2022.

 

Sanjay Wavde and Nina Fitzgerald are partners and Paul Glover is counsel at Ashurst. Mr Wavde can be contacted on +61 (2) 9258 6135 or by email: sanjay.wavde@ashurst.com. Ms Fitzgerald can be contacted on +61 (2) 9258 6778 or by email: nina.fitzgerald@ashurst.com. Mr Glover can be contacted on +61 (2) 9258 6016 or by email: paul.glover@ashurst com.

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BY

Sanjay Wavde, Nina Fitzgerald and Paul Glover

Ashurst

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