Patent Box – Incentivising private sector investments in R&D

Many countries are resorting to tax and economic policies to stimulate innovation domestically. This may include cash grants and other types of financial support; tax credits, deductions, exemptions and holidays; and accelerated tax depreciation rates.

What is ‘Patent Box’?

• It is one of the above mentioned policies to stimulate innovation.
• Generally, all patent boxes have one common feature: they offer concessional tax rates for income accruing to patents.
• There are two intentions behind a patent box.

1. The first is that it will lead to more home-grown research and development (R&D) and thus local innovation.
2. Second, it will reduce erosion of the income tax base.

Significance –

• Because of the tax cost advantage conferred by the patent box, the relative cost of local R&D production is lowered.
• Likewise, corporate groups are disincentivized from shifting intellectual property (IP) ownership abroad—and perhaps incentivised to transfer ownership of foreign IP to the home country—because the ratio of the tax rates on IP-sourced income is tilted in favour of the home country.
• Incentives like tax credits may incentivise local R&D generation, but do not incentivise in-country retention of IP ownership, which ‘patent box’ takes care of.

‘Patent box’ in India –

• India introduced its own patent box in the Finance Bill (2016) by inserting Section 115BBF into the Income Tax Act.
• Under Indian rules, royalty income from patents developed and registered in India is taxed at a concessional 10% rate (plus applicable surcharges). The concessional rate is applied to gross income or revenue.

Significance of Indian patent box –

• Indian patent box rules stimulate home-grown R&D. This is because its concessional rate applies to gross income instead of net income, as is the case in most other jurisdictions.
• Why gross income rule is beneficial? Since R&D costs are not deducted from IP income, they will be deducted from the firm’s other income, to which the standard corporate income tax rate applies.
• A unit reduction to the tax base reduces taxes paid by company. Hence, a deduction applied to ‘other income’ reduces taxes paid in proportion to the statutory corporate income tax (CIT) rate, while a deduction applied to royalty income reduces it only in proportion to the patent box rate. Since the patent box rate is lower than the CIT rate, the gross income rule is beneficial to the taxpayer.

Concerns with Indian patent box –

The eligibility rules are quite restrictive –

1. One restriction is that only royalty income is eligible for patent box treatment. This means that a firm can only use this rate when it licenses out its IP. If, on the other hand, it uses its self-developed IP on its own products and services, then no explicit royalty payments are made and the patent box does not apply.
2. Another restriction is that the patent box does not apply to IP that is developed in other countries, but then transferred to India. This removes the incentive for corporate groups to transfer existing foreign IP to India.
3. A third restriction is that the patent box is only available for Indian patents. It does not apply to Indian patents-in-progress or to Indian R&D that has resulted in US, European or other foreign patents.
4. Apart from these restrictions, the Indian patent box rate is higher than in other jurisdictions. Despite the gross income rule, total taxes paid on R&D activity may therefore be lower in other countries, leading to India suffering a cross-country tax cost disadvantage.

Conclusion –

In summary, the patent box is an important step in making India an attractive destination for R&D investment. The gross income rule is a positive step in providing tax benefits for R&D production. However, eligibility criteria remain restrictive and the overall tax burden on R&D is higher than in some other countries. These factors may mitigate against India establishing itself as an attractive R&D destination.

Source – Livemint

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