Safeguarding your tax through Patent Box Regimes
Patent Box regimes are common in the European Union countries. Ireland was amongst the first few countries to introduce the Knowledge and Development Box. Patent Box regime is also referred to as License Box in Cyprus, IP Box in Spain, Innovation Box in Hungary, High and New Technology Enterprise Tax incentive in China. Primarily it was aimed to provide back end tax incentive after the technology was developed thereby encouraging inventors to maintain their patent in the country where it was developed. However there are some Patent Box Regimes which are tax driven which is against the fundamental principle that income should only benefit from the regime to the extent the taxpayer itself incurred the expenditure that contributed to the intellectual property.
Harmful Tax Competition
It is quite common for Indian companies to register their intellectual property in jurisdictions with low tax incidence even if the intellectual property has been developed in India. This has over the years led to businesses vanishing to tax havens and shifting of profits.
The Organization for Economic Cooperation and Development (OECD) commenced effort to address the harmful tax competition and has recommended, in Base Erosion and Profit Shifting (BEPS) project under Action Plan 5, the nexus approach. This approach prescribes that income arising from exploitation of intellectual property should be attributed and taxed in the jurisdiction where substantial research & development activities are undertaken rather than the jurisdiction of legal ownership only.
Taxation before Patent Box Regime
Prior to the Patent Box Regime becoming effective from April 1, 2017, Section 80RRB of the Income tax Act, 1961 (Act) dealt with deduction in respect of any income by way of royalty. This incentive is however limited to input incentive ranging from grants and weighted deductions in respect of expenditure to tax holidays. Under this Section, where an assessee is an individual (either resident in India; a patentee as per the Patents Act, 1970 or a recipient of any income by way of royalty in terms of Patents Act, 1970) whose gross total income of the previous year includes royalty, will be allowed a deduction from such income of an amount equal to the whole of such income or three (3) lakh rupees whichever is less in respect of royalty on such patents. The tax deduction under Section 80RRB is aimed to encourage innovation and patenting in India but could not achieve the desired result.
Taxation under Patent Box Regime
The Government with the intent to encourage corporates to development, manufacturing, locate and exploitation the patents in India has in Finance Act 2016 introduced a special royalty tax which lowers the effective rate of tax on income earned from patents.
The concessional regime is captured in the form of section 115BBF in the Income Tax 1961, which provides that, if the total income of a person resident in India and who is a patentee i.e. the eligible assessee includes any income earned out of royalty with respect to worldwide commercialization of its patent which is developed and registered in India, the same shall be taxed at the rate of ten (10%) per cent (plus applicable surcharge and cess) on the gross amount of such royalty earned.
For a patent to be developed in India, the eligible assessee must incurred at least seventy five (75%) per cent of its expenditure for the research and development of an invention in India, in respect of which the patent is granted under the Patents Act, 1970.
This regime aims to incentivize commercialization of domestic research and development by taxing patent revenue differently from other sources of revenue.
Who can avail the benefits?
As a step towards encouraging indigenous research and development in India and promote 'Make in India' initiative, only residents individuals and company resident in India can avail for such concessional tax benefits.
The Patent Box Regime is optional. In order to avoid misuse of the deductions and concessions, the concessional regime provides that, the assessee in any given financial year cannot simultaneously avail the deductions under section 80 RRB of the Act and benefits under section 115BBF. Also if the royalty from patents is taxed as per the concessional regime that is, at the rate of ten (10%) percent, the assessee shall not be allowed to avail any further deductions in its expenses.
Income Tax Rules and Form
Recently CBDT has notified Rule 5G of Income Tax Rules and Form 3CFA with respect to the patent box regime under Section 115BBF of the Act. The eligible assessee is required to exercises the said option in Form 3CFA and seek concessional tax treatment for royalty income from patent developed and registered in India. In the form, the eligible assessee has to provide certain information like the description and details of the grant of the patent, holder of the patent, royalty earned from such patents in the previous year, expenditure incurred to develop the eligible patents, details of development of the patent in India. The eligible assesse also needs to indicate in the Form whether it intends to offer the income by way of royalty in respect of an eligible patent as per section 115BBF for the relevant assessment year. In case the option is exercised for that assessment year, the form must be complete in all respects and furnished on or before the due date specified in terms of section 139 of the Act.
The Government has taken an initiative to create a favourable tax environment for enabling India to become a global research and development hub. However, it should not be overlooked that India is competing with other tax favourable jurisdictions like UK, USA, Netherlands, Russia and such other countries where such concessional regimes have been in existence for decades. The success of concessional tax regime in India would also depend on how robust the legal framework pertaining to registration and enforceability of patents is perceived by companies who presently have no presence in India. Nonetheless, this amendment is a positive step in placing India on an enhanced footing in an increasingly innovative and knowledge driven world.
The article has been authored by Ms. Shisham Priyadarshini, Partner, Rajani Associates and Ms. Shruti Bajpai, Associate, Rajani Associates