Patent Box: How UK SMEs Pay 10% on Patent Profits
Quick Answer
The UK Patent Box applies an effective 10% rate of Corporation Tax to qualifying IP profits from patented inventions, provided the company owns or exclusively licences a qualifying patent and has undertaken qualifying development. A company must elect into the regime within two years of the end of the accounting period in which the relevant profits arose.
Opening
The Patent Box is a Corporation Tax regime that applies an effective 10% rate to qualifying IP profits attributable to patented inventions. It was introduced in 2013 and revised in 2016 to align with the OECD’s modified nexus approach (BEPS Action 5).
With the main rate of Corporation Tax at 25% since 1 April 2023, the gap between the full rate and the Patent Box rate is 15 percentage points. For a UK SME with a meaningful patent-derived profit stream, this is a material saving.
The regime is also one of the most under-claimed reliefs in UK tax. HMRC’s most recently published Patent Box relief statistics show only a few thousand companies elect into Patent Box each year.
Who this applies to
- UK companies that own UK, European Patent Office, or qualifying EEA national patents.
- UK companies that hold an exclusive licence to a qualifying patent.
- R&D-active SMEs in engineering, manufacturing, life sciences and technology, particularly those already preparing R&D Tax Relief claims.
- Group structures where qualifying development has been undertaken by the company or another company in the same group.
The three conditions to elect
Qualifying intellectual property
The patent must be granted by:
- The UK Intellectual Property Office.
- The European Patent Office.
- A qualifying EEA national patent office (specified in Corporation Tax Act 2010, Part 8A).
Design rights, trademarks, copyright and unregistered IP do not qualify. Pending applications do not qualify until granted, although profits earned during the application period can be brought into the regime once the patent is granted (subject to a six-year look-back).
Qualifying development
The company (or another company in the same group at the time the development was undertaken) must have made a significant contribution to the creation or development of the patented invention, or a product or process incorporating it.
This is the substance test. A company that acquires a patent off-the-shelf and immediately seeks to apply Patent Box to the profits behind it will not satisfy this condition unless it carries out further qualifying development.
Election within two years
The election must be made in writing, in the computations accompanying the Company Tax Return, within two years of the end of the accounting period in which the relevant profits arose. The procedural detail is set out in HMRC’s Corporate Intangibles Research and Development Manual.
Miss the election window and the relief on those profits is gone for that period. There is no retrospective claim.
Patent Box vs R&D Tax Relief: how they differ
| Issue | Patent Box | R&D Tax Relief (merged scheme) |
|---|---|---|
| What it rewards | Profits from qualifying patented inventions | Expenditure on qualifying R&D |
| Headline benefit | 10% effective Corporation Tax rate on qualifying IP profits | 20% above-the-line expenditure credit (or ERIS for intensive loss-makers) |
| Eligibility trigger | Ownership or exclusive licence of a qualifying patent, plus qualifying development | Project that resolves scientific or technological uncertainty |
| When the benefit accrues | Each accounting period in which qualifying profits arise, after election | Each accounting period in which qualifying expenditure is incurred |
| Can both apply to the same project? | Yes, the same underlying R&D often supports both | Yes |
| Election or claim deadline | Election within 2 years of the end of the accounting period | Claim within 2 years of the end of the accounting period (with AIF before CT600) |
For a wider explanation of how the merged R&D scheme operates, see our RDEC merged scheme guide.
The nexus fraction in plain terms
The nexus fraction, introduced in Finance Act 2016, scales the Patent Box benefit by the proportion of qualifying R&D the company has done itself (in-house or through unconnected sub-contractors) against the total R&D and acquisition cost of the IP.
In simple terms:
- Companies with a strong, documented in-house R&D record receive the largest benefit.
- Companies that have outsourced everything to a connected party receive the smallest.
- Companies that acquired the IP rather than developed it must include the acquisition cost in the denominator, reducing the fraction.
This is by design. The OECD framework that drives the rules rewards businesses that did the inventing.
Worked example
A UK manufacturing SME holds a granted UK patent on a component it manufactures. Qualifying IP profits in the accounting period: £500,000. The company has carried out all of the underlying R&D in-house, so the nexus fraction is effectively 1.
- Full-rate Corporation Tax on £500,000 at 25%: £125,000
- Patent Box effective rate on £500,000 at 10%: £50,000
- Patent Box benefit in this period: £75,000
The company elects into the regime within two years of the end of the accounting period. The election remains in place for future periods unless revoked.
Lexmore’s View
The Patent Box is consistently under-claimed by UK SMEs that already prepare R&D Tax Relief claims. Much of the underlying record-keeping (project documentation, technical narratives, allocations of staff time) is already in the business.
The work to model qualifying IP profit (separating the patent-derived stream from everything else, applying the nexus fraction, choosing between the streaming and apportionment methods) is real. For many R&D-active patent holders, it pays for itself many times over. For some it does not.
We tell clients which group they sit in before any work begins. For a more general overview of the regime, see our Patent Box Explained introduction.
References
- Use the Patent Box to reduce your Corporation Tax on profits (gov.uk)
- Rates and allowances for Corporation Tax (gov.uk)
- HMRC Corporate Intangibles Research and Development Manual: Patent Box (CIRD200000 onwards)
- Corporation Tax Act 2010, Part 8A (legislation.gov.uk)
- Finance Act 2016 (legislation.gov.uk)
- UK Intellectual Property Office
- European Patent Office
Related Services
Lexmore advisory areas covered in this article.
Talk to a Patent Box Specialist
Book a free, no-obligation review of your Patent Box position before the next election deadline.
Frequently Asked Questions
Do I need a granted patent, or is a pending application enough?
You need a granted qualifying patent. Profits earned during the patent application period can be brought into the regime once the patent is granted, subject to a six-year look-back.
My company holds a UK patent but the qualifying R&D was done by our parent company. Do we qualify?
Potentially yes. Qualifying development can be undertaken by another company in the same group at the time. The nexus fraction will apply to determine the proportion of profits eligible.
What if we acquired the patent rather than developing it?
You can still qualify, but the acquisition cost is included in the denominator of the nexus fraction, reducing the proportion of qualifying IP profits. Subsequent qualifying development by the company can improve the position.
How long does the election last?
The election remains in place until revoked. A company that revokes the election cannot re-elect for five years.
Can Patent Box and R&D Tax Relief apply to the same accounting period?
Yes. The two regimes operate in parallel and frequently rely on the same underlying R&D activity. Patent Box rewards the resulting profits; R&D Tax Relief rewards the expenditure that produced them.
What happens if profits are loss-making in a period?
A Patent Box loss reduces the profits of other Patent Box trades in the same company or group, or is carried forward against future Patent Box profits.