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February 11, 2022
2022-0256

Australia introduces bill on 17% patent box for medical and biotech technologies

Executive summary

The Australian Government has introduced a Bill into Parliament proposing to introduce an optional 17% patent box regime (patent box) targeting medical and biotechnology patents, as announced in the 2021-22 Federal Budget (Treasury Laws Amendment (Tax Concession for Australian Medical Innovations) Bill 2022 - Bill here) to apply for income years commencing on or after 1 July 2022.

This Bill follows a July 2021 Discussion Paper, with no further public consultation on any exposure draft Bill and only limited confidential consultation on an early draft of the law. It appears that many improvements called for in submissions have not been incorporated in the Bill. In particular, the proposals remain limited to eligible income from a medical or biotechnology patent only and calls to expand the patent box to Fintech, life sciences outside the medical space and low emissions technologies were not incorporated.

The patent box applies to patents granted or issued after 11 May 2021. This is a positive development, as Treasury’s Discussion Paper previously proposed that the patent box would only apply to patents applied for after 11 May 2021.

A high level overview of key elements of the complex proposals in the Bill is set out below.

Detailed discussion

Design and eligible patent box income

The patent box offers a concessional effective tax rate of 17% on net eligible patent income by allowing a portion of the taxpayer’s ordinary and statutory income derived that would otherwise be included in its assessable income to be made non-assessable, non-exempt income (NANE).

Taxpayers will need to:

  • Identify all eligible patents relevant to that patent box income stream
  • Determine a reasonable apportionment to determine the income arising from the patent box income stream that is specifically attributable to those patents (relies on arm’s-length conditions and consideration of transfer pricing principles)
  • Reduce that amount to reflect the extent of the taxpayer’s Australian research and development (R&D) activities (using the OECD’s R&D fraction formula)

A portion of that amount is then made NANE income to achieve an effective tax rate of 17%

Where income is derived from a patent box income stream, only the proportion of that income that is attributable to the taxpayer’s development of that patent is subject to the concessional tax treatment. Income streams include sales or rental income, royalties or license fees, balancing adjustments derived from proceeds of sale that are received, or damages and compensation derived for an infringement of the taxpayer’s patent.

The R&D fraction formula (which is cumulative, including all R&D expenditure from previous years) ensures a link between the benefits of the patent box and the extent of underlying R&D which generated the intellectual property (IP) that was undertaken by the taxpayer; the higher the fraction, the more patent box income that may be taxed concessionally. The R&D fraction (capped at 1) is:

  • (A/(A + B + C)) x 1.3
    • A = Total amounts of taxpayer’s notional deductions for R&D expenditure in respect of a qualifying patent or patents
    • B = Total expenditure incurred in respect of a qualifying patent or patents on R&D activities conducted outside of Australia by one or more associates of the R&D entity
    • C = Total cost of each depreciating asset in respect of which the taxpayer can deduct an amount under Division 40 for the income year attributable to the qualifying patent or patents
    • A 30% uplift is then applied to the fraction

The numerator “A” in the R&D fraction captures only the R&D expenditure incurred by the taxpayer for R&D activities undertaken in Australia.

For “C” an integrity rule can apply to deem the cost of an asset held by the R&D entity to be its market value if at the asset acquisition time, the R&D entity was not dealing at arm’s length and the asset’s cost was less than its market value.

The amount of each patent box income stream remaining after applying the R&D fraction is multiplied by the patent box NANE fraction (1 - 17%/R&D entity’s corporate tax rate).

The effect of making a portion of the patent box NANE is that the taxpayer will no longer be entitled to claim deductions to the extent that their loss or outgoings are incurred in gaining or producing that NANE income, so the 17% is applied on “net income. This approach introduces further complexity and will require careful analysis of expenses and the establishment of an acceptable apportionment approach. Follow on consequences from deduction denials must also be considered for example where there is a mix of profitable and not yet profitable products. Taxpayers may consider opting into patent box only once losses have been utilized and their patent has been commercialized.

Eligibility

To access the patent box concessional tax treatment, the taxpayer must meet the eligibility criteria:

  • R&D entity - An entity eligible must satisfy the definition of R&D entity in the R&D Tax Incentive provisions contained in section 355-35 of the Income Tax Assessment Act 1997 (ITAA 1997) (must be an Australian resident or nonresident carrying on business through an Australian permanent establishment).
  • Qualifying patent - A qualifying patent must be held by the taxpayer within the meaning of section 40-40 ITAA 1997 and be linked to a therapeutic good registered on the ARTG. A patent qualifies if it has been granted by the relevant authorities in Australia, the United States or Europe. 

The regime is optional for corporate taxpayers, and taxpayers must elect for the patent box to apply using an approved form by the time their income tax return is filed for the year of entry. This election is irrevocable and applies to all of a taxpayer’s medical and biotechnology patents on a prospective basis. Careful consideration of the benefits of the regime and other impacts will therefore be required before opting in.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young (Australia), Perth

Ernst & Young (Australia), Melbourne

Ernst & Young (Australia), Sydney

Ernst & Young LLP (United States), Australian Tax Desk, New York

Ernst & Young LLP (United Kingdom), Australian Tax Desk, London

 

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