Australia: Launch of the patent box regime and guidance on intangible arrangements

In this update we discuss the impact of the patent box regime and consider the changes to intangible arrangements.

In the Australian Federal Budget on May 11 2021 the Treasurer announced a patent box regime for Australia and on May 20 2021 the Australian Taxation Office (ATO) issued a Practical Compliance Guideline on ‘intangibles arrangements’. 

Patent box regime

The regime will apply from July 1 2022 to income derived from Australian medical and biotech patents. The government also said it would consider extending the concession to ‘green’ technology patents, during consultation. The effect of the regime is that the income from such patents will be taxed at a concessional rate of 17%, rather than the standard corporate rate of 30%.  The regime is designed to incentivise R&D activities in Australia and encourage companies to retain ownership of patents in Australia.

The concessional rate will only apply to income from the patent itself rather than income from manufacturing, branding and other attributes.

The Treasury is expected to shortly start a public consultation process on the proposals. Legislation will follow. Until draft legislation is available it is difficult to give detailed guidance on the provisions, but there are a number of issues companies should consider.

First, it is expected the regime will need to be carefully drafted to avoid being seen as a ‘harmful tax practice’, as that concept is used in the OECD’s BEPS project.  The budget announcement made it clear that the government is aware of the issue and is intending that the concession is only available in relation to research and development conducted here, where the patent is registered in Australia  by an Australian company. These conditions are likely to satisfy the OECD.

The budget announcement also notes that many other countries have adopted such regimes, but does not note that many have adopted a tax rate below Australia’s 17% rate on such income. Despite this, the incentive may be important for many companies.

Another issue for such regimes is that the concession may be difficult for start-ups, which are still in a loss position, to access. 

The mechanics explained in the announcement will raise other practical issues which may need to be resolved using transfer pricing (TP) principles.  The budget makes it clear that the proportion of the company’s income which receives the concession is the amount attributable to Australian R&D, and not foreign R&D.  This seems likely to require companies to identify the pool of R&D expenditure that relates to the patent, and where it was conducted. This could potentially be expenditure in past years, further complicating the process. Do R&D systems enable work streams to be split where they lead to multiple patents?  How directly connected does the R&D have to be? Have costs been properly allocated between the various jurisdictions involved, where there was collaboration?

Biotech companies typically seek to use patents in the process of generating income from sales of products or services. The announcement suggests that the total income received will need to be apportioned to identify that part attributable purely to the patent.  In other words, what is the economic contribution of the patent to the revenue from goods and services?  

If the legislation is not prescriptive about deeming a formula for calculating a return on the patent, economic analysis may be required to determine the part of the income attributable to the patent. This position will be even more complicated where multiple patents are used in a product or service.

Where inter-company revenue is involved, both Australian and any foreign country counter party will be anxious to ensure income is not being deliberately diverted to Australia to benefit from the provisions. How will the rules apply where the Australian owner benefits by licencing the patent to other parties, potentially related parties in other countries?

The provision has a start date of July 1 2022, and will apply to income from patents applied for after May 11 2021.

The rules have the potential to incentivise companies to register patents where they might previously have considered registration to not be cost effective.

Guidance on dealings with intangibles

On May 20 2021 the ATO issued draft Practical Compliance Guideline (PCG 2021/D4). Comments on the draft were due by June 18 2021 but the date has been extended to July 16 2021. PCG 2021/D4 refers to dealings with ‘intangibles arrangements’.

Intangibles arrangements are defined as any international arrangement “connected with the development, enhancement, maintenance, protection and exploitation of intangible assets and/or involving a migration of intangible assets”. 

A PCG is not law and does not bind taxpayers or the ATO. It gives examples of dealings with intangible assets and explains how the ATO will view them. What risks to Australian revenue the ATO will be concerned about, and what taxpayers will need to consider and collect in order to be able to avoid action by the ATO against the dealing. 

It is an extremely important document because it enables companies to look at their dealing through the ATO’s eyes and carefully consider what evidence must be assembled, at the time of the dealing.

Dealings that fall within the PCG are almost inevitably going to be reviewed by both the ATO and the groups’ statutory auditor (who is now on notice about the ATO’s focus). It is likely that the ATO will require groups to notify them of such dealings, ensuring a review.

PCG 2021/D4 is 51 pages long, and deals with 12 taxpayer example situations, such as movement of intangibles out of Australia by a global group.

Examples are categorised as ‘high’, ‘medium’ or ‘low’ risk, and an explanation is given for the categorisation. While not discussed in detail in PCG 2021/D4, ‘high’ risk dealings will need to carefully consider not just TP provisions, but also targeted and general anti-avoidance rules (Part IVA, MAAL and DPT).

One consistent theme throughout the examples is the critical need to carefully consider and document the commercial (as opposed to tax) reasons for the dealing, and to preserve this evidence.  

Managing Australian tax risk on a dealing with an intangible asset is more complex than making sure that the price paid in a transfer is arm’s-length.

This article was originally published in the International Tax Review.