1. Tax on IP ownership
Royalty income and capital gains are taxed at the company's marginal rate of corporation tax. For large companies (profits in excess of £1.5 million) this is 28%. There is a separate code for IP created or acquired on or after 1 April 2002. Under this code, IP is taxable on a GAAP (Generally Accepted Accounting Principles) basis, with a tax deduction generally being available for any amortisation of the IP in the company's accounts. Roll-over relief is available to defer gains on post April 2002 IP. Pre April 2002 IP is dealt with under various rules depending on the type of IP in question.
There are incentives for direct income expenditure on certain research and development activities. For large companies this amounts to a 130% tax deduction for qualifying research and development activities (activities which seek to achieve advancement in science/technology). For SMEs (Small and Medium Enterprises - broadly speaking groups with less than 500 employees, €100 million annual turnover and €86 million balance sheet assets) this amounts to a 175% tax deduction which can be surrendered for a 14% cash payment.
2. Withholding taxes
The UK levies a 22% withholding tax on UK source royalties, except if paid to UK companies, EU resident affiliated entities (the EU Interest & Royalty Directive exemption) or recipients benefitting from a tax treaty exemption. There is also a withholding at 22% on certain sales of patent rights.
Following the Indofoods case (see above) it has become more difficult to mitigate UK withholding taxes through insertion of a conduit vehicle resident in a state with a suitable tax treaty. HMRC (HM Revenues and Customs) are likely to look through such "treaty shopping" arrangements and deny double tax relief on the basis that the conduit does not have the necessary "beneficial ownership" to satisfy the treaty test.
Although the UK has a wide treaty network, it is generally perceived as not being tax friendly, due to the relatively high corporation tax rates, detailed anti-avoidance rules and aggressive attitude of the UK revenue authorities to perceived tax abuse. UK vehicles are therefore rarely used for tax planning purposes unless there is already some connection with the UK.
3. CFC rules
Although it is possible for a group to keep IP outside the scope of UK tax by holding it in an offshore company, this is difficult to achieve in practice as the UK has wide ranging CFC rules which catch most offshore passive holding vehicles (as well as many other offshore vehicles).
The recent Vodafone decision has indicated that the UK CFC rules are illegal. However, the rules have been amended in order to bring make them compatible with EU law. Whilst many commentators believe the rules as amended to still be in breach of EU law, this has not as yet been clarified by the Courts.
To the extent that IP is located in the UK and standing at a gain, it will be difficult to move the IP outside the UK tax net.
Vodafone 2 v The Commissioners of Her Majesty's Revenue & Customs 2008 [EWHC] 1569 (Ch)