The Treasury Laws Amendment (Tax Concession for Australian Medical Innovations) Bill 2022 (Cth) (the Bill) is intended to enhance Australia's existing R&D tax incentives (which are not confined to the life sciences sector). Specifically, the Bill allows profits derived from the commercialisation of patented medical or biotechnology inventions developed and owned in Australia to be subject to a reduced corporate tax rate of 17% (compared with the standard corporate income tax rates of 30% generally and 25% for small to medium enterprises).
The patent box tax regime is confined to patents in the medical and biotechnology industries. To be eligible, a patent must be linked to a 'therapeutic good’ that is included on the Australian Register of Therapeutic Goods maintained by the TGA. Therefore, the regime will include patents for medicines, medical devices, vaccines, and other similar products.
In our previous alert, A 'patent box' for Australia – what does it mean and how will it work?, we provided an overview of the Government's initial Budget proposal, and discussed some of the key considerations and concerns relevant to formulating a scheme of this nature. In this alert, we discuss the extent to which the Bill address those issues.
Would limiting the scheme to patents applied for after the budget announcement achieve the government's policy objectives in an appropriate timeframe?
In response to stakeholder comments regarding the long lead time between applying for a patent and generating substantive revenue in the life sciences sector, the scope of the scheme was amended in the Bill, so that it now applies to patents granted after 11 May 2021 (not just patents applied for after that date). As a result of this change, the benefits of the scheme will be brought forward in time substantially.
The other significant change following consultation is allowing patents issued by the United States Patent and Trademark Office or granted under the European Patent Convention to access the regime (in addition to those standard patents granted by the Commissioner of Patents in Australia). The Bill's Explanatory Memorandum notes that 97% of all medical and biotechnology patents filed by Australian entities are filed in one of these three jurisdictions.
What income is 'derived directly' from a patent?
The concept of a 'patent box income stream' is intended to define what income in 'derived directly' from a patent. A patent box income stream may arise from:
- the sale of (or dealing with) a therapeutic good linked to the patent/s;
- royalties or licence fees payable to the patentee taxpayer in respect of the patent/s;
- a balancing adjustment event (eg, a sale) arising in respect of an eligible patent; and
- damages or compensation payable to the patentee in respect of the patent/s.
However, only the proportion of the patent box income stream attributable to the taxpayer’s development of the patent attracts the tax benefit. That proportion is to be calculated by:
- identifying all eligible patents that underlie the patent box income stream;
- determining a reasonable apportionment of the patent box income stream to those patents (as opposed to, for example, marketing and non-patented know how) in a manner that best achieves consistency with OECD transfer pricing principles (without any simplified transfer pricing mechanisms); and
- amending that amount by applying an 'R&D fraction' to reflect the extent of the taxpayer’s Australian R&D activities.
A portion of this remaining amount will then be classified as non-assessable and non-exempt income to achieve an effective tax rate of 17 per cent.
How much of the R&D underpinning the patent must be done in Australia and how will that be assessed?
Rather than setting a 'minimum' proportion of R&D that must be done in Australia, the application of an R&D fraction ensures that benefits to the patentee taxpayer decrease to the extent that the taxpayer did not conduct R&D in Australia, but either outsourced R&D activities to a related party or acquired the patent (noting there is a possible uplift of up to 30% where R&D has been outsourced to a related party or an existing patent has been acquired). This is a quantitative determination, based on total costs incurred on R&D activities. Unlike the existing R&D tax incentive, the Bill does not provide any exception for necessary R&D activities that cannot be conducted in Australia (for example, where there is insufficient patient population to conduct a clinical trial).
How will the scheme apply to complex patent/profit relationships?
A patent will be sufficiently linked to a therapeutic good if that good:
- contains or consists of a pharmaceutical substance; or
- incorporates an invention,
that is properly disclosed in the patent specification and falls within the scope of the claims.
The patented invention or substance does not have to account for the entire therapeutic good for the patent to be eligible for the patent box tax regime. An invention that is just a singular component of the medicine or product will still qualify, but only in respect of the portion of income from sales of that product that can be attributed to the patented feature, component or ingredient.
Similarly, a single medicine or product may incorporate the use of inventions covered by multiple patents, and a particular patent may be relied on for a number of different therapeutic goods.
To what extent will income from sales of a particular product be 'directly derived' from the patent itself?
Where the patent does not account for the entire value received for the good, the income unrelated to the patent must be separated from the income derived from the patent. For example, income may be attributable to the marketing or manufacturing of the goods, by comparison to the underlying patent. The Bill requires this to be undertaken consistently with OECD transfer pricing principles.
Would the Australian company need to be the legal owner of the patent?
To qualify for the patent box tax regime, the taxpayer must ‘hold’ an eligible patent within the meaning of that term in the uniform capital allowance regime. That is, the taxpayer must be the patentee; an exclusive licence to the patent will not be sufficient.
A patent acquired by a taxpayer is not necessarily excluded from the patent box tax regime, however the application of the R&D fraction will ensure that the taxpayer only benefits to the extent that they have themselves incurred costs on R&D after acquiring the patent.
How would the 'single entity rule' under income tax consolidation provisions interact with the scheme?
The Bill clarifies that the patent box tax regime is available to corporate taxpayers who are either:
- Australian residents; or
- residents of another country who carry on business at or through a permanent establishment in Australia, under a double tax agreement in force between Australia and that other country.
For tax consolidated and Multiple Entry Consolidated groups, the law applies as if it were a single entity. Therefore expenditure incurred by a subsidiary on R&D activities is taken to be incurred by the head company, and R&D activities conducted by one member of the group for another member of the same group are taken to have been conducted by the head company on its own behalf.
There is a special rule to override the entry history rule, such that consolidated tax groups are not bound by the irrecoverable election made by an entity, before it joined the consolidated tax group.
How to access the regime
Taxpayers must elect into the regime. The election is irrecoverable and applies prospectively to all eligible medical and biotechnology patents. The election must be made in the prescribed form and provided to the Commissioner of Taxation before the time the taxpayer is required to lodge its income tax return for the relevant income year. The Commissioner cannot extend the time for making this election.
Patent holders in the life sciences sector should keep a close eye on the further development of the patent box tax regime, and consider how it may apply to their current and future operations.
Contact us to discuss how we can support you in that process.
