Further written evidence from the EEF,
The manufacturers' organisation
NOTE ON "PATENT BOX" AND CAPITAL
ALLOWANCES
OVERVIEW
— UK Patent Box is a costly and inefficient
subsidy for a narrow set of companies.
— The planned scheme does not satisfy four
of HM Treasury's five principles for tax reform.
— £1.3 billion would be better spent
reforming R&D tax credit and modernising capital allowances.
BACKGROUND
EEF along with the Institute of Fiscal Studies,
believe that the patent box is an expensive, inefficient and ineffective
give away that does little to either stimulate investment or to
prevent IP from being exploited abroad. The Patent Box, however,
has its supporters, in particular handful of large pharmaceutical
and aerospace companies. EEF, however, have consistently raised
concerns about the economic and policy rationale for the patent
box. In conversations with HM Treasury, we have stressed that
patents are only a small part of intellectual property, and IP
is only a small fraction of innovation in the UK.
According to our evidence, only four firms account
for 20% of all patents, while only 10% of manufacturers use intellectual
property rights (and patents are only one type of IPR) to protect
their competitive position. Consequently we believe that by providing
tax relief for patents, the Patent Box would not directly encourage
innovation. Rather it would provide a distinct subsidy to patent-reliant
industries at the expense of other industries without any significant
economic rationale.
In addition, the planned Patent Box is unlikely
to be internationally competitive, as shown in Table 1. The UK
could follow the lead of other European countries by broadening
the tax relief to a wider set range of intellectual property and
linking it to R&D activity conducted in the UK. But such a
proposal would be even costlier than the £1.3 billion cost
of the patent box as currently defined.
Nor is it clear how the government plans to
value the income from patents embedded within bigger products.
For example, while determining the income generated from a patented
drug may be straightforward, it will be more complex to determine
the level of income generated by a patented-component in a modern
aeroplane engine. Moreover, a lower tax rate on income from patents
would encourage firms to artificially patent their technologies
- raising questions as to how a more limited HMRC would determine
whether such activity represents tax avoidance or modern business
practices.
Consequently, the planned patent box does not
satisfy four of the five principles of corporate tax reform set
out in HM Treasury's recent road map for reform.
Table 1
WILL THE UK'S PATENT BOX ENHANCE COMPETITIVENESS?
Country
| Effective
tax rate | Qualifying IP
| Cap | Can work be performed abroad
| Objectives of policymakers |
Netherlands | 0%-5%
| Patented IP or IP for which an R&D declaration is obtained
| No | Yes for patent IP. Stricter conditions for R&D IP.
| Attract more R&D activities |
| Luxembourg | 0%-5.72% | Software, subject to copyright, patents, trademarks, domain names, designs and models
| No | Yes | Attract IP ownership
|
| Belgium | 0%-6.8% | Patents and extended patent certificates
| No | Yes, if qualifying R&D centre
| Retain & attract R&D and stimulate Belgian patents
|
| Hungary | 0%-9.5% | All IPR (within guidelines)
| No | Yes | EU R&D policy/strategy
|
| Ireland | 0%-12.5% | Patent = 0%. Other defined IP for amortization
| €5 m for
0% rate | Yes, relevant for R&D tax credit
| Retain and attract R&D |
| UK | 10% | ???
| ??? | ??? | ???
|
| France | 15.92% | Patents and extended patent certificates
| No | Yes | Retain and attract R&D
|
Source: Kathy Bishop, IBM, Centre for Business Taxation, Oxford University Summer Conference.
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CAPITAL ALLOWANCES—OVERVIEW
— Advancing technology means manufacturers replace equipment,
on average, every seven to eight years.
— The UK's tax system takes over 30 years to recognise
that investment; in the US it is seven years, in Germany, 10-16
years.
— The gap between the UK's tax system and how modern
businesses invest raises the cost of investing in the UK and harms
our international competitiveness.
— Simple reform to the Short Life Asset regime would
restore competitiveness with minimal cost over first five years.
BACKGROUND
The cost of capital investment is rising and investment cycles
are shortening as new technologies render existing equipment obsolete.
The faster the rate of this depreciation, the earlier manufacturers
are forced to reinvest in new, more productive equipment.
A report by Statistics Canada estimated that, from 1995-2001,
the average depreciation rate for machinery and equipment, based
on the declining balance method, was 27%. By contrast, the UK
tax depreciation rate under the UK's capital allowance regime,
again using the declining balanced method, is only 20% for most
machinery and equipment.
In the intervening decade, modern machinery has become more
productive by increasingly incorporating the latest technologies
and software. Empirical and anecdotal evidence suggests that manufacturers
are replacing their machinery and equipment, on average, every
seven to eight years.
Yet the UK's current rate of 18% means that manufacturers
are only able to recoup their costs after 30-odd years, adding
a premium to investing in the UK.
Table 1
AVERAGE SERVICE LIFE OF MACHINERY AND EQUIPMENT, YEARS
| 1985-1989 (1) |
1995-2001 (1) | 2005-11 (2)
|
| Machinery and equipment | 12.3
| 9.8 | 7.3-7.8 |
| Manufacturing buildings | 35.6
| 27.9 | 20.2-21.8 |
| Source: (1) Statistics Canada and (2) Statistics Canada & EEF
| | | |
| |
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Table 2
AVERAGE RATE OF ECONOMIC DEPRECATION
| 1971-1990 (1) |
1985-2001 (2) | 1995-2001 (2)
|
| Industrial Sector | 12.3 |
- | - |
| Machinery and equipment | -
| 23.0 | 26.8 |
| Manufacturing buildings | -
| 8.7 | 9.9 |
| Source: (1) Institute of Fiscal Studies, (2) Statistics Canada and (3) HM Treasury
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Table 3
UK CAPITAL ALLOWANCE SYSTEM IS INTERNATIONALLY UNCOMPETITIVE
Country | Basis
| Method | Recovery period
|
US* | | AD
| 7 years |
| Ireland | Acquisition cost |
SL | 5-10 years |
| Germany* | Historical, acquisition or production costs
| SL | 10-16 years |
| France* | Initial cost or cost of manufacture
| SL | 10-20 years |
| Canada | Acquisition cost |
AD | 20 years |
| UK (18% capital allowance level) | Pooled costs
| AD | 30+ years |
Source: US Congressional Research Service, PWC & EEF
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EEF PROPOSALS FOR
MODERNISING CAPITAL
ALLOWANCES
Even though the capital allowance regime is far from perfect,
radical reforms are likely to prove complex or costly.
A simple and practical proposal to recognise the true cost
of modern machines with shorter lives would be to extend the time
restriction on short-life asset election from four to eight years.
This would allow a wider range of assets to be written off at
the end of their useful economic lives.
The cost to the Exchequer would be zero in the first four
years after the reform, £620 million in the fifth year, before
steadily falling in cost over time.
An illustrative example
Consider a machine with a useful economic life of five years
which is acquired for £1 million. After the end of year 5,
it is disposed of for £100,000. Under the current regime,
the machine is not eligible for the short life asset treatment.
Therefore it is included in the main pool, with no balancing allowance
unless the business stops trading. The total allowance given on
this machine is £678k. Despite the machine having been sold,
the remainder of the tax write-down value of £222k will be
carried forward and claimed over time through the writing down
allowance at a rate of 18% p.a. (reducing balance method). This
defeats the purpose of the capital allowance legislation which
is to let a taxpayer write off the cost (net of disposal proceeds)
of an asset over the economic life of an asset: The balance of
£222k will take over 20 years to be relieved.
Scenario 1
WITH AN 18% CAPITAL ALLOWANCE LEVEL
| |
| Main pool
(000s) | Capital allowances
(000s)
|
1 | Cost |
| 1,000 | |
| 2 | Written down value after 5 years (12.5% reducing balance)
| | 371 | 629
|
| 3 | If disposed of in year 6
| | | |
| 4 | Disposal proceeds (10% of initial value)
| | -100 |
|
| 5 | WDV eligible for WDA |
(2)-(4) | 271 |
|
| 6 | WDA @ 18% |
| -49 | 49 |
| 7 | WDV carried forward at end of year 6
| | 222 | |
| 8 | Total capital allowances claimed over asset life
| | | 678
|
| |
| | |
If the machine is eligible for the short life asset treatment
under EEF's proposal, it would be treated independently from the
main pool, hence a balancing allowance arises. The total allowance
given on this machine of £900k is higher than £678k
as per Scenario 1 because the remainder of the tax write down
value of £271k will be claimed as balancing allowances in
the year of the disposal as opposed to being carried forward indefinitely
as in Scenario 1. That £271k difference provides a significant
cashflow boost as the company plans for reinvestment.
Scenario A2
WITH EEF'S PROPOSED EXTENSION TO THE SHORT LIFE ASSET
REGIME
| |
| Main pool
(000s) | Capital allowances
(000s)
|
1 | Cost |
| 1,000 | |
| 2 | Written down value after 5 years (18% reducing balance)
| | 371 | 629
|
| 3 | If disposed of in year 6
| | | |
| 4 | Disposal proceeds (10% of initial value)
| | -100 |
|
| 5 | WDV eligible for WDA |
(2)-(4) | 271 |
|
| 6 | Balancing allowance |
| -271 | 271 |
| 7 | WDV carried forward at end of year 6
| | 0 | |
| 8 | Total capital allowances claimed over asset life
| | | 900
|
9 December 2010
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