Chapter 4: Streaming
157.In certain circumstances apportioning the profits of a trade by using the overall ratio of relevant IP income to total gross income, as required at Step 3 of new section 357C, may give rise to a distorted result. This may occur where the relative proportions of income from the exploitation of IP rights and other income differs markedly from the relative proportions of profits derived from such income.
158.New section 357D therefore provides for a company to elect for the provisions of new section 357C to be set aside, and for the relevant IP profits of the trade to be ascertained using the streaming provisions of new section 357DA. It also provides that the provisions of new section 357DA will replace new section 357C where any of the mandatory streaming conditions of new section 357DC is met.
159.New section 357D(1) allows a company to elect to apply new section 357DA. This is a streaming election. No formal election procedure is set down, and a company may simply include the streaming election by way of a note to the computations in its corporation tax return (or an amended return) for the period.
160.New section 357D(2) ensures that where a streaming election is made, it can to be applied to any or all of the company’s trades. This allows a company to pick and choose which of its trades would benefit from a streaming election.
161.New section 357D(3) states that a streaming election has effect for the accounting period in which it is made and each following period, unless the company ceases to use streaming where there has been a change of circumstances as set out in new section 357DB(3).
162.New section 357D(4) stipulates that where a company is required to use streaming because one or more of the conditions in new section 357DC is met, it must apply the provisions of new section 357DA to calculate its relevant IP profits rather than new section 357C.
163.New section 357DA(1) outlines the steps used to determine the relevant IP profits of the trade where either, the company has made a streaming election, or the company meets one or more of the mandatory streaming conditions.
164.Step 1 directs that any credits taken into account in computing the corporation tax profits of the trade other than finance income are to be split in to two streams; a relevant IP income stream (including any notional royalty computed under new section 357CD) and income that is not relevant IP income. Finance income is defined in new section 357CB.
165.Step 2 requires that, having separated the income of the trade into separate streams, all of the amounts deducted in calculating the corporation tax profits of the trade, should now be allocated on a just and reasonable basis against one or other of the streams of income. There is an exception for amounts identified under new section 357CG(3), that is any additional deductions for expenditure on research and development under part 13 of CTA 2009, and any trading loan relationship or derivative contract debits. The effect of not allocating these amounts is that they do not reduce relevant IP profits so that they attract relief at the full corporation tax rate.
166.Step 3 requires that the amounts allocated to the relevant IP income stream under Step 2 above are deducted from that income stream.
167.Step 4 determines any qualifying residual profit figure by deducting an amount representing a routine return, calculated under new section 357CI, from the result of Step 3. Where this is a positive figure, this is the qualifying residual profit, which represents the additional profit over and above a routine return attributed to the exploitation of the all of the company’s intangible assets. If the routine return figure is greater than the figure at Step 3, then subject to Step 7, there will be a relevant IP loss for the period. No further adjustment is necessary under Steps 5 and 6 where there is a loss at this stage in the calculation.
168.Companies with a qualifying residual profit now make a decision regarding how to calculate the amount of this qualifying residual profit that is attributed to the qualifying IP rights. Step 5 sets out that companies that cannot or have not made an election for small claims treatment proceed to Step 6; those that have made an election use the simplified procedure set out in new sections 357CL and 357CM.
169.Step 6 deducts from any qualifying residual profit an amount to be attributed to marketing assets. Whilst it is possible that the result of deducting the marketing assets return figure from the qualifying residual profits creates a loss, in practice a company in that position will always be better off making a small claims election and using the alternative method set out in new sections 357CL and 357CM so long as they meet one of the conditions in new section 357CL(2) or (3).
170.Step 7 is the point at which a company includes in its relevant IP profits for the period any additional amount in respect of profits arising in period where grant of a patent is pending that are allowed under new section 357CQ.
171.New sections 357DA(2) and (3) specify that any positive sum determined from the Steps set out above is the relevant IP profit for the period, whilst any negative amount will be the relevant IP loss for the period.
172.New section 357DA(4) specifies that the routine return figure referred to in Step 4 is 10 per cent of the aggregate of routine deductions allocated against the relevant IP income stream at Step 2. Routine deductions for this purpose are those identified in new section 357CJ and not excluded by virtue of new section 357CK.
173.New section 357DA(5) applies the rule at new section 357CI(2) and (3) where a routine return in computed in cases where there is a streaming election. The effect of that rule is to ensure that the deductions taken into account also include any deductions incurred on a company’s behalf by other members of the group, irrespective of whether or not these have been reimbursed, for example by way of a service fee or adjustment to intercompany balances. Where necessary, a just and reasonable apportionment of amounts incurred by the other company should be made to determine the amount relating to the company’s routine deductions.
174.New section 357DA(6) adapts the rule for calculating a marketing assets return figure at Step 6 where the streaming provisions apply.
175.New section 357DB requires that where a company has made a streaming election, the method it uses to allocate deductions between income streams, at Step 2 of new section 357DA, should not change from accounting period to accounting period, unless there is a change of circumstances.
176.New section 357DB(1) states that the phrase method of allocation refers to the method applied at Step 2 of new section 357DA.
177.New section 357DB(2) requires that where a company applies the streaming rules it must use the same method of allocation in each accounting period for which the streaming election has effect. This applies irrespective of whether the rules are applied by election or are mandated.
178.However, new sections 357DB(3) and (4) provide that where there is a change of circumstances in respect of any of the company’s trades, which makes the method of allocation inappropriate for an accounting period, the company can choose a different method of allocation, or elect not to apply the streaming election, for that accounting period. If the company chooses a different method then new section 357DB(2) will apply to require that that new method is applied for each subsequent accounting period. No formal procedure is set down, and a company may simply include an election not to apply streaming for the accounting period by way of a note to the computations in its corporation tax return (or an amended return) for the period.
179.New section 357DB(5) provides that where a company elects not to apply streaming for an accounting period under new section 357DB(4)(b), this does not prevent it from making fresh streaming elections in subsequent accounting periods.
180.New section 357DC details the circumstances under which a company is required to apply the streaming provisions of new section 357DA in determining relevant IP profits rather than those of new section 357C, other than where is has made an election to do so. Streaming is mandatory where any one or more of the conditions A to C is met in relation to a trade of the company for an accounting period. If, exceptionally, a company operates more than one trade within the Patent Box, and a mandatory streaming condition is met in respect of only one of the trades, then the company is required to apply streaming only to that trade. As with optional streaming elections, it may continue to apply the provisions of new section 357C to calculate relevant IP profits of the rest of its trades.
181.New section 357DC(1) sets out mandatory streaming condition A. This is met for an accounting period where the accounts of the company for the period do not recognise a substantial amount of revenue from the trade that is taken into account in computing the profits of the period for corporation tax purposes.
182.This may happen when, for example there are accounting adjustments affecting prior years’ statements of income, or where additional income is recognised for tax purposes on the basis of a transfer pricing adjustment covering several periods. The latter position is specifically catered for in new section 357DC(4). In these circumstances the general presumption that there is an indirect link between the ratio of relevant IP income to other income and the relevant IP profits to other profits does not apply, so using the rules of apportionment in new section 357C is inappropriate.
183.New sections 357DC(2) and (3) specify that an amount is substantial if it exceeds the lower of £2 million or 20 per cent of the aggregate of the relevant IP income and such licensing income, subject to a de minimis figure of £50,000.
184.New section 357DC(5) sets out mandatory streaming condition B. A company meets this condition for an accounting period if its total gross income from the trade includes relevant IP income, and a substantial amount of licensing income that is not relevant IP income. Licensing income is defined in new section 357DC(6).
185.New sections 357DC(7) and (8) set out mandatory streaming condition C. A company meets this condition for an accounting period if its total gross income from the trade includes income that is not relevant IP income, and a substantial amount of relevant IP income in the form of licence fees or royalties received under an agreement granting rights to another person over IP rights, where the company itself only holds an exclusive license in respect those IP rights. The reason for this is that the licence income received and the royalties paid would result in very little profit. An apportionment process to determine relevant IP profits would not be appropriate in these circumstances.
186.New section 257DC(9) requires a company to make an apportionment of relevant IP income from such licenses if not all of the company’s qualifying IP rights meet the conditions of relevant Head 2 income in new section 357DC(8).