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Tax on Income from Patents – Patent Box Regime

Updated on :  

08 min read.

In this article, we will discuss about patents and tax on income from patents in detail.

What is a Patent?

Patent is a license or a legal document giving an exclusive/sole right over the invention for a set of period to make, use or sell the innovation. Every country will have law governing Patents and grants such license based on application received from an inventor. Patentee is the person whose name is registered as grantee or proprietor of the patent for the time being. Patent is a kind of protection of one’s own invention to exclude anyone exploiting the same.

Need for a Patent Box Regime

Tax planning / tax evasion measures are not specific to India and have been practised all over the world. Moreover, large multinational companies, conglomerates have the advantage to structure their business operations in a way to optimise taxes. There has been practices from inventors to get the patent registered in tax havens even though they are developed in a different country, thereby resulting in shifting of profits from country where it is developed and thereby the developing country could not establish its right over any income arising on such patent registered elsewhere.

Therefore, in order to retain the intellectual property in host country and to promote indigenous research and development, many countries all over the world started introducing favourable treatment for income over exploitation of intellectual property. Further, Organisation for Economic Co-operation and Development (OECD) also recognised the fact that preferential intellectual property regimes are prone to misuse and recommended nexus approach under Action Plan 5 (deals with countering harmful tax practices) in its Base Erosion and Profit Shifting (BEPS) project which involves Global 20 countries including India.

As per nexus approach, income arising from exploitation of intellectual property should be attributed and taxed in the jurisdiction where substantial research and development activities are undertaken rather than the taxing it only in the jurisdiction which has legal ownership of intellectual property.

Patent Tax regime all over the world

Patent tax regimes are more common in European Countries. Ireland was the first country to introduce patent tax regime and named it as ‘Patent Box’ as there was a separate Box to tick in the tax form. Ireland recently also modified its Patent Box regime and named it as ‘Knowledge Development Box’ regime. Many other Countries including France (Patent and Royalties), United Kingdom (Patent Box), Netherlands (Dutch Innovation Box), Spain (Spanish IP Box) etc also have patent box regimes which were introduced either before BEPS recommendation or modelled/remodelled in line with BEPS recommendation.

Patent Box Regime in India

Patent Box regime was introduced in India by Finance Act, 2016 by enacting new Section 115BBF. The name ‘Patent Box Regime’ is commonly used based on the nomenclature given to it by the Country first introduced it i.e., Ireland based on its tax form as mentioned above. Further, patent is being ‘boxed’ off from others and hence justifying the nomenclature well. Prior to introduction of Patent Box Regime (PBR) in India, there was already an input based research and development incentive in Indian tax provisions under Section 80RRB. This is referred to as front end incentive as it provided weighted deduction in respect of expenditure to assessees having royalty income and hence investment linked.

However, PBR a back end incentive specifically was warranted for India for three reasons;

  1. Front end incentive was not able to achieve the desired result of encouraging innovation and patenting in India; and
  2. Government aimed at phasing out investment linked deductions and also has ‘Make in India’ mission;
  3. To adopt nexus approach recommended by OECD in BEPS project.

Accordingly, in order to encourage indigenous research & development activities and to make India a global Research & Development hub, the Government decided to put in place a concessional taxation regime for income from patents. The aim of the concessional taxation regime is to provide an additional incentive for companies to retain and commercialise existing patents and to develop new innovative patented products which in turn encourages companies to locate the high-value jobs associated with the development, manufacture and exploitation of patents in India.

Section 115BBF – Dealing with patent tax in India

Section 115BBF provides concessional rate of taxation at 10% on royalty income in respect of exploitation of patents. Salient features of Section 115BBF is provided below:

  • Applicable to Indian resident who is a patentee (eligible taxpayer);
  • Only such patents which are granted under Patents Act, 1970 are considered
  • Patentee is any person who is the true and first inventor of the invention, whose name is entered on the patent register as the Patentee as per Patents Act, 1970 (Patent Act) and also includes joint true and first inventor
  • Total income of eligible taxpayer must include income by way of royalty
  • Royalty income is in respect of patent developed and registered in India
  • At-least 75% of the expenditure is incurred in India by eligible taxpayer for invention
  • Royalty income means any consideration for the —

i. transfer of all or any rights (including the granting of a licence) in respect of a patent; or

ii. imparting of any information concerning the working of, or the use of, a patent; or

iii. use of any patent; or

iv. rendering of any services in connection with the activities referred in above clauses;

Royalty also includes any lump sum consideration (including advance payment on account of royalty which is not returnable) but excludes income in the nature of capital gains or consideration for sale of product manufactured with the use of patented process or the patented article for commercial use)

  • No other expenditure is allowed under the tax provisions if concessional tax rate under Section 115BBF is availed
  • Eligible taxpayer choosing to avail Section 115BBF benefit, is required to furnish Form No. 3CFA duly verified electronically either by digitally signing it or through electronic verification mode by person authorised to sign return of income
  • Form 3CFA shall be complete in all respects and be filed on or before due date for furnishing the return of income under Section 139(1)
  • Form 3CFA requires certain general details (such as name, PAN, address of taxpayer etc),  details of patent (such as description of patent, patent number, date of grant of patent, whether granted to single person or in joint) and details of royalty income and also expenditure incurred in India and Outside India
  • Particulars of each eligible patent should be reported separately along with royalty income and expenditure details
  • The Director General Income-tax (Systems) shall specify the procedures, formats and standards for the purpose of ensuring secure capture and transmission of data and shall also be responsible for evolving and implementing appropriate security, archival and retrieval policies to furnishing and verification of Form No. 3CFA
  • Terms ‘invention’, ‘Patent’, ‘patented article’, ‘patented process’ and ‘true and first inventor’ shall have the meaning assigned to them in Patents Act

Can a taxpayer choose to opt or not opt for this section?

First and foremost, applicability of Section 115BBF is not mandatory and eligible taxpayer has an option to avail the benefit under Section 115BBF. Further, once an option to avail the benefit of Section 115BBF is exercised in any year, eligible taxpayer is required to continue to avail the benefit for next 5 years. In case option is not exercised in any of such 5 years, eligible taxpayer will not be eligible to take the benefit under section 115BBF for the next 5 years following such year in which option is not exercised.    

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