Patent Box and Nexus Fraction

The Patent Box was introduced to incentivise companies to continue carrying out innovative activity and exploit their IP rights within the UK nearly a decade ago. It works by taxing profits resulting from specific categories of intellectual property arising from R&D activity at a preferential rate.

This regime enables qualifying companies to benefit from a lower effective Corporation Tax rate of 10% on profits derived from the commercial exploitation of patents.

What is Nexus Franction?

Over the years, Patent Box has changed and evolved but perhaps the most impactful change was the modified nexus approach, which took place in July 2021. This new rule was set to help bring the UK in line with the international standards set by the Organisation for Economic Co-operation and Development (OECD) for the taxation of IP rights. Since then, companies are required to demonstrate a direct link (called nexus) between the qualifying research and development (R&D) and the creation of their patented inventions or other qualifying IP rights.

With this change, companies must now calculate the proportion of the profits that are eligible for Patent Box relief based on the proportion of the qualifying R&D activity that was undertaken by the company, also known as nexus fraction.

The qualifying R&D activity must have been undertaken in the UK, or in a European Economic Area (EEA) state with which the UK has a double tax agreement that includes an exchange of information provision.

Calculation of Nexus Fraction

The calculation of the patent box nexus fraction involves determining the proportion of your relevant R&D expenditure that is directly related to the creation, development, improvement, or maintenance of the patented invention. The fraction is calculated using a formula that takes into account four categories of R&D expenditure:

1. Qualifying expenditure on R&D outsourced to related parties.
2. Qualifying expenditure on R&D outsourced to unrelated parties.
3. Qualifying expenditure on R&D carried out internally.
4. Qualifying expenditure on R&D acquired as part of the acquisition of intellectual property rights.

The formula used to calculate the patent box nexus fraction is as follows:

Nexus Fraction = (A + B + C + D) / E

Where: 

A = Qualifying expenditure on R&D outsourced to related parties 

B = Qualifying expenditure on R&D outsourced to unrelated parties 

C = Qualifying expenditure on R&D carried out internally 

D = Qualifying expenditure on R&D acquired as part of IP rights acquisition 

E = Total qualifying expenditure on R&D (sum of A, B, C, and D)

The resulting nexus fraction represents the proportion of R&D expenditure directly linked to the patented invention and determines the percentage of profits that can be eligible for the reduced rate of corporation tax under the patent box regime. For more information please visit the official government website or get in touch with our team of experts and get support with your claim.