1. Introduction and Background

Patent is a grant of protection for an invention. India isnow bringing its own tax benevolence regime for patents i.e. inventions made in India, by virtue of a concessional tax regime under the Indian Income Tax Act, 1961 (‘the Act’). The finance minister in his budget speech mentioned that "Research is the driver of innovation and innovation provides a thrust to economic growth. I propose a special patent regime with 10% rate of tax on income from worldwide exploitation of patents developed and registered in India". Therefore as part of the measures to promote socio-economic growth, India’s proposal to provide a special tax regime for incentivizing Research & Developments (R&D) and to spur commercialization of domestic R&D by taxing patent revenues differently from other commercial revenue is a much needed fillip and is indeed welcome and heartening.

However it is worthwhile to note here that this patent tax incentive regime is definitely not India’s innovation and many countries across the globe have initiated such tax incentive measures to promote research & new innovations.Ireland, a tax friendly country which came into severe criticism in the recent past for its controversial tax mischief legislation viz., Double Irish tax relief is ironically the first country to introduce such a tax incentive regime for innovation by naming it as ‘Patent Box’ (so-called because there is a box to tick on the tax form). Ireland recently has modified its patent box regime and now it gives it’s a new nomenclature as ‘Knowledge Development Box’.These tax incentive regimes are often called Patent Box, Innovation Box or License Box regimes.

The below list provides a snapshot of the countries that have introduced such a tax incentive regime for encouraging innovations and promoting research & development on Intangibles,Intellectual Property Rights, Patents etc.

Surprisingly United States, which houses leading pharma and technology companies is yet to introduce a patent box regime type - currently the process for introducing such a regime is on and is expected to be implemented post the ongoing presidential election.  Further, from the above table it can be deciphered that this has been implemented by most of the European countries and has established such regime as a common tax structure. India surprisingly has been pro-active and the introduction of such aglobal regime is indeed very early for India’s standard, which implies that there is a definite focus on innovation and research in the country.

Further from the Budget memorandum, it appears that India had been inspired to bring in such a regime thanks largely to the OECD’s Base Erosion Profit Shifting (BEPS) Action plan. Action 5 of the OECD BEPS project focuses on countering harmful tax practices. The OECD considers that a preferential Intellectual Property regime can potentially constitute a harmful tax practice if it allows taxpayers to derive benefits while engaging in operations that involve limited substantial activities. Therefore it suggested a modified nexus approach. The impact and analysis of India’s patent tax regime vis-à-vis to the BEPS Action 5 item will be dealt in a separate article. The current article will focus only on the newly introduced Patent Tax Regime in India.

2. Patent Tax Regime – India Version

First and foremost it is imperative to understand that there are certain R&D related tax incentives provided under the Act by virtue of investment linked incentives, which are different from the Patent tax regime. Patent Tax concessional regime is primarily a ‘back end’ incentive i.e. they apply after the technology is developed thereby encouraging inventors to maintain their patent in the country where it was developed.  The investment linked deductions available for research and development in the Act is the front end incentive promoting innovation strategies. However in order for domestic businesses to be globally competitive, commercialization of such R&D is essential for economic growth. Hence in those lines, the Patent tax regime has evolved.

India’s patent tax regime is introduced to allow a concessional tax rate on revenue derived from patents.  A new section 115BBF of the Act, titled ‘Tax as Income from Patent’ is to be introduced inter-alia as follows:

a) Total income of an ‘eligible assessee'includes income by way of ‘royalty’ in respect of a patent developed i.e. for any invention in respect of patent granted under the Patents Act, 1970 and such patent is registered in India, then such income on royalty shall be taxed on gross basis at the rate of 10%.
b) Invention in this regard is borrowed from the Patent Act, 1970 wherein it defines the "invention" as a new product or as process involving an inventive step and capable of industrial application. 

c) Further deduction in respect of any expenditure or allowance incurred shall not be available under the Act.

d) ‘eligible assessee’ means a person resident in India, who is the true and first inventor of the invention and whose name is entered on the patent register as the patentee in accordance with Patents Act, 1970 and includes every such person, being the true and the first inventor of the invention, where more than one person is registered as a patentee under Patents Act, 1970 in respect of that patent.

e) “royalty”, in respect of a patent, means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains” or consideration for sale of product manufactured with the use of patented process or the patented article for commercial use) for:

(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 to in sub-clauses (i) to (iii)

Therefore from the above, it can be construed that the Patent tax regime in India is primarily a financial incentive provided by the Government to commercialize Indian patents and thereby enabling India’s economic growth. Moreover , from the fine print it appears that such a regime is only on patents and one would have to wait and see whether it will be extended to other streams as well. For example, Ireland, Luxembourg, Spain, and Switzerland go farther and also allow income from designs, copyrights, models and trademarks to be taxed at the lower patent box rate. And with the broadest definition of IP-sourced income, China extends its patent box to allow income from certain types of commercial “know-how,” such as process innovation, to qualify for the lower rate.

Further in scenarios where the eligible assesse suffers loss owing to market failures, whether the assesse would still be taxable on a gross basis at 10% remains to be seen. Considering the fact that the investment linked incentives are being phased out, it will be interesting to see what are the R&D tax incentives that will be provided by the Indian Government for enabling innovations and more specifically for high risk innovations. Patent tax regime is only the commercialization of the patent and therefore it is essential that R&D related tax incentives are being maintained and more support is provided.

3. Patent Tax Regime – Will it be a frugal legislation?

It is imperative to note here that  multinational firms’ intangible assets constitute a pivotal role and a value driver, and therefore it will often be difficult to identify the source/location of intellectual property, hence leading to tax planning devises such as the ‘Irish Double Sandwich” etc.  In this regard, a patent box regime scenario will definitely act as a deterrent to move the patents outside of the home country.

In this cutting-edge based global economy, R&D and innovation are increasingly important components of national economic success, particularly for nations that must compete on factors other than just low factor costs. Innovation also leads to higher productivity and higher wages, and is a key driver for stronger trade performance.From an India perspective, a tax policy for innovation indeed goes very well with the current Government emphasis on ‘Make in India’, ‘Startup Action Plan’, Digital India etc. It is also a matter of concern that India’s patent regulation has always been under a scanner, especially that India’s patent litigation has been contentious, where we have seen Indian domestic companies locking horns with big western multinational giants, more specifically in pharma industry.

Hence in this regard, the Government should focus heavily on ensuring an ecosystem when it comes to patent laws, R&D, innovations that is simple and kept frugal.  One would have to wait and see whether the patent (box) tax regime by the Government will be gift box for Indian businesses or a Pandora’s Box. Irrespective of the outcome, such a regime is definitely Pro-Growth and Pro-Innovation.