RESEARCH AND DEVELOPMENT TAX CREDITS & PATENT BOX REGIMES Opening comments – Thanks – Welcome BERNHARD GILBEY 18 November 2016

Patent Box Regimes The background Intellectual Property Valuable, knowhow, income-producing, assets of company Growth of a ‘knowledge based’ economy Opportunities and problems: Unlike large manufacturing machinery and assets Easily moved, globally Planning to ensure profits realized in low-tax jurisdiction Fiscal policy to attract R&D activity and tax economic growth attributable to IP Opportunity for PLC: “progressive power acrylic lenses” “high quality optical lenses for telescopic use” Background – why do IP boxes exist? What is IP? Knowhow, patents, copyright Income production from unique ‘knowledge’ – intellectual property Why is it important? Concentrating on developed countries (in the main) Decline of traditional heavy manufacturing (declining natural [IMMOVABLE] resource, increasing costs, increasing competition etc) Growth of knowledge based economy (services, technological advance, pharma, communications etc) Encouragement of research & technological advance – regulatory protection of ‘intellectual property’ Importance of [MOVABLE] intangible assets – including, e.g. knowhow, patents… Opportunities: For knowledge based companies (like PLC)… IP easily moved, globally – tax became incentive to cross-border migration Tax planning = move IP to low (no) tax jurisdiction (Isle of Man[?]) + licence & royalties payments + repatriate profits with benefit of DTA protection Problems: For domestic tax authorities Tax base erosion / profit shifting Solution: Onshore IP holding regimes through domestic fiscal stimulus The greater the level of economic growth attributable to technological advance, the greater the level of fiscal policy response to claim / protect taxing rights Domestic, tax-advantaged, IP Boxes

Patent Box Regimes What’s in the box? A relatively recent phenomenon Two design principles: Preferential rate of tax ; for Income associated with intellectual property Onshore IP: Holding regime Incentivize future (re)investment in research Development of ‘patent box’ regimes relatively recent phenomenon New global economy Tax base protection etc Focus of ‘patent box’ regime is on ‘back-end’ of knowledge / research process: R&D = tax incentives (super deductions, accelerated deductions etc) for ‘qualifying activities’ IP Box = 2 design principles: Preferential rate of tax (or special deduction for IP income, leading to same effect) Income generated from the IP Aim = relocate / onshore the holding and generation of IP Advantages two-fold: Reduce tax cost for company Incentivize future generation (ease & reinvestment)

Patent Box Regimes Harmful Tax Practices – OECD BEPS, Action 5 BEPS Action Plan, Action 5 (2013): “Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime…” Promoting a level playing field Common criteria & co-operative framework Substance (basic BEPS pillar): To realign taxation of profits with the substantial activities that generate them… To realign the development of the IP with the tax advantage provided The [modified] ‘nexus approach’ Qualifying expenditure as a proxy for qualifying activity OECD ‘nexus ratio’ = 𝑎+𝑏 𝑎+𝑏+𝑐+𝑑 Changing Incentive or unfair ‘State Aid’? BEPS Action 5 – Harmful tax practices = State sponsored: Artificial profit shifting ‘Grab’ for tax base Aggressive tax competition Aims: “reducing the distortionary influence of taxation on the location of mobile … activities” Promoting the “level playing field” Combatting the “race to the bottom” Basic BEPS pillar principle: “realign taxation of profits with the substantial activities that generate them” Or, in the IP Box arena, to realign the place where the IP is developed with the place where the tax benefit is provided / earned The ‘nexus approach’: Benefit of IP regime only available to taxpayers who incur qualifying R&D expenses Expenditure as a proxy for activity: Substantial activity in State offering IP box; and Income from generated IP must be proportionate to R&D expenditure – real value added OECD nexus ratio: a = R&D expenditure incurred by taxpayer (qualifies) b = expenditure for unrelated party outsourcing (qualifies) c = acquisition costs (does not qualify) d = expenditure for related party outsourcing (does not qualify) Plus: transparency for preferential IP regimes: Spontaneous information exchange Self-regulating system

Patent Box Regimes Harmful Tax Practices – OECD BEPS, Action 5 (continued) Regimes meeting ‘nexus approach’ also require: Qualifying taxpayers: Resident companies Qualifying IP assets: Patents Qualifying expenditures: Incurred by claimant (but with a 30% up-lift) Direct connection to IP asset EU: The Anti Tax Avoidance Package (2016): Member States committed to ensuring Patent Boxes accord with nexus approach ECOFIN: Code of Conduct Group on Business Taxation ‘monitoring process’ BEPS AP 5 – further requirements: Qualifying taxpayers: Resident companies, PEs of foreign companies etc. Qualifying IP assets: Restricted Patents (and similar legally protected assets ‘equivalent to patents’ Qualifying expenditures: By taxpayer For actual R&D activities 30% uplift because Note: EU (the BEPS enforcer) response: The Code of Conduct Group on Business Taxation has established a monitoring process which will ensure that Member States implement the revised approach to patent boxes. If Member States are not applying the new approach appropriately, then the Commission will consider introducing legislation to ensure its proper implementation.

Patent Box Regimes Global ‘Patent Boxes’: OECD considered 16 ‘Patent Box’ type regimes around the world: Belgium Netherlands China Portugal Colombia Spain France Spain (Basque) Hungary Spain (Navarra) Israel Switzerland (Nidwalden) Italy Turkey Luxembourg United Kingdom All 16 considered (in whole or part) as inconsistent with nexus approach. OECD examined 16 different regimes as part of BEPS AP 5… Others exist[ed] – e.g. Cyprus … all 16 failed, to some degree, the new [modified] nexus approach set out in the final report… Time now to reconsider position and reassess IP regime offering We’ll consider, as possible options for PLC (not all assessed by OECD): United Kingdom Spain Netherlands France Ireland

POLYCON IPR LOW-TAX STATE (Brand & Product Owner) Patent Box Regimes STEPHEN HOLMES POLYCON LENS COMPANY (manufacturing) INT. LICENSING HIGH-TAX STATE Third Party Licensing & Franchise Agreements SESSION 2 RESEARCH & DEVELOPMENT TAX CREDITS & PATENT BOX REGIMES POLYCON IPR LOW-TAX STATE (Brand & Product Owner)

Patent Box Regimes United Kingdom: Patent Box (since 2013, as amended 2016) Tax rate: [Minimum] reduced corporate tax rate = 10% [to be fully operational by 2021] Income profits from qualifying IP assets Qualifying taxpayers: Companies holding: Qualifying IP rights Exclusive licence in respect of qualifying IP rights Qualifying IP assets: Patents (and similar) Non-qualifying IP assets: Software copyright Qualifying expenditures: Incurred by claimant – the development condition Income sub-streamed for proportionality (to meet modified nexus approach) UK

POLYCON IPR LOW-TAX STATE (Brand & Product Owner) Patent Box Regimes STEPHEN HOLMES POLYCON LENS COMPANY (manufacturing) INT. LICENSING HIGH-TAX STATE Third Party Licensing & Franchise Agreements SESSION 2 RESEARCH & DEVELOPMENT TAX CREDITS & PATENT BOX REGIMES POLYCON IPR LOW-TAX STATE (Brand & Product Owner)

Patent Box Regimes Spain: Patent Box (since 2008, as amended 2016) Tax rate: 60% exemption for income (includes capital gains) derived from licencing qualifying IP 40% taxed at standard rate (25%) = effective rate of 10% Qualifying taxpayers: Companies (licensee must not be resident of low-tax jurisdiction) Qualifying IP assets: Patents, plus Designs, models, secret formulas & procedures, industrial, commercial, or scientific information Non-qualifying IP assets: Software copyright, trademarks Qualifying expenditures: 2016 amendments apply modified nexus approach in Spain Deduction now limited to ratio of expenses directly related to creation / development Transitory regime applies Spain

POLYCON IPR LOW-TAX STATE (Brand & Product Owner) Patent Box Regimes STEPHEN HOLMES POLYCON LENS COMPANY (manufacturing) INT. LICENSING HIGH-TAX STATE Third Party Licensing & Franchise Agreements SESSION 2 RESEARCH & DEVELOPMENT TAX CREDITS & PATENT BOX REGIMES POLYCON IPR LOW-TAX STATE (Brand & Product Owner)

Patent Box Regimes Netherlands: Dutch Innovation Box (since 2007, as amended 2017) Tax rate: Reduced corporate tax rate = 5% Qualifying income (including royalties & capital gains) Qualifying taxpayers: Companies Reduced controls / restrictions on ‘small taxpayers’ Qualifying IP assets (new, connected and on-developed): Patents (and similar) Software copyright Licences to distribute medicines (human and veterinary) Qualifying expenditures: Incurred by claimant – limitations where R&D outsourced to related parties Other: extensive grandfathering + connected and on-developed rules Netherlands

POLYCON IPR LOW-TAX STATE (Brand & Product Owner) Patent Box Regimes STEPHEN HOLMES POLYCON LENS COMPANY (manufacturing) INT. LICENSING HIGH-TAX STATE Third Party Licensing & Franchise Agreements SESSION 2 RESEARCH & DEVELOPMENT TAX CREDITS & PATENT BOX REGIMES POLYCON IPR LOW-TAX STATE (Brand & Product Owner)

Patent Box Regimes France: Patents and Royalties Regime (since 2000, amended…?) Tax rate: Reduced corporate tax rate = 15% Qualifying income includes: Income from licenses, sub-licenses, royalties; and Long term capital gains from transfer & sale of IP Qualifying taxpayers: French companies holding (or held): Qualifying IP rights + exclusive licence in respect of qualifying IP rights Qualifying IP assets: French (and French registrable) patents only Qualifying expenditures: Requirement is ownership (if acquired, for minimum of 2 years) of IP rights No requirement for claimant to have incurred expense – nexus approach failed… “France is in contravention” of obligation to make necessary changes to regime France France in contravention: “In the meeting of 2 June 2016 France declared that no rollback would be necessary since it considered that its regime would not be harmful. The Group asked France to demonstrate the compatibility of its Patent Box regime with the modified nexus approach.” “France claims that a significantly lower level of taxation must be defined by reference to the overall corporate tax environment in the single market and that the absolute level also matters.” Code of Conduct Group disagrees; will assess French regime by reference to all normal criteria of ‘harmfulness’. (Report by the Code of Conduct Group (Business Taxation) to ECOFIN − Patent boxes: state of play and the way forward (03.11.16))

POLYCON IPR LOW-TAX STATE (Brand & Product Owner) Patent Box Regimes STEPHEN HOLMES POLYCON LENS COMPANY (manufacturing) INT. LICENSING HIGH-TAX STATE Third Party Licensing & Franchise Agreements SESSION 2 RESEARCH & DEVELOPMENT TAX CREDITS & PATENT BOX REGIMES POLYCON IPR LOW-TAX STATE (Brand & Product Owner)

Patent Box Regimes Ireland: Knowledge Development Box (new for 2016) Tax rate: Reduced corporate tax rate = 6.25% Income profits from qualifying IP assets Qualifying taxpayers: Companies holding (or held): Qualifying IP rights Exclusive licence in respect of qualifying IP rights Qualifying IP assets: Patents (and similar); and Computer software copyright (broader than UK – although of no use to PLC) Qualifying expenditures: Incurred by claimant – linked to R&D in Ireland First fully compliant modified nexus approach IP regime Other: existing infrastructure already exists Ireland Irish response to attack on the ‘double-Irish’ structure

Patent Box Regimes Other future possibilities Belgium: Luxembourg: Proposed replacement ‘innovation income deduction’ (IID) scheme Patents (and similar) plus extended to cover software copyright 90% of net innovation income (royalties & license fees) deducted from taxable income IID restricted in-line with modified nexus approach Luxembourg: Abolished preferential regime July 2016 A main BEPS target A replacement, nexus approach compliant, IP regime is very likely United States: A new, widely drawn, IP regime much discussed Much needed as IP regimes proliferate globally Likely form part of US Tax Reform program… such as it is… International pressure to make BEPS-compliant to be balanced with domestic need Future regimes Belgium – abolished popular regime July 2016 – replacement will be broader based but with copper-bottomed nexus approach Luxembourg - abolished existing regime July 2016 – expect competitive replacement soon Cyprus – rewriting to conform with OECD modified nexus approach US – much talk; little action – balance need against priority and ‘deadlock’

Patent Box Regimes Closing remarks EU – Corporate Tax Reform Package CC[C]TB ‘R&D’ super-deduction Formulary apportionment proposals BREXIT: Opportunity for UK? Extend Within BEPS framework

Contact Info Slide Bernhard Gilbey Partner +44 (0)20 7655 1318 Bernhard.gilbey@squirepb.com Thanks

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