Industry expert says the patent box plan might see ‘more revenue lost than recouped’

If advanced manufacturing and Australia’s frustrated innovation sector were holding out for a real boost in the federal budget, they are likely to be disappointed.  

The extension of accelerated depreciation is welcome, as are ongoing efforts to encourage more people to take up apprenticeships. 

But the signature announcement for the sector — the creation of a patent box — is a niche measure that may not achieve its goals.  

A patent box is a policy tool that reduces the rate of corporation tax levied on the income generated from certain types of qualifying intellectual property (IP), particularly patents.  

Introduced some years ago in more than a dozen other countries, its seen as a lever to encourage business to invest in research and development and keep patents onshore, rather than losing IP to a lower-tax jurisdiction.  

That’s been a challenge for Australia, which has seen research and development expenditure as a proportion of GDP erode over time (down to just 1.8% in 2017, the most recent OECD figures available, compared to nearly 5% in Israel and more than 3% in Germany, Japan, Sweden and the US). 

But our relatively high corporate taxes have also made it less attractive to keep IP in Australia, given its easy mobility.  

The $206.4 million announcement in the federal budget seeks to address that — in part — by allowing income derived from Australian-owned, locally developed medical and biotech patents to be taxed at a concessional rate of 17%. 

That compares to the standard 30% corporate income tax rate, or the 25% rate for SMEs, but  — worryingly — will only apply to income directly derived from the patent, rather than that from manufacturing, branding or other attributes.  

Does Australia need to do more to keep IP local?  

Absolutely — IP Australia reports while the number of locally originated patents filed in Australia is falling, the number of patents filed by Australians overseas continues to grow.  

Just one in ten patent filings in Australia originates from Australian research, and on average in 2018 Australians filed 3.2 patent applications overseas for every standard patent application that they filed here. 

But there are some challenges with the newly announced scheme.  

The focus is narrow — applying only to biotechnology or medical patents — although the Treasurer has foreshadowed considering other areas such as renewable technology as well.  

While medical, pharmaceutical and biotech patents make up about a third of all patents lodged in Australia, only a small proportion of these originate locally. 

Out of more than 3660 medical technology patents filed in Australia in 2018, for example, only 163 were locally originated. It’s only our third strongest sector, after civil engineering and the combined impact of the furniture and games industries.  

Unsurprisingly, the medical and biotech sector has been actively advocating for a patent box for several years, as a way to address this trend. But it is not clear whether the measures put forward in this budget will be sufficient to arrest this trajectory.  

Part of the challenge is that even at 17%, Australia isn’t particularly competitive.  

The patent box rate in the UK, Spain and France is 10%, Ireland offers 6.25%, and depending on the structure, Hungary and Andorra have patent box tax rates as low as 0%.  

Many of these comparative rates were derived from applying a 50% discount to the prevailing corporate tax rate, and it is because our headline corporate tax rate is not competitive that our 17% rate seems insufficiently generous.  

Since the commercialisation of IP is a highly mobile thing, there is no doubt that decisions as to where to manufacture and exploit IP will be made on an after-tax basis, and in that sense 17% is unlikely to be sufficiently attractive to make a big difference in the short term. 

So is the patent box worth it?  

In one sense, it doesn’t go anywhere near far enough. If the goal is to support local advanced manufacturing as well as innovation, then excluding revenue from manufacturing from the more attractive tax rate fails in that goal.  

There is little point in keeping the IP for a patent on Australian shores but shipping the manufacturing jobs off to another corner of the world.  

At the same time, unless the measures really spur patent innovation, it’s hardly worth the loss in revenue.  

Back in 2015 the Office of the Chief Economist concluded that introducing a patent box would see more tax revenue lost than was likely to be recouped by reallocating IP income to Australia.  

There was likely to be what the report called ‘opportunistic’ filings of patents, not tied to real economic activity and where the R&D was likely to be conducted abroad. 

I think this conclusion, coupled with the biotech lobbying, explains why this policy simply dips our toe in the water by providing an opportunity to a sector that we are strong in (and that we have stated we want to prioritise). 

But revenue is not the only yardstick to measure this policy.  

If — and it’s a big if — it increases the locally originated patent applications, keeps that IP onshore for longer, boosts manufacturing and spurs other sectors to get similarly motivated, we might see a longer term payoff in bringing some life back to Australian R&D.