Claiming R&D tax relief does not change the nexus fraction. What changes it is who did the research, not who claimed relief on it. The R&D fraction, as the legislation calls it, scales each sub-stream of patent profit by the share of the underlying research the company did itself or paid an unconnected party to do. It is the lesser of 1 and (D + S1) × 1.3 ÷ (D + S1 + S2 + A), : D is in-house R&D spending, S1 R&D contracted out to unconnected persons, S2 R&D contracted out to connected persons, and A the cost of acquiring the rights. Do the work yourself and the fraction is 1: the whole relevant IP profit reaches the effective 10% rate. Buy the patent in, or pay a fellow group company to do the research, and part of it goes back to the main rate.
What counts in each of the four terms?
D is the company’s own spending on research relating to the right: staffing costs, software, consumable items, externally provided workers and payments to the subjects of clinical trials, with data licences and cloud computing services added for periods beginning on or after 1 April 2023. They are the same cost categories as an R&D claim, set out in qualifying costs, but the spending need not have been in an R&D claim to count. What matters is that the accounts treat it as R&D and that it relates to the right — research that created the invention, or was done to develop it, the ways it can be used or applied, or something that incorporates it.
S1 and S2 divide payments for contracted-out research by whether the recipient is connected, wherever that person is resident. Neither term is cut to 65% the way a contracted-out payment is in an R&D claim, nor capped at the contractor’s own costs the way a connected-party payment is: what the company paid is what goes in. A covers a payment for an assignment, for the grant or transfer of an exclusive licence, or for a disclosure the company then patents.
One divergence is widening. The Patent Box has not followed the April 2024 changes to contracted-out R&D or the restriction on overseas R&D: HMRC says the pre-April 2024 rules still apply for Patent Box purposes. So the analysis behind the R&D claim cannot be lifted across unchanged.
What does connected-party research or bought-in IP actually cost?
The 30% uplift on the numerator buys headroom: the fraction stays at 1 while connected-party subcontracting and acquisition costs together come to no more than 30% of in-house and unconnected spending.
A company with £1m of in-house research and £300,000 paid to a connected company sits exactly at that limit: £1m uplifted to £1.3m, over £1.3m of total spend, is 1. Take the connected spending to £600,000 and it becomes £1.3m over £1.6m, or 0.8125. On a sub-stream of £1m reaching that step, £187,500 of profit is then taxed at the 25% main rate instead of the 10% Patent Box rate — about £28,000 more tax.
Group structures throw up most of the arguments about which term a cost lands in. Staff supplied by a connected company can count in D rather than S2 where they meet the externally provided worker conditions. A payment routed through a connected intermediary that only administers the contract passes through to the third party, which puts it in S1. Where the intermediary controls the research, it is S2.
Royalties and annual fees under an exclusive licence build up in A, so a licensee’s fraction erodes year by year unless its own or unconnected research keeps the numerator moving. There is one large exception. Where the payments run under a single grant made before tracking began, they count as part of that original series and stay out of A. A later variation, or a second right added to the agreement, goes into A as normal.
Does the expenditure credit itself change the Patent Box numbers?
No. Under the merged scheme the credit is brought into account as a receipt of the trade, so the Patent Box calculation picks it up at its first step. There, credits are sorted into two streams: patent income, split into a sub-stream for each right or product, and everything else. Relevant IP income is a defined list — sales of patented items, licence fees and royalties, proceeds of selling the right, infringement receipts and compensation — and a tax credit is none of them. It falls into the standard income stream, never a relevant IP income sub-stream. HMRC’s manual arrives at the same place, listing income from RDEC credits among income excluded from the regime.
The sources stop short of saying so expressly. The manual is written in the older scheme’s language and does not name the merged scheme credit, and no provision in the Patent Box legislation excludes the credit the way finance income is. The exclusion follows from the definition of relevant IP income rather than from any rule aimed at the credit, so set the reasoning out in the corporation tax computation rather than leave it to be inferred.
A payable ERIS credit is not income for any tax purposes, so it never enters the streaming, and the ERIS additional deduction is an excluded debit, never set against IP income. Under both schemes R&D expenditure is also kept out of routine deductions, a rule amended in 2024 to cover the merged scheme credit. That leaves more profit in the sub-stream, since the routine return stripped out beforehand is 10% of routine deductions.
Why does the tracking have to start years before the patent?
Because the fraction is cumulative, not annual. It is built from expenditure across a period ending with the accounting period and beginning on 1 July 2016 for most companies, with an election to reach back as far as 20 years. Each year’s return recalculates it: new development and acquisition costs go in, and expenditure drops out once a right has expired and no longer brings income into that sub-stream, or once the spending dates back more than 20 years.
Building that record is the work: expenditure identified, traced to a particular right, then monitored. HMRC will accept clear evidence instead of tracking where a fraction cannot be other than 1, but warns that one later acquisition in the same sub-stream sends the company back to reconstruct years of history. Capturing it while the R&D claim is prepared costs little. Rebuilding it after the patent is granted costs a great deal.
Where exceptional circumstances leave the fraction understating the company’s contribution, an election can substitute a higher value fraction — but only where it stands at 0.325 or more.
Can I claim Patent Box and R&D tax relief together? covers the entry conditions and the election deadline. The expenditure record behind the fraction is built on the R&D side, which is where we work: talk it through with us.
Sources
- CTA 2010 s357BLA — the R&D fraction is “the lesser of 1 and” (D + S1) × 1.3 ÷ (D + S1 + S2 + A), with D, S1, S2 and A as defined in the following sections.
- CTA 2010 s357BLB — D: staffing costs, software, data licences and cloud computing services, consumable items, externally provided workers and payments to the subjects of clinical trials, attributable to research undertaken by the company itself; and what it means for research to “relate” to a qualifying IP right.
- CTA 2010 s357BLC and s357BLD — S1 and S2, split by whether the company and the recipient are connected within CTA 2010 s1122, with apportionment where a payment covers other matters, and the foreign permanent establishment reattribution to S2.
- CTA 2010 s357BLE — A: payments for an assignment, for the grant or transfer of an exclusive licence, or for a disclosure the company subsequently patents.
- CTA 2010 s357BLF — the relevant period: relevant day of 1 July 2016, or 1 July 2013 for a new entrant with an accounting period beginning before 1 July 2021; an election for a day up to 20 years earlier; a rolling 20-year period once the accounting period ends on or after 1 July 2036.
- CTA 2010 s357BLH — the election to increase the fraction to the value fraction in exceptional circumstances, available only where the fraction is not less than 0.325.
- CTA 2010 s357BF — the steps: Step 1 divides the credits brought into account in calculating trade profits into relevant IP income and everything else; Step 6 multiplies each sub-stream by its R&D fraction.
- CTA 2010 s357BH — relevant IP income means income within the five Heads: sales income, licence fees, proceeds of sale, damages for infringement and other compensation; s357BHA adds the notional royalty for IP-derived income.
- CTA 2010 s357BI — excluded debits include any additional deduction obtained under Part 13 of CTA 2009 for expenditure on research and development.
- CTA 2010 s357BJB — Head 2 of the deductions that are not routine deductions: R&D expenditure attracting an additional deduction, the additional deduction itself, and (as substituted by FA 2024 for accounting periods beginning on or after 1 April 2024) expenditure in respect of which the company is entitled to an R&D expenditure credit under Chapter 1A of Part 13 of CTA 2009.
- CTA 2009 s1042H — a company entitled to and claiming the merged scheme credit “must bring the amount of the credit into account as a receipt in calculating for corporation tax purposes the profits for the period of the trade concerned”.
- CTA 2009 s1061 — a payment in respect of an R&D tax credit under Chapter 2, which now carries ERIS, “is not income of the company for any tax purposes”.
- CIRD274100: R&D fraction overview — the 30% uplift means up to 30% of R&D expenditure can be outsourced to a connected company, or spent on acquisition costs, without reducing the fraction; and the fraction is calculated cumulatively and reviewed annually, removing expenditure on expired patents or expenditure more than 20 years old.
- CIRD274300: the D term — the company does not have to have made an R&D tax credit claim, and “Patent Box has not followed the rule changes to Overseas Expenditure Provisions and Contracted Out Expenditure that have effect to the R&D Tax Relief Schemes from 1 April 2024”.
- CIRD274400: the S1 and S2 terms — connection applies whether the person is resident overseas or in the UK; there is no 65% restriction as in the old SME scheme; externally provided workers supplied by a connected company are classed as direct qualifying expenditure rather than connected subcontractor payments; and the pass-through treatment where a connected intermediary performs only minimal administrative functions.
- CIRD274500: the A term — royalties and annual fees under an exclusive licence are treated as acquisition costs and cumulatively increase A, reducing the fraction unless in-house or unconnected R&D continues.
- CIRD272000: tracking and tracing — expenditure must be identified, traced to a particular qualifying IP right and monitored; it need not have been in an R&D or RDEC claim; and HMRC’s acceptance of clear evidence in place of tracking where the fraction cannot be other than 1, with the warning about later acquisitions.
- CIRD275000: Patent Box calculation flowchart — step 17 directs that excluded income and items such as finance income and RDEC are kept out of relevant IP income sub-streams, and step 23 states the formula (D+S1)x1.3/(D+S1+A+S2), capped at 1.
- CIRD220130: finance income and excluded income — “Income arising from RDEC credits” is listed among income excluded from the Patent Box regime.
- CIRD275500: the value fraction — the alternative fraction in exceptional circumstances, the 0.325 floor, and examples such as a write-down of acquired IP.
This page describes the rules as they stood at the review date above, as general information rather than advice on your circumstances. For how that distinction works, see our terms; for an answer on your own facts, talk to us.