Britain is facing fresh scrutiny from Brussels over its flagship tax break for intellectual property, because of concerns it could be an illegal state subsidy.
London is one of several capitals caught in a rapidly expanding probe by Europe’s top competition authority into whether tax sweeteners to multinationals broke rules on state support for companies.
According to people familiar with the case, the European Commission has asked the Treasury to explain the “patent box” – an almost £1bn a year tax break for profits from patented products and processes – and show that it attracted genuine research investment.
It is one part of a two-pronged informal investigation that is also looking at how Ireland, the Netherlands and Luxembourg have used so-called “comfort letters” to attract groups such as Apple and Starbucks with special tax rates.
A formal investigation has yet to be launched, and enforcing state aid restrictions on tax policy – an area where member states enjoy great freedom – is notoriously difficult. But if the commission finds evidence of illegal state support, it can demand that all lost revenues are recouped.
On Monday, Brussels issued an injunction against Luxembourg to provide information and made clear that its informal investigation had broadened to tax regimes on intellectual property.
The decision to send a questionnaire to the UK regarding its “patent box” was not made public. Other countries with similar regimes include Belgium, Luxembourg, the Netherlands, Cyprus, Hungary and Malta.
British officials are confident the scheme meets EU state aid rules. The patent box is expected to cost the UK Treasury £350m in 2013-14, its first year of operation, according to 2012 Budget documents. But the cost is forecast to rise to more than £900m by 2016-17.
The UK Treasury issued a defence of the patent box last week, addressing the possibility it would be criticised as a “harmful” tax practice by the OECD. It said “most” of the activities qualifying for the patent box would meet a “substance test”, one of the key criteria for fair tax competition.
Last year, after a separate non-binding probe by tax officials, Brussels found the UK patent box to be harmful and in breach of a voluntary EU tax code. The UK said its regime was “more tightly defined and imposes tougher eligibility criteria” than is the case in France, Spain, Belgium and the Netherlands.
The Treasury has said the benefits of the scheme would be felt by the pharmaceutical sector, life sciences, manufacturing, electronics and defence.
GlaxoSmithKline, which announced a £500m factory in Cumbria in the wake of the launch of the patent box, said it had “transformed” its view of Britain as a location for new investment. The Institute for Fiscal Studies, the independent think-tank, has described it as “an expensive and poorly targeted policy” that would benefit only a few large companies.
Tax advisers have told clients they expect the UK to be forced to make minor modifications to the scheme in response to criticism, which has been led by Berlin. German politicians have complained about the competition and distortions it causes. Patent applications filed by German businesses in Britain increased 27 per cent to 471 in 2012, ahead of the introduction of the patent box.
The commission had approved the use of patent boxes, notably with a decision on Spain in 2008. But since then it has become more concerned about them, saying it had “received indications that special tax regimes seem to mainly benefit highly mobile businesses and do not trigger significant additional research and development activity”.
“The commission is therefore gathering information to assess whether the regimes grant a selective advantage to a particular group of companies, in breach of EU state aid rules,” it said on Monday.
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