New rules for deducting patent costs

Budget 2024^[1] introduced new rules for the immediate 100 per cent deduction of capital acquisition costs of certain capital assets, including patents. This is the latest announcement by the federal government aimed at encouraging investment-in and retention-of intellectual property in Canada.  

Recognizing that patent-owning businesses grow faster and pay higher wages, the last several years have seen several tax-incentive policies, investments and consultations aimed at strengthening Canada's intellectual property regime.^[2]

The proposed new rule: Immediate 100 per cent deduction

Patents are capital assets. Like all capital assets, there are special rules for deducting patent costs, which generally can't be deducted as business expenses. Patents (and licences to use patents) are classified under Class 14 or Class 44 of the capital cost allowance ("CCA") classes in the Income Tax Regulations.

The new rule allows for the immediate expensing (i.e. 100 per cent deduction) of new additions of Class 44 property^[3] under the following conditions:

• The property is acquired on or after Budget Day (April 16, 2024) and becomes available for use before January 1, 2027.
• The deduction is only available for the year in which the property becomes available for use.
• Neither the taxpayer nor a non-arm's-length person previously owned the property.
• The property has not been transferred to the taxpayer on a tax-deferred "rollover" basis.^[4]

Patent costs default to Class 44, which, before Budget 2024, allowed a 25 per cent declining balance deduction, subject to the "half-year rule."^[5] However, because of the temporary Accelerated Investment Incentive announced in 2018,^[6] the half-year rule was suspended for Class 44 property and allowed a first-year CCA deduction that is three times the standard rate.

A taxpayer can elect not to include property in Class 44,^[7] in which case the property will be eligible for Class 14 treatment. Class 14 property is depreciated over the property's useful life on a straight-line basis. Typically, for a patent, this would be the acquisition costs depreciated over the remaining life of the patent. Class 14 property is also eligible for the temporary Accelerated Investment Incentive.

What patent costs are included?

Patents can be acquired from a third party or acquired directly by applying for a patent with the Canadian Intellectual Property Office ("CIPO").

Acquiring patents/licenses from a third-party

Costs associated with the acquisition of patents (or licenses to use patents) from a third-party, including the purchase price and legal fees, would typically be considered capital expenditures and are eligible for inclusion under Class 14 and Class 44. The new rule would apply to these costs.

Patent application costs

The rules concerning the deductibility of costs tied to the development and acquisition of patents, which are directly borne by an inventor during the patent application process with CIPO, are more complex. These costs, which can include development costs, legal fees and registration fees, can be expensed in several ways.

If a patent is granted, these costs can be expensed as capital costs and deducted as Class 44 or Class 14 allowances. The New Rule would apply to these costs. However, if the application is not granted, then there is no capital property and these costs can't be depreciated as capital expenses (though they may be deductible in other ways).^[8]

In addition, these expenses may also qualify for deductions under different sections of the Income Tax Act. For instance, legal fees relating to patent applications can be deducted as business expenses pursuant to paragraph 20(1)(cc) of the Income Tax Act. However, registration fees paid to CIPO would not be eligible.^[9] Certain development costs may also fall under the scientific research and experimental development (SR&ED) regime and be deductible under those rules.

Finally, if a taxpayer has claimed deductions under paragraph 20(1)(cc) for expenses related to the acquisition of a patent, this could result in an increased recapture amount when the property is sold. Moreover, subsection 13(12) of the Income Tax Act treats amounts deducted under paragraph 20(1)(cc) (and subsection 20(9)) as part of the capital cost of the property. As a result, amounts deducted under these provisions could be applicable to recapture calculations when a patent is sold as though they were included in Class 14 or Class 44.

Conclusion

Budget 2024 introduces a significant tax incentive in acquiring patents by enabling the optional immediate deduction of all expenses for properties classified under Class 44, a departure from the previous requirement of approximately eight years to deduct more than 90 per cent of such costs.

Not only does this new rule incentivise the acquisition of patents, but it may also present an opportunity to enhance tax efficiency in certain situations. For example, the new rule may allow for the immediate deduction of a portion of the acquisition costs of a business with patent assets.

Combined with the continued investment in the SR&ED program and the recent consultation on a potential patent box regime, the implementation of these new rules reflects a concerted effort by the federal government to foster innovation and bolster Canada's intellectual property landscape, potentially reshaping the investment dynamics within the realm of patents and intellectual property.