Agenda. South African Tax and Exchange Control Implications of Export of Intellectual Property ( IP )

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2 Agenda South African Tax and Exchange Control Implications of Export of Intellectual Property ( IP ) 1. What is IP? 2. History of IP for exchange control purposes 3. History of IP for tax purposes 4. Current South African exchange control regulations 5. Current South African tax treatment

3 What is IP?

4 What is IP? Definition of IP for exchange control and tax purposes No specific definition of IP for exchange control purposes Definition of IP for tax purposes in section 23I of the Income Tax Act o Patent as defined in the Patents Act o Design as defined in Designs Act o Trademark as defined in the Trademarks Act o Copyright as defined in the Copyright Act o Equivalent of the above in a foreign country o Property of a similar nature o Knowledge connected to the use of the above Therefore, IP for exchange control purpose = IP for tax purposes

5 History of IP for exchange control purposes

6 History of IP for exchange control purposes South African Exchange Control Regulations Exchange control regulations promulgated on 1 December 1961 Purpose of the regulations = prevent & restrict capital outflows 2002 ~ Exchange Control Regulation 10(1)(c) did not have a definition for capital, but it was understood this includes IP. Thus, export of IP required SARB approval 2004 court case ~ Couve and another vs Reddot International (Pty) Limited and others ~ supported the position that IP is capital March 2011 ~ Oilwell vs Protec International Ltd and Others case found previous ruling to be incorrect. SCA ruled that intangible assets were not capital for Exchange Control Regulation 10(1)(c). Thus, effectively IP could be exported without exchange control approval, as long as it was sold at a fair market value

7 History of IP for exchange control purposes (Continued) South African Exchange Control Regulations June 2012 ~ amendment to include that IP (registered or not) is capital in terms of Exchange Control Regulation 10(1)(c) 2014 ~ Relaxation of exchange control regulations o Private (i.e. unlisted) companies in the technology, media, telecommunications, exploration and other research and development fields permitted to set up offshore related entities, and if necessary, assign IP to these new related entities, for two purposes: listing for the first time on a foreign stock exchange; or to facilitate the raising of loan or venture capital funding However, IP must remain registered in SA, even if assigned to an offshore entity Sale, transfer and assignment of IP to unrelated persons requires prior SARB approval

8 History of IP for exchange control purposes (Continued) South African Exchange Control Regulations March 2017 ~ Budget proposals for relaxation of exchange control regulations in relation to IP

9 Historic tax treatment of IP

10 Historic tax treatment of IP Historic South African Tax Treatment Pre-2007: o Development of IP deductible; o Royalty payments deductible for the payor; and o Receipt of royalties taxable (within SA tax net) Inefficient mechanisms to prevent tax arbitrage resulting from: o o Assigning SA IP to entities with a lower effective tax rate; followed by Licensing IP back to fully taxable SA taxpayers Section 23I introduced in the 2007 TLAB Anti-avoidance provision ~ in respect of affected IP i.e. (i) IP that was at any time owned by a resident; or (ii) IP that was developed by the taxpayer or a resident who is a connected person in relation to the taxpayer (at the time of development or at the time of the royalty/license payment).

11 Historic tax treatment of IP (Continued) Historic South African Tax Treatment Implications of section 23I Licensee denied a deduction in respect of royalty expenditure incurred for the use of affected IP to the extent that the royalty receipts do not constitute income of the licensor However, if the payment of royalties for the use of affected IP is subject to WHT at a minimum of 10% (DTA relief from domestic rate of 12%), licensee permitted a deduction up to 1/3 of the royalty expenditure Reason for section 23I ~ most of IP created by taxable SA tax residents is subsidised by government, SA tax allowances and general SA infrastructure This anti-avoidance rule effective for all IP payments made on or after 1 January 2009

12 Historic tax treatment of IP (Continued) Example of application of historic section 23I Deduction for royalty expenditure of R1m incurred by South African resident developer limited to R (1/3 of R1m royalty payments), due to the application of the 12% WHT

13 Current South African Exchange Control Regulations

14 2017 Budget Proposals 2017 Budget Proposals 1 st proposal - companies and individuals will no longer need SARB s approval for standard IP transactions Currently, related party outward licence arrangements require prior SARB approval, provided it can be demonstrated that the licence arrangement is for a fair and market-related royalty 2 nd proposal the prohibition on loop structures be lifted for all IP transactions, provided they are at arms-length and at a fair market price In line with the above, proposed relaxation of the tax treatment of tainted intellectual property

15 Current South African Exchange Control Regulations Exchange Control Circular No.7/2017 Sale, transfer and assignment of IP to unrelated persons Authorised Dealers can now approve, subject to certain conditions i.e.: Sale, assignment or transfer at arm s length; and Auditor s letter or IP valuation certificate confirming basis for the sale price Previously approval by SARB only Excludes sale and lease back agreements ~ sale and licence back arrangements

16 Current South African Exchange Control Regulations (Continued) Exchange Control Circular No.7/2017 All inwards funds in respect of these transactions must be repatriated to SA within 30 days from transaction date Likely to significantly improve the timeframe for obtaining approval for these transactions Sale, transfer and assignment of IP to related persons These transactions continue to be subject to SARB approval Generally such arrangements are declined The Circulars contain no indication of a change to this policy

17 Current South African Exchange Control Regulations (Continued) Exchange Control Circular No.7/2017 Licensing of IP by South African residents to non-resident related and unrelated persons Authorised Dealers may approve outward licensing of IP to non-resident parties, subject to: Review of license agreements; and Auditor s letter confirming basis for royalty or license fee Should apply to both related and non-related parties No substantive change in the approval process or documentation requirements

18 Current South African Exchange Control Regulations (Continued) Exchange Control Circular No.7/2017 All royalties and/or fees in respect of these transactions must be repatriated to SA within 30 days from entitlement date Main benefit ~ reduced timeframes within which the required approval may be secured

19 Current South African Exchange Control Regulations (Continued) Exchange Control Circular No.8/2017 Limited relief for loop structures Proposal ~ prohibition on loop structures be lifted for all IP transactions, provided that they are at arms-length and at a fair market price e.g. SA co develops IP, sells it to offshore subsidiary who then license it back to SA persons Only applies to South African unlisted technology, media, telecommunications, exploration and other R&D companies Such companies may establish offshore entities without primary listing offshore, permitting the creation of loop structures in order to raise loans and capital

20 Current South African Tax Treatment

21 Current South African tax treatment of IP South African Tax Treatment Numerous amendments / refinements to section 23I ~ Anti-avoidance provision ~ in respect of tainted intellectual property, i.e. IP which - was the property of the end user (as defined) or connected person (as defined) in relation to the end user; is the property of a taxable person, i.e., inter alia, a non-resident; a material part of which was used by a taxable person in carrying on a business while that property was the property of a taxable person, and the end user of that property acquired that business or a material part thereof as a going concern; or was discovered, devised, developed, created or produced by the end user of that property, or by a taxable person that is a connected person in relation to the end user, if that end user, together with any such taxable person, holds at least 20% of the participation rights in a person by or to whom an amount is received or accrues - (i) by virtue of the grant of use, right of use or permission to use that property or, (ii) where that receipt, accrual or amount is determined directly or indirectly with reference to expenditure incurred for the use, right of use or permission to use that property.

22 Current South African tax treatment of IP (Continued) South African Tax Treatment Application of section 23I ~ No deduction in respect of royalty expenditure incurred to use tainted IP, or expenditure determined directly or indirectly with reference to expenditure to use tainted IP to the extent amount is not income for recipient 1/3 of expenditure allowed as a deduction where it is subject to WHT at 10% ½ of expenditure allowed as a deduction where it is subject to WHT at 15%

23 Current South African tax treatment of IP (Continued) Example of application of current section 23I South Africa resident developer denied deduction in respect of the royalty expenditure incurred Deductions will equally be prohibited if a connected person in relation to the South African developer licensed the IP from the foreign person

24 Questions and answers

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