Moving Intellectual Property Offshore: Exchange Control, Transfer Pricing and Capital Gains

By Willem Oberholzer, Director, KISCH Tax Advisory 

Many South African companies are looking to externalise their local Intellectual Property (“IP”) – intangible asset/s - to attract foreign investment and expand their business into international markets. 

The?South African Exchange Control Regulations (ECR) promulgated in?1961?in terms of the Currency and Exchanges Act No.9 of 1933 apply to South African residents and regulate how much capital and under what conditions said capital may be transferred offshore. The ECR places restrictions on the transfer of locally owned IP offshore. The objective of exchange control is to prevent the loss of foreign currency supply through the offshore transfer of capital and to control the flow of financial/real assets into and out of the Republic. Prior approval is required before residents can transfer/licence their IP offshore. The Minister of Finance is responsible for this approval, with this task having been delegated to the Exchange Control Department of the South African Reserve Bank (SARB). Certain banks are appointed as Authorised Dealers in Foreign Exchange for purposes of the ECR and their function is to assist the Exchange Control Authority in administering exchange control. Applications to the Reserve Bank for approval must be made through an Authorised Dealer. Authorised Dealers are only permitted to approve the outright sale, transfer and assignment of intellectual property?to unrelated?non-resident parties if: 

• The transaction is at an arm’s length and a fair and market?related price; 
• The Authorised Dealer views the sale/transfer/assignment agreement; and 
• The Authorised Dealer is provided with an auditor’s letter/IP valuation certificate confirming the basis for calculating the sale price.

The above?mentioned dispensation excludes sale and lease back agreements.  

Where the IP emanates from publicly financed research and development, approval must be sought from the National Intellectual Property Management Office (NIPMO), in accordance with the?Intellectual Property Rights from Publicly Financed Research and Development Act No. 51 of 2008. 

If you grant a licence to a non-resident party to use your intellectual property (as opposed to selling it), it is still considered transferring intellectual property offshore, and you are still required to get an Authorised Dealer’s approval to do so. National Treasury’s Currency and Exchanges Manual for Authorised Dealers doesn’t draw a distinction between non-exclusive licencing (allows a rights-holder to keep their IP rights – they just assign a third parties the right to use them) and exclusive licencing (this prevents the rights-holder from using their IP or licensing it to anyone else). It can be argued that a non-exclusive licence is not a transfer of intellectual property offshore and, therefore, should not require approval from an Authorised Dealer, but currently, under the law, it does. 

From a tax perspective, IP is considered to be an asset for the purposes of capital gains tax and therefore disposing/selling of IP may attract capital gains tax. Also, it is important to know where the place of effective management of the foreign entity is deemed to be, because, if the place of effective management is deemed to be in South Africa, SARS has the right to tax the foreign income of any such foreign company. Another tax consideration when concluding any foreign IP assignments/licenses is whether such a foreign company constitutes a so-called controlled foreign company (“CFC”) – this is where more than 50% of the participation rights in the company are held by South African residents. Where the foreign company does constitute a CFC, the profits of the foreign company may, in certain circumstances, be attributed to the resident shareholders and taxed in their hands. Also, from a transfer pricing perspective, the legal and economic ownership of the IP must be aligned to ensure that the legal owner is entitled to the benefits flowing from the exploitation of the IP (the alignment of legal and economic ownership is analysed with a focus on the performance of the “DEMPE” functions – the “Development, Enhancement, Maintenance, Protection and Exploitation” of the IP).  

If you have any queries on the above or require any tax advice, please contact:

Willem Oberholzer 
Director
KISCH Tax Advisory 
+ 27 83 326 0500
Willemo@kisch-ip.com