0
LES South Africa Afternoon Discussion

IP Structuring and its implications

Andre Visser
What are we talking about?
•
•
•
•

What is Intellectual Property (IP)?
What must be done with it when created?
Does it ha...
Focus
•
•
•
•

Some of my own practical experiences
Loose thoughts
Not intended as a whitepaper on international tax struc...
The concept IP for this discussion
• Very wide concept
• Registered IP: Trade Marks, Patents, Designs
• Also unregistered:...
Tax definition
• Section 25I of the Income Tax Act (ITA)
“means any
(a) patent as defined in the Patents Act, 1978, includ...
Tax definition
(d) copyright as defined in the Copyright Act, 1978;
(e) patent, design, trade mark or copyright defined or...
Exchange Control
• Always relevant in any discussion on South African tax or
structuring
• No specific definition of IP, b...
Where does it begin?
•
•
•
•

Invention, idea, concept, design
Usually an individual/s
Also in a corporate environment e.g...
Employee / Contractor
• Employment agreement NB
• Even if legislation and common law may provide
assistance, better to add...
Transfer of IP
• IP is an asset
• There is always a cost involved in transferring an asset
• On disposal: CGT
Natural pers...
The individual
• Separate IP into a vehicle
• Risk
• Structuring
• Raising of finance
• Commercialisation and disposal
• T...
Mr A
Receives shares

Company

• No CGT, donations tax or other taxes
• No money has to flow

Transfer IP
In the Company
• IP may be further developed, commercialised and utilised
• Various options to consider
• Where is the IP ...
Research and Development
• R + D comes at significant cost
• Realisation that some incentives required to stimulate R +
D ...
• Recent changes to tighten control and requirements
• Tax payer must
• Be carrying on trade
• Have actually incurred the ...
• Not eligible
•
oil, gas or mineral exploration or prospecting;
•
administration, financing, compliance or similar
expend...
Funding
• To develop IP, funding is essential
• In broader terms * loan funding
* equity
• Equity is provided by investors...
• Some flexibility if an instrument such as preference share
is utilised
• Loan funding: could be from shareholders, finan...
Thin Capitalisation
• Recent changes to Section 31 of ITA
• One single anti-avoidance provision under the ITA
• The princi...
Transfer Pricing
• “affected transaction”
• Transaction,
operation,
scheme,
agreement
understanding between connected resi...
Exchange Control
• Thin capitalisation also relevant for exchange control. If
75% or more of shares held by non-resident, ...
Government Funding
• Number of government research grants and facilities are
available
• However, in terms of Intellectual...
• NIPMO operates in a similar manner to the Reserve Bank
insofar as control of IP is concerned
• Also strict requirements ...
Should IP be separated from the business?
•
•
•
•

Creates planning flexibility
Isolates the risk of the business from the...
• However, there may also be certain disadvantages
• Enforcement of IP in certain jurisdictions
• Certain accounting diffi...
Public funding
•
•
•
•

If IP portfolio is strong
IP may be securitised. Not common in South Africa
Require separate vehic...
Should we move offshore?
• Considerations
• Low tax jurisdiction to minimise tax costs
• Maximise royalties to move income...
Difference between tax objectives and
IP objectives
• Tax:
•
Create optimal tax structure
•
Reducing tax liability
•
Minim...
Basic conditions
• House IP in low tax jurisdiction
• Maximise royalty flows to that jurisdiction
• Ensure proper protecti...
Transfer of IP : Exchange Control
•
•
•
•

Must obtain exchange control approval
Difficult
Must value the IP (arms-length ...
Transfer of IP: Tax
• Transfer pricing provisions relevant
• Both SARS and Reserve Bank cautions of no-tax or low tax
juri...
How to set up entity
• Subsidiary – with approval of Reserve Bank
• Individuals – use R4 million foreign investment
allowa...
Tainted IP
• Section 23 of ITA
• Tainted IP
• IP owned by connected person
• Was utilised in the business of taxpayer
• Tr...
Controlled Foreign Company
• Income earned by CFC is taxed in South Africa (Section 9D
of ITA)
• Foreign company in which ...
Break the link
• Connected person or South Africans should not own the IP
/ foreign company
• Most popular solution: forei...
• Donations will impute income to South African donors
• Section 25B of the ITA:
if income accrues to an ascertainable ben...
Royalty tax withholding
• Foreign company will enter into licence agreement/s with worldwide
entities
• If to South Africa...
Management and Control
• If effective management and control is in South Africa, the
entity will be regarded, from a South...
Loop structure
• Holding of an equity interest in South African company or
assets, via an offshore structure

Offshore
ent...
Conclusion
• Proper structuring requires careful upfront planning
• Tax and exchange control issues are quite often a
sign...
THANK YOU
QUESTIONS?

Andrè Visser
Partner
PHONE
FAX
EMAIL
WEBSITE

+27 (0) 12 432 6206
+27 (0) 12 432 6544
andre.visser@a...
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  1. 1. LES South Africa Afternoon Discussion IP Structuring and its implications Andre Visser
  2. 2. What are we talking about? • • • • What is Intellectual Property (IP)? What must be done with it when created? Does it have value? How can further development or commercialisation be funded? • Can it be taken offshore?
  3. 3. Focus • • • • Some of my own practical experiences Loose thoughts Not intended as a whitepaper on international tax structuring Some recent tax changes highlighted
  4. 4. The concept IP for this discussion • Very wide concept • Registered IP: Trade Marks, Patents, Designs • Also unregistered: client lists, formulas, know-how • It is an asset • It has value (in most instances more than is appreciated) • Valuation difficult (reason for strict control)
  5. 5. Tax definition • Section 25I of the Income Tax Act (ITA) “means any (a) patent as defined in the Patents Act, 1978, including any applications for a patent in terms of that Act; (b) design as defined in the Designs Act, 1993; (c) trade mark as defined in the Trade Marks Act, 1993;
  6. 6. Tax definition (d) copyright as defined in the Copyright Act, 1978; (e) patent, design, trade mark or copyright defined or described in any similar law or that in paragraph (a), (b), (c) or (d) of a country other than the Republic; (f) property or right of a similar nature to that in paragraph (a), (b), (c), (d) or (e); and (g) knowledge connected to the use of such patent, design, trade mark, copyright, property or right”
  7. 7. Exchange Control • Always relevant in any discussion on South African tax or structuring • No specific definition of IP, but it is accepted that the same approach is followed as SARS • Accordingly wide meaning • Knowledge of Reserve Bank on nature of IP however problematic
  8. 8. Where does it begin? • • • • Invention, idea, concept, design Usually an individual/s Also in a corporate environment e.g. researchers The individual quite often takes no further steps – leaves IP where it is • Cost often the determining factor as well as the unknown factor – will it work?
  9. 9. Employee / Contractor • Employment agreement NB • Even if legislation and common law may provide assistance, better to address IP and ownership in a proper agreement • Contractors / consultants: more often than not, no arrangement. IP accrues to contractor • To transfer later, becomes a difficult process, together with tax and other costs
  10. 10. Transfer of IP • IP is an asset • There is always a cost involved in transferring an asset • On disposal: CGT Natural person 0 – 13.3% Companies 18.65% Trusts 26.64% • Donation: donations tax 20%
  11. 11. The individual • Separate IP into a vehicle • Risk • Structuring • Raising of finance • Commercialisation and disposal • Tax advantages • Problem: transfer will incur CGT or donations tax • However, Section 41 to 47 of the ITA provides for rollover relief
  12. 12. Mr A Receives shares Company • No CGT, donations tax or other taxes • No money has to flow Transfer IP
  13. 13. In the Company • IP may be further developed, commercialised and utilised • Various options to consider • Where is the IP owned? • Should it be sold or licensed? • What funding opportunities exist? • Should we go offshore?
  14. 14. Research and Development • R + D comes at significant cost • Realisation that some incentives required to stimulate R + D growth in South Africa • Section 11D of the ITA (introduced in 2006) • Basic principle: Deduction of up to 150% of expenditure incurred • General principle: expenditure (costs) may be deducted for tax purposes • Section 11D allows additional 50% deduction
  15. 15. • Recent changes to tighten control and requirements • Tax payer must • Be carrying on trade • Have actually incurred the expenditure • R + D in South Africa • Directly and solely for R + D • “trade” – pre-production expenses may be deducted once trade commences • Activity must be • Discovery of novel, practical and non-obvious information • Creation of patent, design or computer program • Creation of knowledge essential to the above
  16. 16. • Not eligible • oil, gas or mineral exploration or prospecting; • administration, financing, compliance or similar expenditure; • the creation or enhancement of trade marks or goodwill; • development of internal business processes; • market research, market testing or sales or promotion; or • social research, including arts and humanities.
  17. 17. Funding • To develop IP, funding is essential • In broader terms * loan funding * equity • Equity is provided by investors or owners. Usually evidenced by a share certificate • If an offshore investor involved, share certificate must be endorsed for exchange control purposes (often forgotten) • Capital is fixed and investors earn dividends • Dividends are subject to 15% dividends tax. SA Companies excluded • To repay requires a process (usually share repurchase)
  18. 18. • Some flexibility if an instrument such as preference share is utilised • Loan funding: could be from shareholders, financial institutions or government • From shareholders – capital is advanced subject to repayment. Usually no, or limited interest • From financiers – interest will be payable. Security? • IP could be provided as security, deed of security registered in appropriate registry. • Interest payment will be deductable by the company, reduces taxable income • If offshore funder – exchange control approval required
  19. 19. Thin Capitalisation • Recent changes to Section 31 of ITA • One single anti-avoidance provision under the ITA • The principle is that transactions between residents and non-residents must be on an arms-length basis • If not, SARS may impose arms-length provisions and tax accordingly • For instance, if capital is regarded as insufficient, portion of loan funding interest, may not be deductable for tax purposes
  20. 20. Transfer Pricing • “affected transaction” • Transaction, operation, scheme, agreement understanding between connected resident and nonresident parties • Any term or condition different to that which would have existed between arms-length parties • Accordingly, loan transactions may be adjusted to armslength terms • Previous safe harbour rules no longer applicable
  21. 21. Exchange Control • Thin capitalisation also relevant for exchange control. If 75% or more of shares held by non-resident, then local borrowing restrictions may apply • Reserve Bank will also scrutinise loan arrangements • repayment terms • Interest payable (excessive interest not allowed)
  22. 22. Government Funding • Number of government research grants and facilities are available • However, in terms of Intellectual Property Rights from Publicly Financed Research and Development (IPR Act), such IP must be commercialised for the benefit of people of South Africa • Description of IP very wide (excludes copyright) • Cannot deal with such IP without consent • National IP Management Offices (NIPMO) established for this purpose
  23. 23. • NIPMO operates in a similar manner to the Reserve Bank insofar as control of IP is concerned • Also strict requirements for transfer of IP (especially offshore) • In our experience, stricter than Reserve Bank
  24. 24. Should IP be separated from the business? • • • • Creates planning flexibility Isolates the risk of the business from the IP Assists with international planning and expansion Creates tax efficiencies through licensing arrangements within the group • Properly manage IP • Can spin of business and retain IP • Separates income from IP from business income • Assists with franchising • Capital raising (e.g. through a bond issue)
  25. 25. • However, there may also be certain disadvantages • Enforcement of IP in certain jurisdictions • Certain accounting difficulties • Proving damages
  26. 26. Public funding • • • • If IP portfolio is strong IP may be securitised. Not common in South Africa Require separate vehicle for this IP is packaged into a bond, listed on the bond exchange and traded • Cheaper than bank financing • Essentially a loan from the public in return for a return
  27. 27. Should we move offshore? • Considerations • Low tax jurisdiction to minimise tax costs • Maximise royalties to move income to IP holding entity • Maximise tax deduction for local entity • Minimise royalty withholding taxes through double tax treaties
  28. 28. Difference between tax objectives and IP objectives • Tax: • Create optimal tax structure • Reducing tax liability • Minimise value to minimise taxes d • IP: • Protect IP (i.e. Not in risky jusidictions) • Maximise value for enforcement, and defendable royalty rates
  29. 29. Basic conditions • House IP in low tax jurisdiction • Maximise royalty flows to that jurisdiction • Ensure proper protection of IP rights and enforceability of IP rights d • Avoid liquidation issues • Ensure strong corporate law environment (e.g. Piercing corporate veil) • “Kangaroo countries” • International treaties to enforce IP
  30. 30. Transfer of IP : Exchange Control • • • • Must obtain exchange control approval Difficult Must value the IP (arms-length principle) If approved, IP may be transferred on receipt of proceeds in South Africa • Oilwell decision seemed to create a possibility, but this was changed by amendment on 8 June 2012
  31. 31. Transfer of IP: Tax • Transfer pricing provisions relevant • Both SARS and Reserve Bank cautions of no-tax or low tax jurisdictions • Mauritius: Popular destination from South Africa • Low Tax (0 – 3%) and double tax treaty within South Africa and various other countries • Close to South Africa • CGT will apply on transfer
  32. 32. How to set up entity • Subsidiary – with approval of Reserve Bank • Individuals – use R4 million foreign investment allowance • Trust – cannot invest offshore
  33. 33. Tainted IP • Section 23 of ITA • Tainted IP • IP owned by connected person • Was utilised in the business of taxpayer • Transferred ownership to non-resident • South African person, who retains use of IP, not entitled to deduction in South Africa
  34. 34. Controlled Foreign Company • Income earned by CFC is taxed in South Africa (Section 9D of ITA) • Foreign company in which South Africa residents hold more than 50% of participation or voting rights (excluding headquarter company) • Certain exclusions, e.g. DTA or CFC pays 75% or more of tax in South Africa, in other jurisdiction
  35. 35. Break the link • Connected person or South Africans should not own the IP / foreign company • Most popular solution: foreign trust • Trust will hold the shares in the foreign company. Beneficiaries under the trust will receive eventual benefits • Significant planning required to totally break the link due to imputation rules • Must be set up by non-resident • Funding of the trust must be at arms-length (transfer pricing)
  36. 36. • Donations will impute income to South African donors • Section 25B of the ITA: if income accrues to an ascertainable beneficiary of a trust, income will be taxed in the hands of the beneficiary in South Africa
  37. 37. Royalty tax withholding • Foreign company will enter into licence agreement/s with worldwide entities • If to South Africa, be careful of tainted IP provisions and royalty withholding tax (RWT) • 15% fo the amount of any royalty paid to non-resident • Royalty = right of use or permission to use IP (as defined), as well as imparting scientific, technical, industrial or commercial knowledge or information
  38. 38. Management and Control • If effective management and control is in South Africa, the entity will be regarded, from a South African tax perspective as a South African resident • All income and capital gains will be taxed in South Africa • Practically: appoint foreign director/s • Hold board meetings in the specific country • Day to day management must take place in that country
  39. 39. Loop structure • Holding of an equity interest in South African company or assets, via an offshore structure Offshore entity Mr A SA Company • Prohibited by exchange control authorities • Could obtain approval, however, very rare and difficult
  40. 40. Conclusion • Proper structuring requires careful upfront planning • Tax and exchange control issues are quite often a significant challenge • Structuring should not be to the detriment of IP protection, or create an unnecessary administrative burden
  41. 41. THANK YOU QUESTIONS? Andrè Visser Partner PHONE FAX EMAIL WEBSITE +27 (0) 12 432 6206 +27 (0) 12 432 6544 andre.visser@adamsadams.com www.adamsadams.co.za PHYSICAL ADDRESS Lynnwood Bridge 4 Daventry Street Lynnwood Manor Pretoria South Africa POSTAL ADDRESS PO Box 1014 Pretoria 0001 South Africa
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