Selling your intelectual property - Extremely serious consequences that may arise

Two contentious cases: what every IP–proprietor ought to know before commercialising any IP

The phrase "Intellectual Property" ("IP") embraces a number of different legal instruments. Some of the better-known examples include: patents, designs, trade marks and copyright. These are regarded in our law as a type of asset. As such, the sale of IP is treated very similarly to the sale of other types of asset.

However, there are differences between IP and other assets, and their consequences are significant – in some case, these are fatal to an entire transaction. In the IP domain, the very nature of these assets alone automatically triggers certain limitations in the Income Tax Act and in the Exchange Control Regulations when IP is sold. In this article, we consider two of the most topical, and contentious consequences that may arise.

The purpose of this article is to provide a timely warning against rushing into IP commercialisation without a thorough consideration of the possible consequences beforehand. More specifically, both scenarios look at commercialisation involving some form of sale of IP to a foreigner.

Scenario 1: Sale of IP to a non-resident
If you intend selling IP that you've developed to a foreigner, then beware the Exchange Control Regulations. These sales occur commonly, but not exclusively, in inter-group arrangements, typically, where a foreign parent–company funds its South African subsidiary to conduct R&D in South Africa, and requires that ownership of the R&D should be assigned to it (the parent company).

Click here: for our discussion on the brand new Protec judgment, in which our courts have made some very important promouncements on this contentious topic.

The consequences of non-compliance are simply too costly to contemplate, and the message is clear: in these transactions, there's no substitute for obtaining expert advice in advance.

Scenario 2: Sale and lease-back of IP
Scenario 1 considers transactions that incorporate the sale of IP to a non-resident. Let's explore the issue further: what consequences arise in a foreign-sale-and-leaseback scenario?

If you're a South African taxpayer, and you pay royalty fees for the right to use IP (eg: licensing of a trade mark or computer software), then you're probably claiming a tax deduction for that expenditure (If you're not claiming a deduction – you ought to be!) See our discussion on IP-based Tax Incentives. In an extremely complicated and aggressive introduction to the Income Tax Act recently, severe limitations have been placed on those deductions.

At its most simple level, this limitation is focused on cases where IP is sold to a foreigner, and then licensed back to a South African taxpayer. Again, this occurs commonly, but not exclusively, in the inter-group arrangements described above, where the foreign parent–company licenses its subsidiary to use the IP that was created and sold to it. There are a number of different commercial transactions and sophisticated structures that will be caught in the net cast by the new limitation. This discussion can become extremely complicated, and no more is said of it here. However, for more information, download our article on this aspect.

Not all license agreements will be affected by this development. For those cases that are affected, the size of the limitation will vary between cases, depending on other issues relating to double taxation treaties. In the worst-case-scenario, the entire deduction that was allowed previously will now be excluded in its entirety. In the best-case-scenario, only one third of the previous allowance will be permitted.

If you suspect that you're likely to be affected by this, you may want to take expert advise on the issue, and consider strategies for minimising your exposure to this limitation. Similarly, if you're about to enter into a commercialisation transaction involving IP, it would be prudent to take advice on how the transaction may be structured most efficiently, in order to minimise your tax burden.

If this has been of interest to you, and if we can be of assistance, you're very welcome to contact us.

This article is intended to provide a brief sketch of certain principles. It is not intended to be a comprehensive statement of the law, nor does it constitute an opinion or guarantee of any kind, and should not be construed as such. It should not be relied upon as a substitute for specific advice regarding particular scenarios. Margo® Attorneys, Inc. cannot accept responsibility for the consequences of any person relying on the contents of this document for any other purpose.