Judgment facilitates the export of IP

Chinese companies are searching the globe for technology. A recent court judgment in South Africa means that exchange control approval for the export of intellectual property from the country is no longer required.

In March, the Supreme Court of Appeal ruled in the case of Oilwell (Pty) Ltd v Protec International Ltd & Others on the issue of the assignment of IP from a South African resident or entity to a non-resident or foreign entity. In particular, the court ruled on whether approval under regulation 10(1)(c) of the Exchange Control Regulations is required for such transactions.

Regulation 10(1)(c) imposes restrictions on the export of capital and states that “no person shall, except with permission granted by the Treasury and in accordance with such conditions as the Treasury may impose … enter into any transaction whereby capital or any right to capital is directly or indirectly exported from the Republic”.

Since the decision in Couve & Another v Reddot International (Pty) Ltd in 2004, there have been a number of conflicting decisions on the implications of, and exchange control requirements for, the transfer of IP from a South African resident or entity to a non-resident or foreign entity. Prior to the Oilwell ruling, the prevailing view was that exchange control approval was required for such transactions under regulation 10(1)(c) and that a failure to obtain approval would result in the transaction being null and void, ab initio.

Although the Oilwell ruling has provided much-needed clarity on such issues, the situation is not necessarily as straightforward as it seems.

The court, in dismissing Oilwell’s appeal, found that:

1. a trademark does not qualify as “capital” or “a right to capital” and therefore that regulation 10(1)(c) should not be interpreted to include the assignment of a trademark;
2. a trademark, like other IP rights, is territorial in nature and can therefore not be “exported”; and
3. in the event that a trademark does qualify as “capital” or “a right to capital”, a failure to obtain exchange control approval under regulation 10(1)(c) does not result in the assignment being null and void ab initio.

It is interesting that the court, having found that an assignment of a trademark offshore does not require exchange control approval under regulation 10(1)(c), went on to consider the effect of an assignment of intellectual property in contravention of regulation 10(1)(c). Nonetheless, the court found that the absence of Treasury approval does not, by itself, mean that the transaction is unenforceable, and that it is theoretically possible to obtain the requisite approval ex post facto.

Despite this judgment, the payment of royalties from South Africa to a non-resident for the use of intellectual property still requires exchange control approval under Exchange Control Regulation 3(1)(c). Therefore, once the IP has been transferred abroad, the user of such IP in South Africa will be required to obtain exchange control approval before any royalties can be paid to the new foreign owner of the IP.

For Chinese and other foreign acquirers of intellectual property, the decision in the Oilwell appeal means that it may now be possible for South African IP owners to transfer their IP to foreign persons without the need to go through the often complex, lengthy and expensive process of obtaining exchange control approval.

In addition, there is no longer a need to justify the purchase price for any IP to the exchange control authorities.

The situation is not, however, as simple as it seems on the surface, as there are a variety of potential tax consequences that must be properly considered before assigning any IP offshore.

Tax consequences

Although the court has found that the terms “capital” and “right to capital” should not be interpreted to include a trademark or any other form of intellectual property, a trademark or IP, including any right to use such trademark or IP, is, however, included in the definition of an asset for capital gains tax (CGT) purposes in the eighth Schedule to the Income Tax Act.

Therefore, an assignment of a trademark offshore will be a disposal of an asset for CGT purposes, and the gain or loss realized by the South African owner of the IP will be determined in terms of the provisions of the eighth Schedule. Any gains realized will be subject to CGT at an effective rate of 14%. If the IP is assigned to a connected party offshore, the disposal will be deemed to take place at market value for CGT purposes. The assignment may therefore still require the determination of the market value of the IP so assigned.

The assignment of IP may also result in the recoupment of certain capital allowances claimed by the South African owner for tax purposes, and these recoupments will be subject to income tax at the rate of 28%.

Where the IP is assigned for nominal value, such an assignment may also be deemed to be a donation and donations tax at 20% may be payable on such a disposal where the nominal value is not considered to be adequate consideration for the IP assigned.

In addition, where IP is assigned to a connected party offshore, the South African transfer pricing rules will apply to any royalties charged to South African group company subsequently utilizing the IP.

New opportunities

On the positive side, the ability of South African residents now to assign IP to related parties offshore without exchange control approval opens up opportunities for South African groups that were previously closed because the exchange control authorities were previously loath to approve the transfer of IP to related parties offshore.

For potential acquirers in China and elsewhere, the acquisition of South African IP now looks more feasible and attractive.