One of the main surprises in the 2017 South African Budget Review was the announcement of what appeared to be a real shift in policy in respect of the tax and exchange control treatment of certain intellectual property ("IP") arrangements.
Following the announcements in the Budget Review on 22 February 2017, the South African Reserve Bank ("SARB") has issued Circulars 7/2017 and 8/2017 (the "Circulars") to give effect to these exchange control proposals that represent amendments to the Exchange Control Manual (the "Manual"). However, contrary to the expectations created by the phrasing of the Budget proposals, the amendments in these Circulars do not appear to result in significant relaxation of the exchange controls restrictions pertaining to IP.
Budget proposal vs actual outcomes
The 2017 Budget Review contains two important statements in this context. The first statement is that government proposes that companies and individuals will no longer need the 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. The second statement appeared to be even more substantial in that it proposes that 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, the 2017 Budget Review also proposed relaxing the tax policies for IP focusing on the pertinent anti-avoidance measures contained in the Income Tax Act,1962, which restrict the deductibility of payments made to foreign persons in respect of the use, or the right to use, of certain "tainted intellectual property", which, broadly speaking, encompasses IP that was previously owned and/or developed or used by South African tax resident persons or parties related to such persons (section 23I of the Income Tax Act). An example of this is a scenario where IP is developed in South Africa and subsequently sold by the South African owner/developer to a related non-resident IP holding company ("IP HoldCo") and the IP HoldCo subsequently licenses the IP back to a South African resident (subsequent to certain other requirements).
The Circulars reflect the following relaxations:
Sale, transfer and assignment of IP to unrelated persons
Where previously the sale, transfer and assignment of IP to unrelated persons required prior SARB approval, authorised dealers can now approve such arrangements, but are subject to same conditions as those previously applied by the SARB. In our view, this merely shifts control from the SARB to the authorised dealers. In practice, an authorised dealer is required to enforce the policies of the SARB and therefore, they would need to carefully consider the application and be satisfied that, inter alia, the sale of the IP is undertaken at a fair and market-related price. However, on a positive note, this is, from a practical perspective, likely to substantially improve the timeframe for obtaining approval for these transactions. However, the above-mentioned dispensation excludes "sale and lease back agreements". We assume this refers to a sale and licence back arrangement.
Sale, transfer and assignment of IP to related persons
The sale, transfer and assignment of IP to related persons continues to be subject to prior SARB approval. It is our understanding that such arrangements are, in most instances, declined on the basis that it is contrary to the SARB's policy. The Circulars contain no indication of a change to this policy.
Licensing of IP by South African residents to non-resident related and unrelated persons
Although this was previously dealt with in the IP guidelines issued by the SARB, the Manual now explicitly provides that authorised dealers may approve the licensing of IP by South African residents to non-resident parties. Based on the wording, it seems that this would apply to both related and non-related parties. This does not give rise to a substantive change in the approval process or documentation requirements in respect of licensing arrangements, apart from the fact that authorised dealers now have the authority to approve outbound licensing arrangements to related non-resident parties. Again, it is expected that the main benefit of not having to approach SARB will be reduced timeframes within which the required approval may be secured.
Appropriate tax treatment
We note that a specific condition is now included, requiring that the sale, transfer, assignment and/or licensing of IP must be subject to appropriate tax treatment. In our view, this means that in the context of cross-border related party transactions, it will be important to ensure that the transaction is conducted on an arm's length basis and supported by the necessary transfer pricing documentation. We understand that, in practice, it also means that that applicant entity will now be required to ensure that the necessary tax returns are filed and that taxes due are paid to the South African Revenue Service ("SARS").
Limited relief for "loop structures"
As noted above, the Budget Review proposed that the prohibition on "loop structures" be lifted for all IP transactions, provided that they are conducted at arms-length and at a fair market price. The reality is that relief from the SARB's policy on so-called "loop structures" only applies in limited instances to South African unlisted technology, media, telecommunications, exploration and other research and development companies as set out in Circular 8/2017.
Previously, the Manual provided that South African unlisted technology, media, telecommunications, exploration and other research and development companies could apply for approval for a primary listing offshore to raise loans and capital for their operations. Such companies are now permitted to establish companies offshore without the requirement to have its primary listing offshore, permitting the creation of loop structures in order to raise loans and capital.
There are no other clear references to changes to SARB's policy on loop structures in terms of the circulars. As such, the SARB's general policy to prohibit loop structures appears to remain in force.
We await to see the corresponding reforms to the tax policies which will be issued by way of the following documents:
- The draft amendment bill, which is
likely to propose relevant amendments to section 23I of the Income
Tax Act (usually issued in June or July); and
- The updated version of the transfer
pricing practice note providing the proposed approach to ensure
appropriate pricing on intangibles that are hard to value. In our
view, however, it is unlikely that SARS would issue such a practice
note prior to the finalisation of the Organisation for Economic
Cooperation and Development's implementation guidance on how
tax authorities can reprice transactions involving hard to value
Based on our interpretation of the Circulars, it appears that although the SARB has shifted control of certain IP related transactions to the authorised dealers, which should avoid time delays and facilitate administrative ease of securing such approvals, this does not represent the expected significant relaxation of the current IP exchange control restrictions. In particular, the prohibition against the sale of IP by South African residents to related offshore parties remains very much in place.
As regards licence arrangements, in our view, the focus on the transfer pricing aspects of IP transactions is even more important. This is on the basis that authorised dealers, in fulfilling their mandate, will strictly adhere to the policies and guidelines imposed by the SARB, in particular given the conditions in the Circular that a) the licence arrangement needs to be conducted on an arm's length basis, and b) is subject to the appropriate tax treatment (although it remains to be see how compliance with this provision will be handled in practice). It will, therefore, be increasingly important that any transaction involving the licensing of IP by a South African resident to non-resident related parties are supported by a detailed transfer pricing analysis.
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