By Sean Gilmour, a Partner in the Tax Practice at Webber Wentzel
The 2017 Budget announced that the regulatory framework regarding cross-border intellectual property transactions is to be relaxed, for both tax and exchange control purposes.
The framework in question comprises a series of anti-avoidance provisions which were introduced to prevent erosion of the South African tax base. The erosion of concern to National Treasury results from the assignment from South Africa of intellectual property developed in South Africa to foreign entities with a lower effective tax rate, followed by the licensing of that intellectual property back to fully taxable South African taxpayers. The royalties would, in such a scenario, remain fully deductible in South Africa but potentially subject to a low rate of tax in the jurisdiction in which the licensor is tax resident.
The current section 23I of the Income Tax Act essentially limits South African taxpayers from claiming a deduction for royalties paid to non-residents in respect of intellectual property which was originally developed in South Africa. The limitation does not apply to payments made to controlled foreign companies (CFCs) if the royalty income is fully imputed to a South African resident shareholder under the CFC provisions. The limitation which is in place is also dependent on whether the payment in question is subject to the withholding tax on royalties and if it is, at what rate.
The 2017 draft Taxation Laws Amendment Bill (DTLAB) notes concerns which arise as a result of the wide definition of "tainted intellectual property" and various interpretations of the term 'developed' in the context of "tainted intellectual property". These difficulties are noted as having a potential impact on South African based infrastructure in the context of local modifications or improvements of existing intellectual property that was not originally developed by a South African taxpayer. Section 23I may apply in a scenario in which a South African company acquires an intellectual property rich foreign subsidiary and uses South African based expertise within the group to further enhance the intellectual property.
The DTLAB proposes an exemption from the deductibility limitations and will apply if the payments are made to a CFC which is resident in a 'high tax' jurisdiction. The CFC in question must be subject to an aggregate amount of foreign tax which is at least 75 per cent of the amount which would have been payable had the CFC been tax resident in South Africa.
The relevant definition of "tainted intellectual property" which remains unchanged is still very complex and somewhat difficult to interpret, and some refinement or clarification of this would have been welcomed. That being said, the relaxation effectively renders the provisions academic when transacting with a CFC in a high-tax jurisdiction and multinationals with operations in such jurisdictions will benefit from the proposed change.
The amendment is to come into operation on 1 January 2018 and will apply in respect of years of assessment commencing on or after that date.