Executive Summary for Busy Entrepreneurs:
1.Reserve Bank permission for transfer of a South African patent, trademark, design or copyright is not (currently) required.
2.Payment of royalties for use of a South African patent, trademark, design or copyright is revenue expenditure not capital expenditure for income tax purposes
3. Tax deductions for royalties for use of a patent, trademark, design or copyright anywhere in the world originally created or owned by a South African taxpayer but transferred to a foreign entity are not allowed.*
4.Patents, trademark, design, copyright and even trade secrets developed together with a South African University or research council require Department of Trade and Industry permission for transfer to a foreign entity.
Justin Sanford’s new blogpost draws attention to a recent judgment that affects South African entrepreneurs intending to use their knowledge assets in other countries. The way that SARS characterized the rights to intangibles illustrates both how much legal institutions created for tangible goods struggle when dealing with knowledge, and how the metaphor of intellectual “property” leads to confusion.
The Supreme Court of Appeal is South Africa’s second highest court, and a judgment from it can only be appealed to the Constitutional Court if it raises a constitutional question. In Oilwell v Protec the Supreme Court of Appeal ruled that trademarks registered in South Africa are not “capital” within the meaning of that term in the exchange control regulations and its empowering statute. As a result, a South African entity can transfer a South African trademark to a foreign entity without requiring SA Reserve Bank permission. As a logical consequence a South African entity can transfer a South African registered patent, or the South African copyright to a foreign entity without Reserve Bank permission. How did this come to be an issue? What does this mean for entrepreneurs in South Africa?
To understand the judgment, and other legal provisions that affect cross border arrangements of intangibles its useful to re-visit some basic points. The term “intellectual property” is of recent origin, and it was intended by lawyers as a metaphoric collective term for widely different statutory schemes; patent, trademark, copyright and design. Each of these differs from the other in some significant way. Copyright, patent and design rights are intended to create incentives for innovation and creativity, while trademark is consumer protection legislation, intended to enable consumers to be sure of the origin of the goods they buy. Patent, trademark and design are registered while copyright does not require registration. All grant the rights holder the legal power to stop others from doing certain things, but none confer on the rights holder the power to do those same things.
Two patent holder that hold overlapping patents could stop each making a product. A copyright holder isn’t entitled to distribute or make copies of a video that is banned by the Film and Publications Act.
Patents, trademarks, designs and copyright are all territorial. What that means is that a patent in South Africa applies only in South Africa. For example if Intellectual Vultures Ltd has registered a patent for a back scratcher in South Africa but there is no patent registered in Lesotho then anyone in Lesotho is free to make a back scratcher of that type. If Intellectual Vultures Ltd has registered a trademark over the word “bakscratchz”in South Africa but not in Botswana then anyone in Botswana could sell stuff marked with the word “ bakscratchz” in Botswana.
The situation is a little different for copyright. When Henrietta Sutton pens her new politically correct novel entitled “Non-gender specific mutual regard for life, or at least as long as both persons consent” in Rondebosch she acquires copyright in South Africa, but also in every other country that is a party to the Berne Convention. But what she acquires is not single right, but rather a unique right in each country. In South Africa that rights lasts for her life, and then another fifty years, in the United States it persists for seventy years after she has died, and presumably lost interest in continued revenue (in the unlikely event that there is any) from her work.
The rights relating to intangibles can’t be removed from the territory of a country, any more than the title to a house could be moved from the territory in which the house is located. Of course trademarks, patents and copyrights are located “everywhere” in the Republic of South Africa and are not localised in one particular spot. They aren’t for instance fixed to offices of the Department of Trade and Industry in Tshwane. I point this out because even some “intellectual property” lawyers seem to be confused by the concept by a territorially defined right to an intangible which is neither universal nor located at specific point in space. The idea that “Intellectual Property” is a tangible “thing” somehow distinct from and underlying the statutory schemes of patent, copyright, trademark and design and not only a thing but a thing that can be shipped overseas seems to underlie at least some of the confusion evident in the Intellectual Property Rights from Publicly Financed Research Act.
In the Oilwell case, a South African company called Oilwell argued that a transfer of a trademark from it to an foreign company, Protec International Limited, was not allowed by the Foreign Exchange Regulations. The trademark was in the word ‘Protec’ and had been registered in the name of Oilwell in South Africa but later transferred to Protec International Limited. If the claim had succeeded then Oilwell would get the trademark back. The register that records the trademark holder would have had to be amended. The Foreign Exchange Regulation that Oilwell claimed invalidated the transfer states “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.” The Reserve Bank acts as the agent of the Treasury in giving or denying permission required under the regulation. The Treasury wasn’t involved in the case and so didn’t present an interpretation of the regulation in court.
The judge who gave the judgment of the Supreme Court of Appeal, Judge Harms said that the term ‘capital’ is capable of a number of different meanings depending on the context. He then discussed what ‘capital’ means in the regulation that he had to interpret. He concluded that ‘capital’ was intended in a financial sense, as money that could be invested, but not things on which money had been spent, such as land, movables or goods.
Judge Harms ruled that intellectual property is territorial and can not be exported. It is also not capital for purposes of the Foreign Exchange Regulations, and so does not require Reserve Bank permission for transfer.
This isn’t the first time in which the Supreme Court of Appeal has had to decide whether a right to a trademark is capital or not. In BP Southern Africa (Pty) Ltd v Commissioner for South African Revenue Services the court had to decide whether licensing royalties that BP South Africa paid to BP plc, a foreign company incorporated in the United Kingdom, and listed on both the LSE and NYSE were ‘capital’ expenditure.
The question the court had to decide was whether the licensing royalty for use of the BP trademarks was ‘intended to produce income’ for the purposes of Section 11 (a) of the Income Tax Act. ‘Revenue’ expenditure is not ‘capital’ expenditure. The judge giving the decision of the Supreme Court of Appeal, Judge Ponnan, concluded that the licensing royalties were paid so that BP South Africa could use the trademarks and not so that it could acquire “ownership” of the trademarks, and therefore that the amount paid was ‘revenue’ expenditure and not ‘capital’ expenditure. Based on the reasoning by the court if a South African transferred ‘ownership’ in a trademark registered in South Africa to a foreigner then the South African may be liable for capital gains tax. However if the South African merely licensed the foreigner to make use of the South African trademark then the royalties received would be income.
Royalties and license fees are regarded as gross income in the Income Tax Act (s 1 s v ‘gross income’ (g)(iii)). But even that is complicated. Its complicated by Section 23I of the Income Tax Act. The intention of Section 23I is that a South African taxpayer (which includes a local establishment of a foreign firm) may not get a tax deduction for research and development of ‘intellectual property’ and then transfer the right to earn the revenue to an entity that does not pay South African income tax. It includes expenditure in South Africa that results in South African patents, copyright, designs and trademark and also expenditure by a South African taxpayer that results in copyright, trademarks, patents and designs in other territories. Expenditure hit by the section is disallowed. It doesn’t apply to capital expenditure in terms of Section 11 (gC). A brief informative note on the section by Pitsi Rammutla is here.
Another potential barrier to foreign investment in South African start-ups are the provisions of the Intellectual Property Rights from Publicly Financed Research Act.
That Act refers to “intellectual property” anywhere in the world that is developed by a South African public university or research council with a few exceptions, not relevant to entrepreneurs. A patent, trademark, design, copyright or even trade secret developed by an entrepreneur together with a South African public university cannot be the subject of an “offshore” transaction without the approval of the National Intellectual Property Management Office, a subsidiary of the Department of Trade and Industry. “Offshore transaction” is not defined in the statute and so the prohibition is likely void for vagueness.
I wrote about some of the problems with the Act in 2009, before the Act was passed, suggesting that the problems could be resolved by suitable amendments. They were not resolved and that post remains a largely accurate guide for entrepreneurs considering working with universities or research councils.
The recent decision of the Supreme Court of Appeal in Oilgate has removed one barrier to South African entrepreneurs accessing foreign capital. However several laws still in place require careful structuring of transactions involving “intellectual property” and foreign investors. South African entrepreneurs would benefit from a systematic survey of these laws and their impact on entrepreneurs.
Update: Readers may have noticed the logical conclusion from the territoriality of patent, trademark, copyright and design rights; that they do not extend to places outside of the territory of countries with patent, trademark, copyright and design laws; the High Seas, Antarctica and countries such as Afghanistan that don’t have such laws. One consequence is that international agreements on biodiversity have not paid attention to the oceans.
* I’ve reworded point 3 of the summary for greater accuracy.
