Wednesday, 16 July 2008

SA reducing incentives for intellectual property outflows

In an article for Clayton Bonnette explains how the introduction of S231 of the South African Income Tax Act seeks to squash so called "intellectual property arbitrage".

"It is not uncommon for intellectual property rights (IP) to be developed by one group company and subsequently transferred to another group company on arms length terms. The reasons for transferring IP between group companies are generally not only motivated by the possibility of reducing royalty withholding taxes. There are non-tax reasons too and these include ensuring that the continued development of the IP takes place where the necessary technical skills can be found and that the jurisdiction from which the licensing of the IP takes place is "credible". The "credibility" of the jurisdiction not only facilitates the international exploitation of the IP but also increases the possibilities of raising additional capital to fund the ongoing development expenditure.

The perceived resulting loss of tax base in the country in which the IP was initially developed has resulted in a number of tax administrations carefully scrutinising these types of arrangements. In order to counter so-called "intellectual property arbitrage", section 23I was introduced into the Income Tax Act, no 58 of 1962 (ITA) by the Revenue Laws Amendment Act, no 35 of 2007.

Section 23I, which comes into operation on January 1 2009, places restrictions on the quantum of the royalty payments to non-residents (payee) that a South African taxpayer (payor) may claim as a tax deduction in certain circumstances.

The mischief that section 23I broadly seeks to cure is to deny or restrict the tax deductibility of the royalty expenditure incurred by a payor, where the royalty is payable to a payee that is a non-South African resident for the use of IP that was either originally owned by a South African resident or was created or developed in South Africa."

1 comment:

Michael F. Martin said...

Classic case of how protectionism backfires. They're restricting transfers nominally to encourage IP development in South Africa. But by doing so they're going to shift IP development overseas. What's better for promoting IP: giving tax breaks to the person who develops it and transfers it overseas or making that person pay taxes? What makes the government think that it will make more money if inventions are only practiced in South Africa?

GSK cannot be pleased with this development. If I'm them, I'm thinking seriously about moving headquarters to a more tax-friendly jurisdiction.

This happened on a smaller scale in Silicon Valley when the Santa Clara County tax assessor effectively forced Intel into moving its headquarters to the Central Valley.