As intellectual property rights become increasingly important business assets, the need for tax planning in relation to IP becomes more important. A critical question is whether to hold intellectual property rights in a separate IP holding company, and if so whether the IP holding company should be an offshore company.
One of the first issues that need to be considered is whether it is preferable to have centralised or localised ownership of intellectual property assets in a group structure. Localised ownership is where the intellectual property assets remain in the various group entities whereas centralised ownership is where the intellectual property assets are housed in a single entity.
Localised ownership of intellectual property is often favoured where the intellectual property in question is used only in a local business; where companies want to avoid inter-company royalties under, inter alia, transfer pricing requirements or where it is anticipated that the local business might be “spun-off” or sold and the IP assets are integral to the business.
By contrast, centralised ownership of intellectual property assets offers many advantages which include: centralised strategic planning; the ability to manage legal, marketing and administrative matters through a single team; co-ordinated policies; around protection and enforcement and cost savings on administrative and maintenance functions.
If it is decided to hold intellectual property centrally, this is often done in an IP holding company, in which case the following issues need to be considered:
- which intellectual property rights are to be held in the IP holding company (patents, trade marks, registered designs, copyright or only some of these rights);
- the jurisdiction in which the IP holding company is to be formed;
- the royalties and usage fees that are to be paid to the IP holding company by group companies for the use of the intellectual property.
The selection of an appropriate jurisdiction for the formation of an IP holding company requires not only consideration of tax issues, but also needs to take account of South African exchange control requirements, and intellectual property treaty arrangements. All too often IP treaties are not accounted for in the design of an appropriate IP holding company structure and in some instances jurisdictions are chosen which are not appropriate for the particular class of intellectual property that is to be held in that company.
It is not only the popular jurisdictions such as Switzerland, Mauritius, Jersey, etc that are appropriate for the IP holding companies, but other jurisdictions are beginning to compete in order to attract IP holding companies. For example, the United Kingdom has recently announced that as from April 2013 it is introducing “Patent Box” legislation in terms of which there will ultimately be a 10% tax rate for companies generating profits from patents. It is the stated objective of the UK Government to establish the United Kingdom as the most competitive corporate tax regime in the G20 countries for patent and technology-rich companies. It will be noted that it is not a broad incentive for all classes of intellectual property but is currently restricted to patents and does not include trade marks and copyright.
The Patent Box corporate tax rate will apply to income generated from the exploitation of patented technology, irrespective of the method of commercial exploitation, whether it be licensing, the sale of products, its use in internal processes or by incorporating it into services that are sold by the company. Patent Box will be phased in over 5 years and the 10% corporate tax rate will apply to worldwide profits from qualifying intellectual property. For now qualifying intellectual property will conclude only patents granted by the UK Intellectual Property Office and the European Patent office. Despite this, it may provide interesting opportunities for South African companies wishing to exploit their patented technologies in the United Kingdom and Europe.
In order to be able to take advantage of Patent Box a company must be able to demonstrate that it has continued to invest in and advance the technology that forms the subject matter of the patents. Research and development (“R&D”) tax incentives are also provided in support of this, as is the case in South Africa.
In South Africa R&D tax credits are regulated under, inter alia, section 11D of the Income Tax Act (“Act”).
In terms of section 11D of the Act a company may deduct an amount equal to the expenditure incurred by it in respect of scientific or technological R&D undertaken in South Africa if, inter alia, such R&D is incurred in the production of income and in the carrying on of a trade. Provision is also made for an additional 50% deduction of such expenditure thereby increasing the total deduction claimable to 150% of the expenditure. The R&D must be approved by a committee established by the Minister of Science and Technology. This committee has regard to, inter alia, the innovative nature of the R&D and the extent to which carrying on that R&D requires specialised skills.
The Act also provides that depreciation allowances may be claimed in respect of certain R&D assets. In particular, in terms of section 12C(gA) of the Act, a taxpayer will be entitled to an accelerated write off of 40/20/20/20 over four years for new and unused R&D machinery or plant (or improvements thereto) owned by the taxpayer. Furthermore, in terms of section 13(dA) of the Act, a taxpayer is entitled to a 5 per cent allowance in respect of buildings (or improvements thereto) used by the taxpayer for the purpose of carrying R&D therein.
In addition to the above, various other allowances are granted in respect of intellectual property assets. For example, section 11(gC) of the Act provides for a depreciation allowance in respect of expenditure actually incurred during any year of assessment commencing on or after 1 January 2004 to acquire (otherwise than by way of devising, developing or creating) certain intellectual property excluding trade marks.
Section 11(gB) provides for a deduction in respect of, in particular, expenditure actually incurred in the registration of any trade mark or the renewal of the registration of any trade mark provided that such trade mark is used by the taxpayer in the production of his income.
In summary many generous tax deductions and/or allowances are granted in respect of intellectual property assets. It should be possible to obtain these deductions and/or allowances whether the intellectual property assets are housed on a centralised or localised basis. In addition it should be possible to transfer intellectual property between group companies on a tax-free basis.