Oilwell judgment: an ‘open season’ on offshore IP transactions?

For a number of years, South African exchange control law has complicated offshore transactions relating to intellectual property. The Supreme Court of Appeal has brought clarity to this issue in Oilwell (Pty) Ltd v Protec International Ltd ((295/10) [2011] ZASCA 29, March 18 2011): the court ruled that the assignment of intellectual property from a South African resident (or entity) to a non-resident (or foreign entity) does not require approval in terms of Regulation 10(1)(c) of the Exchange Control Regulations.

 

The practice of requiring exchange control approval for assignments of intellectual property (whether they be patents, trademarks, registered designs or copyright) was based on an interpretation of Regulation 10(1)(c) of the South African Exchange Control Regulations:

A 2004 High Court decision, Couve v Reddot International (Pty) Limited (2004 (6) SA 425 (W)), ruled that an assignment of patent rights from South African residents to foreign entities is subject to Regulation 10(1)(c). It is important to note that this judgment was confined to patent applications and did not address the broader issue of intellectual property in general.

Couve held that a patent application is “capital” within the meaning of Regulation 10(1)(c) of the regulations. As such, an assignment of a patent application amounts to the export of capital and therefore requires exchange control approval from the Treasury. The Couve judgment was subsequently interpreted by the tax and exchange control authorities in South Africa to apply to the assignment of all forms of intellectual property, not only patent rights. Any transaction where the necessary approval had not been obtained was considered to be null and void.

In Oilwell, the Supreme Court of Appeal held that trademarks do not constitute 'capital' within the meaning of Regulation 10(1)(c). This judgment effectively overturns previous Treasury and Reserve Bank policy.

 

Oilwell (Pty) Ltd sought to reverse the assignment of a trademark which had taken place in 1998, when the PROTEC mark was assigned to a foreign entity (Protec International Limited). Oilwell, relying on the Couve judgment, built its case on the fact that no exchange control approval was sought for the underlying transaction, thereby arguably invalidating the assignment. 

 

Although, on the face of it, the Oilwell decision has brought much needed clarity to the exchange control issues surrounding the transfer of the ownership of intellectual property offshore, the situation is not necessarily as clear or simple as it seems.

        

In the Oilwell appeal, Harms DP considered the meaning of the term 'capital' within the context of the Currency and Exchanges Act (9/1933). After extensive analysis of this legislation and the context in which it was enacted, he held that the term 'capital' was used in a financial sense, rather than having a broader economic or accounting meaning. He also held that a restrictive interpretation should be applied to the term in view of the fact that legislation that creates criminal and administrative penalties requires such interpretation. All of this led to the court’s conclusion that the term 'capital', as used in Regulation 10(1)(c), does not refer to intellectual property. Accordingly, foreign exchange approval is not required for offshore assignments of intellectual property.

Although the Oilwell appeal has resolved many issues relating to the interpretation of Regulation 10(1)(c), it is not necessarily the final salvo doing away with exchange control requirements on IP transactions. At the time of writing this article, it was unclear what response the Treasury would take towards the judgment. If the Treasury were to decide that it wishes to preserve exchange control requirements on IP transactions, it could approach this in a number of ways:

All of these options, as well as other options, are all fraught with difficulty.

 

It is important to note that, despite the Oilwell judgment resolving issues relating to exchange control approvals under Regulation 10(1)(c), it did not do away with all exchange control requirements on IP transactions. The payment of royalties from a South African resident company to non-resident for the use of intellectual property still requires exchange control approval. This is required under Regulation 3(1)(c) and was not dealt with in Oilwell. By way of example, in intra-group transactions where intellectual property has been transferred to a foreign group company, the South Africa company will require exchange control approval before any royalties can be paid to the foreign group company, the new owner of the intellectual property. Royalty or licence fee payments can generally not be avoided in intra-group transactions of this sort, as transfer pricing rules for intra-group transactions have to be observed.

 
For South African owners of intellectual property, Oilwell potentially means that they will be able to transfer their intellectual property to a foreign owner without the need to obtain exchange control approval. Caution should be exercised before taking such a step though.

Apart from ongoing exchange control challenges, there is the potential pitfall of tax. Various forms of intellectual property are included in the definition of an asset for capital gains tax (CGT) purposes in the Income Tax Act. An assignment of intellectual property to a foreign entity will be a disposal of an asset for CGT purposes and any gains realised will be subject to CGT at an effective rate of 14%. If the intellectual property is assigned to a foreign entity that is also a connected party, the disposal will be deemed to have taken place at market value for CGT purposes. This requires a valuation to be conducted to determine this value. 

 

Quite apart from capital gains tax issues an assignment of intellectual property may also result in the recoupment of capital allowances, subject to income tax of 28%. The practice of assigning intellectual property without value is something that will create potential difficulties with the South African tax authorities. Where intellectual property is assigned for nominal value the assignment may be seen as a deemed donation and donations tax at 20% may be payable.

 

We expect to see greater scrutiny of international intellectual property transactions by the South African tax authorities to mitigate any abuse of the opportunities created by the Oilwell judgment.

 

The Oilwell judgment potentially allows South African residents to now assign intellectual property to related parties offshore without exchange control approval. Caution needs to be exercised though in relying too prematurely on this judgment or seeing it as an 'open season' on assignments of intellectual property out of South Africa.