A Look at the Disposal of Intellectual Property Owned in South Africa to an Offshore Purchaser

It often occurs that a company established in South Africa has developed a specific software program or other processes and/or applications upon which it basis its particular service offering or product.

As the company grows and becomes more successful, shareholders of the company may find themselves in a position where they are considering the viability of globalising its business by entering into operating model partnerships with other providers, licensing the software, process and/or application developed and, eventually, selling equity in the business to investors.

In so doing, the question often arises as to whether the disposal of intellectual property owned in South Africa to an offshore purchaser, would be a possibility.

The South African Exchange Control Regulations

Regulation 10(1)(c) of the Exchange Control Regulations applicable in South Africa, states that 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 South Africa.

For the purposes of Regulation 10(1)(c), the term “capital” is expressly defined as including any intellectual property right, whether registered or unregistered.

As such, a disposal of intellectual property owned in South Africa could only be disposed of to an offshore purchaser in the event that prior approval from the South African Reserve Bank (SARB) has been obtained.

It has further historically been the case, that the SARB will generally be extremely hesitant to approve of such a disposal of intellectual property owned in South Africa to an offshore entity and that such an application would have to provide a convincing motivation as to why such approval should be provided, such as the absence of a market of use for the intellectual property in South Africa, as well as being accompanied by an extensive valuation of such intellectual property.

In terms of Exchange Control Circular No. 3/2014, the SARB has issued a statement confirming that the abovementioned position has been relaxed to an extent in that unlisted companies in the technology, media, telecommunications, exploration and other research and development fields may apply to the SARB to attend to a primary listing offshore to raise foreign loans and capital for their operations, subject to the following conditions:

  • Registration with the Financial Surveillance Department;
  • The company must operate as a South African tax resident and be incorporated and effectively managed and controlled in South Africa;
  • The intellectual property must remain registered in South Africa, but may be assigned offshore, subject to appropriate tax treatment;
  • The offshore listed entity must secondary list in South Africa within 2 (two) years following the successful offshore listing;
  • A report must be submitted to the Financial Surveillance Department on the status of the offshore listing; and
  • An annual report must be submitted to the Financial Surveillance Department on the operations, including details of the funds raised offshore.

Potential Loop Structure

The general hesitance of the SARB to approve applications to dispose of intellectual property owned in South Africa may be further amplified by the prohibition of so called “Loop Structures”. A Loop Structure can be defined as the circumstances when a South African resident holds a South African asset indirectly through a non-resident entity.

In the event that a South African entity holds intellectual property and disposes of such intellectual property to an offshore entity, which offshore entity in turn is the holding company of the South African entity, such offshore entity would not be able to have South African residents as shareholders, otherwise such structure would be deemed to be a Loop Structure, which would be prohibited by the SARB.

The Option of Emigration

In the event that the South African residents, as envisaged in paragraph 3, were to emigrate before taking up shareholding in the offshore entity, this may successfully eradicate the creation of a potential Loop Structure. As such, the structure within which such intellectual property will be held will not be prohibited.

This, however, will not resolve the issues raised in paragraph 2 relating to Regulation 10(1)(c) of the Exchange Control Regulations, as SARB approval would still be required in order to dispose of such South African owned intellectual property to an offshore entity, which applications are met with general hesitance by the SARB.

It should further be noted that, in order to officially emigrate from South Africa, it would require a separate application to the SARB by each of the South African residents in order to place their emigration on record with the SARB. From a tax perspective, this will also trigger a “disposal” of the South African assets held by such persons, potentially resulting in Capital Gains Tax.

The Alternative: Licencing of Intellectual Property

In the event that intellectual property remains registered and owned in South Africa, it would be possible to license the right of usage of the intellectual property to offshore licensees.

In consideration for the usage of the intellectual property, such offshore licensees would pay a royalty or licensing fee to the owner of the South African owned intellectual property. This would create an inward flow of funds into South Africa and would not require further approval from the SARB.

Conclusion

Given the general hesitance of the SARB in terms of applications relating to the disposal of intellectual property owned in South Africa to an offshore purchaser, the most viable alternative may be that the company should consider the possibilities of globalising its business through the mechanism created by the relaxation of the Exchange Control Regulations in terms of Exchange Control Circular No. 3/2014.

The aforementioned position would not enable the South African owned intellectual property to be disposed of to an offshore entity, but would assist the company to raise foreign loans and capital by way of a primary listing offshore, in terms of which the intellectual property could be freely assigned offshore, subject to the conditions stated as per paragraph 2 above.

Phillip Kruger

Divisional Director | Legal, Johannesburg

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