The concept of economic ownership, a latent sprig in South Africa’s Exchange Control Regulations has finally matured.
Assume that you develop software and pay the developer’s cost plus a reasonable profit margin. You contract verbally and fail to provide for acquisition of copyright in the code. Naturally, you expect to use the software without further payment to the developer. However, in such arrangements the developer typically retains ownership of the copyright. What if he institutes copyright infringement proceedings against you, interdicting you from using the software unless you pay an additional royalty for the use of the copyright? Fortunately, in this instance, the law generally comes to your assistance, implying a term in your agreement with the developer granting you a royalty-free licence to use the software. Fair. You paid full price to develop the software, so why should you pay again to use it?
Now, let’s consider a common arrangement relating to trademarks. You (a South African) wish to launch a new pen and are considering calling it “X”. You could call it “Y”, but have decided on “X”. Frankly, both “X” and “Y” are suitable marks, and when first putting your pen on the market, it would make no difference whether you called it “X” or “Y”. You could even have called it “Z” and people would still have bought the pen because none of these trademarks enjoyed any reputation. So what is the initial value of the trademark “X”? The cost of filing the registration, approximately R3,000. Now, assume that you file the South African “X” trademark application in the name of a Mauritian company prior to any sale or marketing in the country. Over time, you advertise your “X” pen, market it, exercise quality control, create sales channels and distribution networks. Thereby generating a reputation in the trademark “X” and creating value in the brand. Who paid for this value creation? You. Who provided all the “value generating” services without reimbursement? You. So, after having done everything to grow value in the “X” trademark, are you obliged to pay a royalty to use this now valuable mark? Interestingly, many trademark attorneys (fixated on legal ownership and rights) think so. But this does not sit comfortably, does it? And an uncomfortable gut feel is often the overture to a legal counter-argument.
Time to introduce the concept of “transfer payments” – previously a latent sprig in our Exchange Control Regulations. This is similar to the concept of “transfer pricing” in our tax law. Basically, in an international transaction (i.e. between a South African and a foreigner), the parties are required to deal at arm’s length. Take a step back and ignore legal ownership for now. Who is the economic owner of the “X” trademark? You. According to this concept, if you are the 100% economic owner of an asset, you should not pay to use the asset. So, no “outgoing” royalty payments are permitted. Let’s take this further. What if the Mauritian company licenses the “X” trademark to third parties? All royalty income should transfer for your benefit. And, what if the Mauritian company sells the trademark for value? The sales price should flow to you.
This concept of economic ownership has matured into another powerful tool in the armoury of our Regulators, which can be used to challenge numerous structures that were originally designed to withstand assaults based on legal ownership and rights only.