Claiming full allowances for acquisition of IP

Generally, people understand s11(gC) of our Income Tax Act as follows: where a person (assignee) acquires ownership of intellectual property (excluding licensed rights, trademarks and bare know-how) that conferred an enforceable monopoly, the assignee is entitled to claim annual allowances calculated at:

Patents / copyright: Purchase price / 20
Designs: Purchase price / 10
(Capped at the purchase price)

Provided that the intellectual property is brought into use by the assignee for the first time for the purposes of his trade, annual s11(gC) allowances are available for the entire 10 or 20-year allowance periods.

But let’s look at s11(gC) a little closer:

s11 For the purpose of determining the taxable income derived by any person from carrying on any trade, there shall be allowed as deductions from the income of such person so derived-
(gC) an allowance in respect of any expenditure actually incurred by the taxpayer during any year of assessment commencing on or after 1 January 2004 to acquire (otherwise than by way of devising, developing or creating) any—
i) invention or patent as defined in the Patents Act, 1978 (Act No. 57 of 1978);
ii) design as defined in the Designs Act, 1993 (Act No. 195 of 1993);
iii) copyright as defined in the Copyright Act, 1978 (Act No. 98 of 1978);
iv) other property which is of a similar nature (other than Trade Marks as defined in the Trade Marks Act, 1993 (Act No. 194 of 1993); or
v) knowledge essential to the use of such patent, design, copyright or other property or the right to have such knowledge imparted,

which shall be allowed during the year of assessment in which that invention, patent, design, copyright, other property or knowledge is brought into use for the first time by the taxpayer for the purposes of the taxpayer’s trade, if that invention, patent, design, copyright, other property or knowledge, as the case may be, is used by the taxpayer in the production of his or her income: Provided that—
aa) where that expenditure actually incurred by the taxpayer exceeds R5 000, that allowance shall not exceed in any year of assessment—
A) five per cent of the amount of the expenditure in respect of any invention, patent, copyright or other property of a similar nature or any knowledge connected with the use of such invention, patent, copyright or other property or the right to have such knowledge imparted; or
B) 10 per cent of the amount of the expenditure in respect of any design or other property of a similar nature or any knowledge connected with the use of such design or other property or the right to have such knowledge imparted;

Note the phrase “if that invention, patent, design, copyright, other property or knowledge, as the case may be, is used by the taxpayer in the production of his or her income”.

This was imported from s11(gC)’s predecessor, s11(gA) – a section that still applies to assignments concluded before 1 January 2004.

Since the assignee’s entitlement to s11(gC) allowances must be tested each year that the allowance is claimed, the assignee must show that:

  • he “uses” (i.e. performs an “infringing act”) in each year of the 20-year allowance period; and

  • the performance of the “infringing acts” is linked to “the production of his or her income”.

For example, an assignee of:

  • a patent or design is required to produce income by making, importing or selling the patented product; or

  • copyright subsisting in a recipe is required to produce income from making copies of the recipe book. (Baking and selling bread made using the recipe is insufficient)

Merely performing a single “act of infringement” is insufficient for the assignee to claim allowances for the entire 20-year period, an assignee must produce income from performing repeated and specific “acts of infringement” for the entire 20-year period.

However, this wording also has an unintended consequence. Let’s assume that an assignee purchases patent ZA90/0576 for R20m from a person (not being a connected person) and that he intends to produce income by making and selling the patented product for the foreseeable future. This patent is due to expire in 2010. In other words, it only has 3 years left before expiry. Once expired, the patent no longer exists and obviously cannot be “used”. For each year 2007 to 2010, the assignee may claim R1m s11(gC) allowances, totalling R4m. From 2011 onwards, since the assignee can no longer claim to satisfy the “use” requirement, no further allowances may be claimed. Furthermore, our Income Tax Act does not provide for acceleration of the remaining R16m s11(gC) allowances due to “destruction” (i.e. expiry) of the intellectual property asset.

It is therefore doubtful whether the entire purchase price for designs or patents acquired by assignment after 7 June 2007 may ever be claimed unless a corresponding amendment is made to the acceleration provisions in our Income Tax Act.

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