Deduction of upfront royalty payments


Generally, deductions relating to royalty expenditure are claimed under "the general deductions section", s11(a) of our Income Tax Act. However, despite the decision in ITC 1822 (which relates to fixed term licences), most up‐front premium payments may only be deducted in terms of s11(f).

The problem with s11(f) is that subsection (dd) provides that:

"the provision of this paragraph shall not apply in relation to any such premium or consideration paid by the taxpayer which does not for the purposes of this Act constitute income of the person to whom it is paid …"

Although sections 9(1)(b) and 9(1)(bA) deem most royalty receipt from South African licensees to be South African sourced and therefore taxable in the hands of the licensor, s35 of our Income Tax Act imposes a withholdings tax on such royalty payments (which tax may be reduced to zero by Double Taxation Agreements) and s11(1)(l) of our Income Tax Act provides that:

"Exemptions.‐ (1) There shall be exempt from normal tax ‐ (l) any amount received by or accrued to any person which amount has been subject to withholding tax in terms of the provisions of section 35."

Referring back to s11(f), "income" is defined in s1 as: "the amount remaining of the gross income of any person for any year or period of assessment after deducting therefrom any amounts exempt from normal tax under Part 1I of Chapter II;"

Accordingly, despite s9(1), due to the application of s35, s11(1)(l), the definition of "income" in s1 and s11(f)(dd), no licensee may claim a deduction in respect of an upfront premium where the premium is paid to a foreign licensor.

It is also worth noting that allowances in terms of s11(f) are spread over the lesser of:

However, where the parties have a right to renew, the allowance is spread over the probable duration of use of the intellectual property (IP) licensed. But, if after estimating the probable duration of use, the licence is terminated earlier, the outstanding balance due to be deducted falls away and is not accelerated by s11(o) of our Income Tax Act.

(Updated 2007)

Articles: Taxation