Roll-up international licences

It appears to have become common practice to combine a licence, provision of technical services agreement, and continued R&D services agreement into a single agreement and call the composite agreement a “licence”. In principle, this is not necessarily incorrect, but then one must be careful to apportion the “royalty” payments between the three categories.

For practical reasons, one may be tempted to combine all the above provisions into one agreement. For instance, cancellation of the licence would typically require automatic cancellation of the other provisions. But from SARS’ perspective, the motivation may appear more insidious.

SARS’ sensitivity is understandable when the provisions are analysed independently:

Licence

  • Typically royalty payments are deductible by the licensee in terms of s11(a) of our Income Tax Act.
  • Royalty payments to a foreign licensor are subject to withholdings tax of 12%. However, this is frequently reduced to 0% by the application of a double taxation agreement (DTA).
  • The licensor receives a royalty, which is regulated by the Royalty article in the DTA.

Provision of technical services

  • Typically payments are deductible by the licensee in terms of s11(a) of our Income Tax Act.
  • Payments for technical services are not subject to withholdings tax.
  • The payment is categorised as a Business Profit and regulated by the corresponding Business Profit provision in the DTA. In terms of most DTA’s, business profits received by a foreign resident are not subject to tax in South Africa unless the technical services are provided through a permanent establishment (PE) in South Africa. Accordingly, if the licensor has a PE in South Africa, these receipts will be subject to South African tax at a rate of 35%.

R&D expenditure

  • The licensee may only deduct this expenditure in terms of s11D of our Income Tax Act. However, this section requires the R&D activities to be conducted in South African. Since this requirement will not be satisfied, no related expenditure may be claimed as deductions or allowances by the licensee.
  • Payments for R&D is not subject to withholdings tax.
  • The payment is categorised as a Business Profit and regulated by the corresponding Business Profit article in the DTA. It is doubtful whether the R&D will be conducted through a PE in South Africa, so the licensor is unlikely to be subject to tax in South Africa on these payments.

By rolling-up all the above provisions into a “licence”, the parties secure all the benefits associated with the “royalty payments”: the licensor will not be taxed in South Africa irrespective of whether it provides technical services from a permanent establishment in the country; and the licensee obtains deductions relating to R&D expenditure irrespective of whether such R&D is conducted in South Africa.

The onus of proving the apportionment of expenditure between the three provisions rests on the taxpayer. Consequently, composite licence agreements should be drafted to distinguish clearly between the considerations payable in respect of each of the above categories.

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