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Exchange control flexes its muscles

In a case pending before our Cape Town High Court, the South African Reserve Bank (SARB) is defending an application by Promethea (a company registered in Vanuatu) to review SARB’s decision to refuse approval for the expatriation of intellectual property from South Africa.

During 2004/2005, Colin Vale developed a prototype pressure paraffin stove, for which he won the Goodyear Tyre Corporation’s “Innovation of the Year” award together with R100,000 in prize money. At about the same time George Long invented a wick paraffin stove for which we was awarded a “2004 Prototype Award” from SABS Design Institute. Patent applications were filed for both inventions.

During 2006, Vale and Long assigned their patents to Promethea, a company registered in Vanuatu in consideration for 10% bearer shares in the company. However, no exchange control approval for the assignment was ever obtained. Ultimately, the pressure stove was made in Vietnam and sold in South Africa. However, the relationship between the parties soured and certain patent rights have consequently been lost.

Commercialization and survival of all the intellectual property is now under threat due to the parties’ alleged contravention of our Exchange Control Regulations, in particular Regulation 10(1)(c), which requires prior approval for the export of “capital” from South Africa.

This is not an exceptional case. Back in 2006 a survey was conducted, which found that 423 families of patents cite only South African inventors and foreign applicants (typically in tax havens). Since SARB policy was to allow the expatriation of intellectual property from South Africa in exceptional cases only, we can assume that most of these patentees are following the Promethea case very closely.

The new licensing tax anti-avoidance section, which came into force on 1 January 2009, aims to tackle a portion of the tax loss resulting from these transfers. However, more needs to be done to stem the tax loss on foreign commercialization and licensing income.

One of the reasons for what appears to be a systematic contravention of our Exchange Control Regulations is the lack of awareness by inventors and legal practitioners of the types of transactions that require Exchange Control approval. To summarise, approval is required in the following instances:

Where intellectual property is assigned by a South African to a foreigner.
Where a South African concludes a licence and pays royalties to a foreigner.
Where a South African grants a foreigner a licence at a discounted royalty rate. Consider “non-assert agreements”.
Where a South African grants a foreigner a licence that permits the foreigner to sublicense the intellectual property and retain a spread on the sublicensing income (i.e. the foreign licensee receives more from the sublicensee than the foreigner pays on to the South African licensor).
Where promissory notes relating to royalty payments are transferred to a foreigner.
Where intellectual property is ceded by a South African to a foreign as security.
Where a South African licensor permits a foreign licensee to institute infringement proceedings relating to the licensed intellectual property and to retain damages.

There are no exceptions to the above categories. As such, even where a South African researcher has been contracted by a foreign entity to perform R&D services on market-related terms, any transfer of intellectual property from the inventor to the foreign entity will require Exchange Control approval. Fortunately, approval is in such instances simple to obtain. Also beware of “improvements clauses” in licences that require the South African licensee to assign improvements to the foreign licensor. Not only does this have Competition Law implications, but the clause requires SARB approval. Remember that it is not the assignment that requires approval, but the entering into an agreement that could have the effect of exporting “capital”. As such, even if no improvements are made by the licensee and no assignment consequently takes place, the licensee is none the less liable for having contravened our Exchange Control Regulations by having entered into the agreement.

Also think twice before making applications to SARB for the following transactions since they are, as a general rule, declined:

Assignment of intellectual property by a South African to a foreign “related” party. (The term “related” is not defined and is interpreted broadly by SARB).
Assignment of intellectual property to a foreign unrelated party combined with a royalty-bearing licence granted by the foreign party to the South African assignor.

Finally, bear in mind that the purpose of the application is to justify the terms of the transaction. Do not merely summarise the terms in plain English or conclude that “they were the best terms the parties could agree upon”. If the application is rejected, one is generally given the opportunity to make representations to SARB in person. However, be prepared to justify and argue the reasonableness of the terms in front of a panel of experts.

Related articles: s23I of our Income Tax Act; Transfer Pricing

Update: See apparent shift in SARB policy. Also see the decision in Oilwell v Protec.

Anthony van Zantwijk

Sibanda & Zantwijk Patent Attorneys

January 2009

(Based on an interview published in Finweek 19 Feb 2009)

Last Updated ( Wednesday, 03 March 2010 )