The Supreme Court of Appeal recently, after a period of some uncertainty, confirmed that royalties are taxable.
A South African entity entered into a license agreement with its foreign principal in terms of which it was authorised to use certain licensed marks and licensed marketing indicia, which I will broadly term "trade marks". In terms of the license agreement, the South African entity paid substantial royalties to its foreign principal, the proprietor of the brand and trade marks for the use thereof. The lower courts found, in the circumstances of this matter, that the royalty payments were that of a capital nature. Fortunately, the Supreme Court of Appeal has now confirmed that royalty payments are revenue expenditure, rather than expenditure of a capital nature. Their comments, which essentially confirmed the previous legal position included the following:
· "Expenditure incurred for purposes of acquiring a capital asset of the business is capital expenditure whereas expenditure which is part of the cost incidental to the performance of the income producing operations … is revenue in nature."
· "A distinction is thus drawn between expenditure made to acquire an income - producing concern (in respect of which the outlay is usually non-recurrent) and money spent … in working the concern for the present production of profit."
· "The conclusion to be drawn from all the cases seems to be that the true nature of each transaction must be examined in order to determine whether the expenditure in question is capital or revenue expenditure" and that, …"in deciding that question each case must be decided on its own facts and circumstances."
· The royalty payment was made in consideration for the use of the trade marks. Its purpose was to procure for the licensee, "… the use - not ownership - of the intellectual property of another from its sole and rightful owner for the duration of the agreement."
· The ownership of the intellectual property remained with the proprietor throughout the term of the agreement and that upon termination thereof the local licensee "would automatically cease to have the right to use the intellectual property in question."
· The anticipated and recurrent nature of the royalties was a strong indicating factor that they are related to revenue rather than capital. The Court stated that: "The recurrent cost of procuring the use of something which belongs to another is usually recognised as being of a revenue nature. The most obvious example is the recurrent rent paid by a tax payer for the use of premises from which he/she trades", which is certainly "expenditure incurred in the production of income and of a non-capital nature and therefore deductible …for the purpose of determining taxable income".
The Court found that the royalty fees paid in this matter were to all intents and purposes indistinguishable from ongoing rental payments for the use of another’s property and that the royalties neither created nor preserved any capital asset in the hands of the tax payer.
The confirmation of many previously existing principles, is comforting. It is however very important to reiterate that each case will be decided on its own facts. Thus although the general principles have now again been confirmed, there are certain scenarios, where the Court could arrive at a different decision such as for example in the case of an indefinite exclusive license agreement where for example a single payment is made.