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The South African Revenue Service has issued detailed guidance on the interpretation and application of section 23I of the Income Tax (IT) Act, which relates to the prohibition of deductions for “tainted” intellectual property (IP).
According to the Draft Interpretation Note – issued on January 9, 2018 – section 23I disallows a deduction for expenditure incurred for the use of IP when income is shifted between the contracting parties to trigger little or no tax. According to the guidance, although deductions are prohibited in the circumstances listed in section 23I, a portion of the expenditure may be allowed as a deduction if the provisions of the IT Act relating to withholding tax on royalties apply.
Section 23I – which was inserted in the IT Act through the Revenue Laws Amendment Act, 2007 – applies to expenditure incurred on or after January 1, 2009.
The guidance states: “Transactions involving the use of IP belonging to another person normally carry a charge in the form of a royalty. Usually the payment received will fall within the recipient’s gross income and the payee will be allowed to claim a deduction for the expenditure incurred in paying the royalty.”
“Instances arose in which self-developed IP was sold or transferred to another party connected to the resident developer. The connected person typically paid no tax or tax at a very low rate. These transactions were designed to reduce the group’s overall tax liability in South Africa. Section 23I was therefore inserted with the aim of preventing the avoidance of tax.”