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In my previous article I summarised the goal of a company seeking to grow internationally by locating its intellectual property (IP) offshore.
This second of two articles zeros in on the functions which an offshore company (ie ForeignCo) will need to undertake, in order for it to show that it owns IP and claim that such IP is located in its offshore company.
While you read the remainder of this article, put yourself in the shoes of a brand new business located in a new country. Imagine the business plan that you put in place: what functions would you expect to see in that business for that business plan to succeed.
There are three elements required for a SA startup to move its IP offshore
That is what we are really trying to achieve — regardless of all the noise around laws, taxes and exchange controls.
So, if you can create those business resources, and give them those functions, you will succeed in building value offshore.
Three elements needed
There are three, specific elements required to own IP in ForeignCo.
ForeignCo must show that it is a genuine business centred around the IP. It must show that it performed certain functions, funded those functions and built a genuine business that could succeed or fail depending on the IP’s success or failure.
The three ownership elements are, firstly, the process of creating the IP: ForeignCo needs to show that it was ultimately responsible for the process of development, enhancement, maintenance and commercialisation of the IP.
The second is to show that ForeignCo supplied the assets which created the IP.
The third is to show that ForeignCo held the commercial risk in respect of the IP – ie the commercial failure or success would land on the shoulders of ForeignCo.
ForeignCo must have a real governance function
Let’s start with the first element: development, enhancement, maintenance and commercialisation of the IP.
Think of these activities as the important functions which create the IP’s value.
In order to show that ForeignCo performed these activities, we need to show that ForeignCo has a real governance function that controls all the important functions.
So, to show how ForeignCo is responsible for these important functions, lets run through the process of “development” function. Remember what I said above – what would you personally expect to see being done? Here are some of the elements which may exist:
- A process which identifies a market opportunity, and a product which solves that opportunity (the “eureka moment”).
- A process that created the product (“giving life” to the solution identified above).
- Building the strategy for developing and commercialising the product – but also, very importantly, budgeting and funding that strategy.
- Creating a marketing programme with focused outcomes.
- Enforcing or protecting legal rights over any IP – registrations or contractual protections.
- Managing and carefully controlling the quality control of services performed by outsourced entities, especially related parties (ie your SA business).
- So, in practice, we’d expect to see that the someone located in ForeignCo’s jurisdiction devised the IP in response to a market opportunity, proposed a plan which was adopted at board level to develop, fund and commercialise that IP, and went through a practical (verifiable) process of creating the real life product or IP which could then be commercialised.
The rest of the elements should then fall into place – ForeignCo would obviously need to create and use assets to perform those functions. Similarly, ForeignCo would have a business plan which required it to take a certain amount of risk in order to commercialise the IP.
Do bear in mind, if you can’t perform an important function offshore, or provide assets or take commercial risk in your SA company, then the SA company has to be compensated with an appropriate share of the returns earned on the IP.
Profit must come back to SA
What that really means is that, at best, a material amount of the profit must come back to South Africa (converted into rands) and be taxed here.
At worst, key features of the IP may be regarded as created and owned by your SA company, not by ForeignCo, falling under the regulation of the Reserve Bank’s exchange controls.
This is the reason why you should carefully manage the governance functions you’d expect to have offshore, to establish your IP there.
Creating and managing those governance functions are a key value add of our firm as advisors, and I would recommend running through this process conceptually, in advance so that you can plan what needs to be done offshore.
Read more: A fail-safe way to moving IP offshore: Part 2 [Opinion]
Read more: What startups should know about tax, when setting up an overseas company
Read more: How to structure functions and operations across your international group
Read more: Here’s how SA startups can legally create an offshore company
Read more: The ins and outs of taking your startup offshore
Adrian Dommisse has extensive experience in corporate and financial transactions across Africa, Europe, Eastern Europe, and the Middle East. He founded Dommisse Attorneys law firm in 2008, and holds three degrees in economics and law.
Featured image: Free-Photos via Pixabay