Taxation of Patents, Copyrights, Trademarks and Other Intellectual Property

Intellectual Property can exist in various forms such as Copyright, trademarks, patents, designs and trade secrets. Companies earn revenue from intellectual property through Licensing. Licensed Patent, Trademarks and Copyrights attract royalty income when transferred to Residents or non-residents at a specified Consideration.
The Income Tax Act Revised 2021 and the VAT Act 2013 provide the basis of taxation of the payments received from Patents, Copyrights and Trademarks in form of Royalties. Below are some of the Tax Considerations and implications highlighted under the various Tax Rules:

1. Withholding Tax

Royalty income accrues from the use or the right to use:
a) a patent, trade mark, design or model, plan, formula or process; or
b) the copyright of a literary, artistic or scientific work; or
c) any industrial, commercial or scientific equipment.
The Third Schedule Section 5 (g) of the Income Tax Act Provides that Withholding Tax on Royalty Income is charged the rate of 5%. The Section reads as follows: in respect of a royalty or natural resource income, five per cent of the gross amount payable;
This tax is however not final and is therefore subjected to further taxation under Section 10 (1) (b) of the Income Tax Act.

2. Value Added Tax

The VAT Act 2013 makes mention of Patents, Trademarks and Copyrights under Part IV: Place and Time of Supply Section 8 (2) (e ). The Section reads as follows:
(2) If the place of business of the supplier is not in Kenya, the supply of services shall be deemed to be made in Kenya if the recipient of the supply is not a registered person and—
(e) the supply is a transfer or assignment of, or grant of a right to use, a copyright, patent, trademark, or similar right in Kenya.
The VAT implications of the transfer of the Intellectual Property to be considered are as follows. Where a Kenyan entity transfers Intellectual Property to a non-resident entity, the transfer of the Intellectual Property will comprise an exported service which is currently zero-rated (i.e. subject to VAT at 0% for Kenyan VAT purposes). A transfer by a non-resident entity to a Kenyan entity will however constitute an imported service for which the Kenyan entity will be required to account for VAT (as if it has made a supply to itself), using the reverse charge mechanism. In addition, if a Kenyan VAT-registered business licenses out its Intellectual Property or gives another person within Kenya a right to the use of its Intellectual Property, any license fees or royalties payable will be subject to VAT at the current rate of 16%.

3. Capital Gains Tax

Section 34 (1) (j) of the Income Tax Act provides for the taxation of Capital Gains. The Section reads as follows:
tax upon the capital gains of a person charged under section 3(2)(f) shall be charged at the rate of five percent and shall not be subject to further taxation.
Where the value of the Intellectual Property has appreciated since creation, the transfer of the Intellectual Property will likely result in gains for the owner of the Intellectual Property. Where the selling entity is in Kenya, such gains will be subject to capital gains tax at the current rate of 5%. It is therefore important to consider whether or not the Intellectual Property is sitting with the appropriate entity before the Intellectual Property gains too much value. Note that the chargeable gain is determined by offsetting the transfer price/consideration against the initial acquisition cost of the Intellectual Property, along with costs incurred in improving/defending the Intellectual Property and any transaction expenses with respect to the transfer/assignment of the Intellectual Property.

4. Stamp Duty

A transfer of an Intellectual Property will also trigger stamp duty implications depending on the nature of the document for the transfer under the Eighth Schedule Part I of the Income Tax Act: Accrual and Computation of Gains from Property other than Investment Shares Transferred by Individuals. Where the Intellectual Property is transferred by way of a deed of assignment, nominal stamp duty would apply. Where transferred by way of an instrument under the Movable Property Security Rights Act (MPSRA), the instrument of transfer will be exempt from stamp duty in Kenya. Licensing agreements under which the Intellectual Property is licensed from one entity to another will also be subject to nominal stamp duty.

Other Considerations

Transactions involving Intellectual Property are common with Multi-National Corporations and foreign companies. Therefore, for companies operating across multiple jurisdictions and/or where opportunities for considerable revenue generation can be earned through Intellectual Property licensing, whether locally or in new markets, the incorporation and establishment of an Intellectual Property holding company is given due consideration.
Below are some of the tax considerations to take into account in the establishment of an Intellectual Property holding company, the assignment of existing Intellectual Property to the Intellectual Property holding company (to ensure that it owns the Intellectual Property rights to be licensed) and in the licensing arrangements, whether intra-group or to unrelated third parties:

1. Transfer pricing on the assignment

Kenyan transfer pricing rules require transactions between a Kenyan entity and its related non-resident affiliates to be undertaken at arm’s length. Thus, transfers of Intellectual Property (i.e. when assigning the Intellectual Property rights to the Intellectual Property holding company) from a Kenyan entity to a non-resident related entity should be undertaken at the market value of the Intellectual Property.

2. Transfer pricing on the license fee

Licensing fees charged between related entities should be at market rates to avoid transfer pricing issues. This is aimed at ensuring that companies do not shift profits by way of setting up Intellectual Property holding companies in low-tax jurisdictions and then charging high licensing fees to operating companies in other jurisdictions.

3. Applicability of double tax treaties (DTTs)

Consider whether Double Taxation Treaties exist between the jurisdictions of a non-resident entity transferring the Intellectual Property and a Kenyan recipient entity, as these may provide for taxation of capital gains in the country of residence of the transferring entity (being the non-resident entity). In such circumstances, Kenyan capital gains tax will not apply. We can consider the structure of the proposed transfer in order to determine whether there are any treaty limitations that would prevent the parties relying on the applicable DTT.
By CPA Allan Wasonga
Audit Manager, Grohney & Co. Associates