Mauritius is all the rage. Due to the favourable tax regime in Mauritius, the country is seen as the gateway to Africa. Foreign companies often route their investments through Mauritius by setting up a Category 1 Global Business Company (GBL1) which has an effective tax rate of 3% and is able to take advantage of Mauritius’ extensive double taxation treaty (DTT) network, or a Category 2 Global Business Company (GBL2), which is treated as a non-resident of Mauritius and therefore exempt from tax in Mauritius. Mauritius is therefore an ideal jurisdiction for incorporating intellectual property (IP) holding companies.
IP holding companies (IPHC) are usually set up by multinationals, or businesses with plans for international expansion, to reduce the tax burden on the income derived from operations. Valuable IP of the group, such as trademarks, copyright works including software, trade secrets, designs, patents and customer data, are assigned to the IPHC which is incorporated in a tax-friendly jurisdiction. In return for a licence fee, the IPHC then licences rights to exploit the IP to operating companies in the group (Opcos) and third parties. Licensees which are also subsidiaries also pay a dividend to the IPHC. The IPHC’s income would be subject to little or no tax, thereby maximising shareholder returns.
Assuming that the IPHC and Opco are in Mauritius and Nigeria respectively, the countries have signed a DTT, which is yet to be ratified, so the DTT will not apply. Therefore the licence fee and dividend paid to the IPHC would be subject to a 10% withholding tax (WHT). This will be the final tax due to the Federal Inland Revenue Service (FIRS) since the IPHC is a non-resident company. In Mauritius, depending on whether the IPHC is a GBL2 or GBL1, the net licence fee and dividend received will either be tax exempt or subject to an effective tax rate of 3% respectively. In Nigeria, as in many jurisdictions, the licence fee paid by the Opco is a tax deductible expense. If the licence fee is fairly high, it could considerably reduce the Opco’s profits chargeable to the companies income tax (CIT) of 30%.
This, in very simplistic terms, is how IPHCs are used to minimise tax and maximise profits. If only it were that simple, for there are mechanisms available to the FIRS, which may be used to claw back tax. There are also certain considerations from a regulatory and IP law perspective which must be taken into account.
In this article, we will look at some of the pitfalls that groups with an IPHC may face in Nigeria.
Restrictions under the NOTAP Act and Guidelines
The National Office for Technology Acquisition and Promotion (NOTAP) regulates the technology landscape in Nigeria. A main function of NOTAP is to ensure that Nigerians license in foreign technology on the most favourable terms available. Accordingly, all agreements to transfer foreign technology must be registered with NOTAP, failing which the foreign party will be unable to repatriate its profits. Therefore, the licence between the IPHC and Nigerian Opco must comply with the NOTAP Act and Guidelines, which restrict the contractual freedom that the parties, otherwise, may have had.
For instance, IPHCs often licence trademarks to Opcos. However, NOTAP will not register trademark licenses unless, the trademark is internationally recognised, the license includes rights to use know-how and the licensed products will be manufactured locally for export. Also the licensor cannot own 75% or more of the local company’s equity. The purport of this is first, an IPHC will usually not be permitted to licence new brands to the Nigerian Opco; second, a bare trademark licence without more is not registrable; and third the Opco cannot be a wholly owned subsidiary of the IPHC, therefore a simple structure with only two companies cannot be used.
The NOTAP Guidelines also impose caps on the fees chargeable, thereby limiting the amount of profits that can be extracted from the Nigerian Opco. Trademark royalties are capped at 0.5% of the net sales value of the licensed products, while the IPHC may charge no more than 5% of net sales value for use of patents, know-how, designs or copyright. Annual fees for software support are capped at 22% of the software license fee.
Tax adjustments for artificial transactions
Aside from NOTAP, the FIRS will take great interest in the fees paid to the IPHC, which must be consistent with the arm’s length principle. To determine this, the IPHC must use one of the methods prescribed under the Nigerian Transfer Pricing Regulations 2012. These methods will not be discussed in detail here. It suffices to say that each entails comparing the fees charged by the IPHC with those charged in a comparable transaction between unconnected parties. The difficulty with this, particularly in a jurisdiction like Nigeria, is the unavailability of data on comparable transactions.
Nevertheless, the IPHC must find a way, acceptable to the FIRS, to make that comparison, perhaps by using foreign data and making downward adjustments to reflect the lower buying power of the Nigerian Opco. If the FIRS considers that the fees charged are inconsistent with the arm’s length principle, it may treat the licence between the IPHC and Opco as artificial. Although the FIRS has the power to disregard the licence entirely, which would be disastrous because all Opco’s profits derived from exploiting the IP in Nigeria may be subject to the 30% CIT rate, the FIRS will more likely adjust the respective tax liabilities of IPHC and Opco by treating them as if they had contracted as unrelated parties.
To illustrate this in simplistic terms, say IPHC licensed the right to exploit a patent to Opco whose net turnover of the licensed products is ₦100 million. IPHC charges a 70% royalty entitling it to ₦70 million. Opco deducts ₦7 million – 10% WHT. Opco also pays ₦9 million CIT, 30% of ₦30 million. Therefore the total tax payments to FIRS are ₦16 million. However, following an audit, FIRS determines that on the open market, the highest royalty that the patent would obtain is 25%. Therefore, IPHC should have paid only ₦2.5 million WHT while Opco should have paid ₦22.5 million CIT, a total of ₦25 million.
The Transfer Pricing Regulations do not specify how adjustments will be made, and the FIRS is yet to issue guidelines in this regard. However, the previous Government demonstrated its determination to enforce the Regulations, mandating in 2014 that all groups with Nigerian Opcos submit their transfer pricing policies to the FIRS. It remains to be seen whether this would be also a priority for the new Government. In the interim, groups should abide by the arm’s length principle when establishing an intra-group pricing policy, and maintain contemporaneous transfer pricing documentation, which will serve as proof that the group companies contract on this basis.
The IP enforcement strategy is another issue to consider when establishing an IPHC. Under Nigerian trademark law, the Opco can only sue infringers if:
(i) it is registered as a licensee at the Trade Marks Registry;
(ii) IPHC fails to act two months after Opco requests that IPHC does so; and
(iii) it joins IPHC as a defendant.
However, the IPHC may grant the Opco a right to sue directly without recourse to IPHC, under the license.
Similarly under the Nigerian Patents and Designs Act, the Opco may only sue for infringement of licensed patents or designs if the IPHC unreasonably refuses or neglects to commence proceedings. In the case of copyright, which protects software, compilations of data and content, only an exclusive licensee may sue for infringements.
Therefore, if IPHC does not wish to concern itself with the costs and logistics of infringement litigation before the Nigerian Federal High Court, the Opco must be given adequate rights under the licence to permit it to sue. This should pose no real issue, except for copyright licenses, which must be exclusive for the Opco to have standing. If it is intended that the IPHC would increase its revenue by licensing copyright works to third parties in Nigeria as well as Opco, the group may have to re-think this strategy. Ultimately, once the group has done its number-crunching, it may find that if the IPHC licenses third parties directly rather than indirectly through the Opco, the tax that it would save on third party revenue far exceeds the costs of litigation, which is likely to occur infrequently in any case.
Other than the above, there are differences between the GBL1 and GBL2 which one must take into account prior to setting up an IPHC. It is advisable to seek advice from a qualified Mauritian Counsel or management company, whose business is to manage GBL1 and GBL2 companies. From a more practical perspective, the set-up, management and administration costs of an IPHC and a local Opco will exceed that of a single local company which holds and exploits the IP. Therefore, before establishing an IPHC, one must be certain that the business will generate sufficient revenue and the tax savings are such to justify these costs.