TAXATION OF SOFTWARE TRANSACTIONS
By Aziza Hannah Bacay on June 24, 2021
This also speaks true for software transactions where the software may be transferred electronically, instead of delivery through variety of media, such as magnetic tape, disk, CD-ROM, and the like.
Software is defined as “a program, or a series of programs, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software).” (Section 2, Revenue Memorandum Circular [RMC] 44-2005, Sept. 1, 2005). It is “generally assimilated to literary, artistic or scientific work protected by copyright laws.”
RMC 44-2005 differentiated the types of software transactions, the classification of payments made in relation thereto, and their corresponding tax implications.
Payments made in consideration for the use or right to use software are generally treated as royalties. However, there are instances when payments for the software transaction may constitute business income.
Transfer (full or partial) of copyright rights
When only copyright “rights” are transferred, the payments made in consideration thereof are treated as royalties. A transaction is considered a transfer of copyright right if the transferee acquires any one or more of the following:
• The right to make copies of the software for purposes of distribution to the public by sale or other transfer of ownership, by rental, lease or lending.
• The right to prepare derivative computer programs based upon copyrighted software.
• The right to make public performance of the software.
• The right to publicly display the computer program.
• Any other rights of the copyright owner, the exercise of which by another without authority shall constitute infringement of said copyright. (Section 5[a], RMC 44-2005)
If the payment is made to a domestic corporation, such payment shall be subject to final income tax of 20 percent based on the gross amount of royalties paid.
On the other hand, if the payment is made in favor of a non-resident foreign licensor, it shall be subject to 25-percent final income tax based on gross amount paid, unless there is an existing tax treaty providing for a reduced rate.
Transfer of copyrighted articles
On the other hand, in a transfer of copyrighted article wherein the transferee acquires a copy of the software, but does not acquire any of the rights enumerated above and the transaction does not involve the provision of services or know-how, any income derived will be considered business income.
A copyrighted article includes “a copy of software from which the work may be perceived, reproduced, or otherwise communicated, either directly or with the aid of machine or device.” (Section 5[a], RMC 44-2005).
Income from a transfer of copyrighted article shall be considered business income subject to the graduated income tax rate (zero to 35 percent) if the transferor is a resident individual, or the regular corporate income tax rate (20 to 25 percent) if the copyrighted article is owned by domestic corporations. The payment made by the end user to the local subsidiary/reseller/distributor shall be subject to 2-percent withholding tax of the gross amount of the payment creditable against the taxable income of the said local subsidiary/reseller/distributor.
On the other hand, if the transferor is a non-resident foreign corporation, the income payment is subject to 25-percent final withholding tax, subject to the applicable tax treaty reduced rate.
Value added tax for software transactions
RMC 44-2005 states that the following transactions shall be subject to 12-percent value-added tax (VAT):
• Royalty payments for the use of a copyright over a software.
• Payments made to resellers/distributors or retailers who are engaged in the trade or business of distributing or selling software.
• Payments for services rendered in the Philippines in connection with purchased software.
If the payments are made to a non-resident licensor/reseller/distributor, the person in control of the payment shall be required to withhold the VAT for and on behalf of the non-resident licensor. The licensee may claim the VAT withheld as its input tax upon filing its VAT return.
As mentioned above, transfer of software can be made electronically without having to deliver the actual good through CD or other forms of hard drive containing the software. In this regard, the BIR issued several rulings discussing that the electronic transfer of software from the non-resident foreign corporation is an importation of software and is also subject to VAT under Section 107 of the NIRC, as amended. (DA ITAD BIR Ruling 093-06, Aug. 22, 2006; DA ITAD BIR Ruling 094-06, Aug. 22, 2006; DA ITAD BIR Ruling 103-06, Aug. 29, 2006].
Customs duty implications
Although the electronic transfer of software from a non-resident foreign corporation is considered an importation, it is not subject to customs duties pursuant to the World Trade Organization e-commerce moratorium, which currently bans countries from applying customs duties on electronic transmissions. Furthermore, the Philippine tariff system only recognizes physical import of tangible articles and does not have a specific classification for software transmitted electronically. Thus, there is presently no legal basis for the imposition of customs duty.
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Aziza Hannah A. Bacay is a junior associate of Mata-Perez, Tamayo and Francisco (MTF Counsel). This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any question or comment regarding this article, you may email the author at info@mtfcounsel.com or visit MTF website at www.mtfcounsel.com.