BDB Laws Tax Law For Business appears in the opinion section of Business Mirror every

Thursday.

Tax on software
Intellectual property, no matter how intangible, is also taxed by the government. Thus, if you sell an idea and you earn one peso from it, the government would most likely want its share. An idea is most often embodied in a software. The Bureau of Internal Revenue (BIR) had issued Revenue Memorandum Circular (RMC) 44-2005 to clarify tax on software and create a guideline on the different classifications thereof. The RMC classifies software payments either as business income, royalties, rental income or capital gains. A transfer of software is classified as a transfer of copyrights if, as a result of the transaction, the transferee acquires any one or more of the following rights: a. The right to make copies of the software for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending. b. The right to prepare derivative computer programs based upon the copyrighted software. c. The right to make a public performance of the software. d. The right to publicly display the computer program. e. Any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of such copyright.

When only copyrights are transferred, payments made in consideration therefor are taxable as royalties. On the other hand, when copyright ownership is transferred, payment made in consideration therefor is considered business income of the transferor. Another classification under RMC 44-2005 is transfer of copyrighted articles. A copyrighted article incorporating software includes a copy of software from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. The copy of the software may be fixed in a CD-ROM, or in the main memory or hard drive of a computer, or in any other medium. In case of transfer of copyrighted articles, if the transferee acquires a copy of a software but does not acquire any of the rights described above (or only acquires a de minimis grant of such rights), and the transaction does not involve the provision of services or of knowhow, the transfer of the copy of the software is classified solely as a transfer of a copyrighted article and payments therefor constitute business income. Contracts for the use of software may also be accompanied with the provision of services (e.g., installation, maintenance and customization of the software) by personnel of the relevant foreign licensor/owner. These are called after-sale services. Payments as consideration for after-sales service in a mixed contract are not royalties alone, but are deemed to include income from services. RMC 04-2005 also refers to site license or enterprise license or network license arrangements, which refer to arrangements in which the transferee obtains rights to make multiple copies of the program for operation only within its own business. Although these arrangements permit the making of multiple copies of the program, such rights are generally limited to those necessary for the purpose of enabling the operation of the program on the licensees computers or network, and reproduction for any other purpose is not permitted under the license. Payments under such arrangements are generally dealt with as business income. Another type of transaction involving the transfer of computer software is the more unusual case where a software house or a computer programmer agrees to supply information about the ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques. In these cases, the payments are characterized as royalties to the extent that they represent consideration for the use of, or right to use, secret formulas or for information concerning industrial, commercial or scientific experience which cannot be separately copyrighted. Thus, software payments may be considered either as royalties or business income, or a combination of both. In general, it is the rights acquired by a company over a software, whether these were saved in CDs or installers or downloaded through the Internet from a web site is determinative of whether the income derived therefrom are royalties or business income. Whether or not a software and the use thereof is classified as business income, royalty, rental income or capital gain is often a bone of contention between taxpayers and revenue collectors. Tax treatment depends on how payment for the software is classified. Thus, a careful classification of every type of intellectual property that is contained in software must always be obtained so that tax payments are properly made.

The author is a senior associate of Du-Baladad and Associates Law Offices (BDB Law). If you have any comments or questions concerning the article, you can e-mail the author at irwin.nidea@bdblaw.com.ph or call 403-2001 local 330.