Income Classification of Software Payments

 

shutterstock_219004666_1024x768_0

A software is 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).

Software payments can be classified as follows:

  1. Business Income
  2. Income from services
  3. Royalties
  4. Rental Income

Software payments are classified as follows in each of the following categories of software transactions:

  1. Transfers of Copyright Rights

Transfer of copyright rights results to the acquisition of a person of any of the following rights:

  1. 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;
  2. The right to prepare derivative computer programs based upon the copyrighted software;
  3. The right to make a public performance of the software;
  4. The right to publicly display the computer program; or
  5. Any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of said copyright.

The software payment is classified depending on the extent of substantial rights transferred.

  • If only the copyright rights are transferred, payments made will be classified as royalty income.
  • If the copyright ownership is transferred, payments made will be considered as business income.

 

  1. Transfer of Copyrighted Article

A copyrighted article incorporating a software includes a copy of a software from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device.

The classification of software payment will depend on the extent of the benefits and burdens of ownership transferred.

  • If a person acquires a copy of the software but does not acquire any of the rights above or only acquires a de minimis grant of such rights, and the transaction does not involve the provision of services or of know-how, the payments for which constitute business income.
  • If the transaction involves a transfer of insufficient benefits and burdens of ownership, the transaction will be classified as lease generating rental income.
  1. After-sales Service

After-sales services refer to the accompanying services such as installation, maintenance and customization software provided by the personnel of the relevant foreign licensor/owner of the relevant local subsidiary, re seller and distributor.

The whole amount of software payment relating to after-sales services must be apportioned as follows:

  • The part of the payments representing the use of software will be treated as
  • The other part of the payments representing the provision of services will be treated as income from service.

However, if one part of what is being provided constitutes the principal purpose of the contract and the other parts are only ancillary and largely unimportant character, the treatment applicable to the principal part will be applied to the whole amount of the consideration.

  1. Site License/ Enterprise License/ Network License Arrangements

These are arrangements in which the transferee obtains rights to make multiple copies of the program for operation only within its own business. The rights are generally limited to those necessary in enabling the operation of the program on the licensee’s computers or network.

Software payments under these arrangements will generally be treated as business income.

  1. Supply of information

This is a transfer of computer software where a software house or computer programmer agrees to supply information about the ideas and principles underlying the program, such as logic, algorithms or programming languages and techniques.

Software payments on this may be classified 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.

  1. Transfer of Ownership

Payments on the transfer of full or partial ownership of the rights in the copyright are generally not royalties but business income or capital gains.

 

Source:

Revenue Memorandum Circular 44-2005

 

Leave a Reply

Your email address will not be published. Required fields are marked *