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RMC 44-05

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64 views3 pages

RMC 44-05

Uploaded by

saintkarri
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

REVENUE MEMORANDUM CIRCULAR NO.

44-05
SUBJECT : Taxation of Payments for Software
TO : All Internal Revenue Officers and Others Concerned

SECTION 1. Scope. — This Circular shall provide for the guidelines for the taxation of computer software payments.

SECTION 2. Definition of Software. — "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). It can be transferred through a variety of media, for example in writing or electronically, on a magnetic tape or disk, or on a
laser disk or CD-ROM, or it can be downloaded through the Internet or through a network. It may be standardized with a wide range of
application or be customized for specific users. It can be transferred as an integral part of computer hardware or in an independent form
available for use on a variety of hardware.

SECTION 3. Payments For the Use of Software As Royalties.


a. Definition of ROYALTIES — The term "royalties", as generally used, means payments of any kind received as a consideration for
the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, or films or tapes
used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use
of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or
scientific experience.
The definition covers both payments made under a license and compensation which a person would be obliged to pay for
fraudulently copying or infringing the right.

b. Definition of royalties includes payments for the use of copyright over software — Software is generally assimilated as a literary,
artistic or scientific work protected by the copyright laws of various countries. Thus, payments in consideration for the use of or the
right to use a copyright relating to software are generally royalties.

SECTION 4. Categories of Transactions. — Transactions involving software may take any one or more of the following categories:
a. A (full or partial) transfer of a copyright right in software;
b. A transfer of a copy of the software (a copyrighted article);
c. The provision of services for the development or modification of the software; or
d. The provision of know-how relating to software programming techniques.

Any transaction involving software which consists of more than one of the transactions above shall be treated as a separate
transaction, with the appropriate provisions of this Circular being applied to each such transaction. However, any transaction that is de
minimis, taking into account the overall transaction and the surrounding facts and circumstances, shall not be treated as a separate
transaction, but merely as a part of another transaction.

SECTION 5. Characterization of Transactions. — The character of payments received in a transaction involving the transfer of
computer software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use
and exploitation of the program.
a. Transfers of copyright rights. — A transfer of software is classified as a transfer of a copyright right if, as a result of the transaction,
a person acquires any one or more of the rights described below:
i. 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;
ii. The right to prepare derivative computer programs based upon the copyrighted software;
iii. The right to make a public performance of the software;
iv. The right to publicly display the computer program; or
v. Any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of
said copyright.

The determination of whether a transfer of a copyright right in a software is a sale or exchange of property is made on the basis of
whether, taking into account all facts and circumstances, there has been a transfer of all substantial rights in the copyright. A transaction
that does not constitute a sale or exchange because not all substantial rights have been transferred will be classified as a license
generating royalty income.

When only copyright rights are transferred, payments made in consideration therefor are royalties. On the other hand, when
copyright ownership is transferred, payments made in consideration therefor are business income.

b. Transfer of copyrighted articles. — 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 copy of the
software may be fixed in the magnetic medium of a floppy disk or a CD-ROM, or in the main memory or hard drive of a computer,
or in any other medium.

If a person 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 know-how, the transfer of the copy of the
software is classified solely as a transfer of a copyrighted article and payments for which constitute business income.
The determination of whether a transfer of a copyrighted article or right in a software is a sale or exchange of property is made on
the basis of whether, taking into account all facts and circumstances, the benefits and burdens of ownership have been transferred. A
transaction that does not constitute a sale or exchange because insufficient benefits and burdens of ownership of the copyrighted
article have been transferred, such that a person other than the transferee is properly treated as the owner of the copyrighted article,
will be classified as a lease generating rental income.

c. After-Sales Service. — Contracts for the use of software are often accompanied with the provision of services (e.g., installation,
maintenance, and customization of the software) by personnel of the relevant foreign licensor/owner or of the relevant local subsidiary,
reseller, and distributor. Payments as consideration for after-sales service in a mixed contract are not royalties alone, but will include
income from services. The appropriate course to take with such a contract is, in principle, to break down, on the basis of the information
contained in the contract or by means of a reasonable apportionment, the whole amount of the stipulated payments according to the
various parts of what is being provided under the contract, and then to apply to each part of it so determined the taxation treatment
proper thereto. Thus, the part of the payments representing the use of the software will be treated as royalties and taxable as such and
the other part of the payments representing the provision of services will be treated as income from services and taxable as such.

If, however, one part of what is being provided constitutes by far the principal purpose of the contract and the other parts stipulated
therein are only of an ancillary and largely unimportant character, then the treatment applicable to the principal part should generally be
applied to the whole amount of the consideration. (De minimis)
d. "Site License" / "Enterprise License" / "Network License Arrangements". — These 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 licensee's computers or network, and reproduction for any other purpose is not
permitted under the license. Payments under such arrangements will generally be dealt with as business income.

e. Supply of information. — Another type of transaction involving the transfer of computer software is the more unusual case 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 or techniques. In these cases, the payments may be 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.

f. Transfer of Ownership. — Where consideration is paid for the transfer of full or partial ownership of the rights in the copyright, the
payments made therefore are, in general, not royalties but business income or capital gains.

SECTION 6. Computer Hardware Bundled With Software. — The tax treatment of payments involving the sale of computer hardware
bundled with software, where the software is bundled in the Philippines, are covered by this Circular. On the other hand, computer
hardware bundled with software, where the software is bundled abroad will be dealt with in another revenue issuance.

SECTION 7. Modes of Acquiring Software And the Relevant Tax Treatment Thereof.

A. Acquisition of ownership over a copyright

1. From a local owner of a copyright. — Payments made to a copyright owner for a full or partial transfer of a copyright shall be
subject to Philippine income tax as follows:
a. Transfer by a resident individual owner of copyright — A resident individual owner of a copyright is subject to the graduated
income tax rates (5% - 32%) under Section 24 of the National Internal Revenue Code of 1997 (NIRC). The amount paid in
consideration of the copyright or portions thereof transferred shall form part of the copyright owner's gross income (Section 32,
NIRC), from which his taxable income 1 shall be computed.
b. Transfer by a domestic corporation owner — The amount paid in consideration of the copyright or portions thereof transferred
shall form part of the copyright owner's gross income (Section 32, NIRC), from which his taxable income, subject to 32%
income tax under Section 27 of the NIRC, shall be computed.
2. From a foreign licensor. — Payments made to a copyright owner for a full or partial transfer of a copyright shall be subject to
Philippine income tax as follows:
a. Transfer by a nonresident alien individual — A nonresident alien individual engaged in trade or business in the Philippines
shall be taxed in the same manner as a resident individual owner of a copyright.
b. Transfer by a foreign corporation — The amount paid in consideration of the copyright or portions thereof transferred by a
resident foreign corporation engaged in trade or business within the Philippines shall form part of the copyright owner's gross
income (Section 32, NIRC), from which his taxable income, subject to 32% income tax under Section 28 of the NIRC, shall be
computed.
The amount paid in consideration of the copyright or portions thereof transferred by a nonresident foreign corporation shall be
subject to a final tax of 32%, based on the gross income (Section 28, NIRC).
However, if the foreign owner of the copyright is a resident of a country which has an existing tax treaty with the Philippines,
royalties paid to such owner are subject to the reduced tax rates on royalties under the relevant tax treaty, provided the conditions
prescribed therein are complied with by the owner.

B. Acquisition of copyright rights

1. By a Local Subsidiary/Reseller/Distributor/Retailer —
a. From a local licensor or reseller/distributor licensee
Payments made by a local subsidiary/reseller/distributor/retailer to a domestic corporation owner of a copyright or a
reseller/distributor licensee of a copyright shall be subject to a final income tax of 20%, based on the gross amount of royalties under
Section 27(D) of the NIRC, to be withheld by the local subsidiary/reseller/distributor/retailer making the payments.

b. From a nonresident foreign licensor


Payments made by the local subsidiaries/resellers/distributors/retailers to a nonresident foreign licensor/owner of the software
are royalties subject to 32 percent final income tax, based on the gross amount thereof (Section 28[B][1], NIRC), the full amount of
which shall be withheld and collected by the subsidiary/reseller/distributor/retailer making the payments (Section 2.57-1[I][1], RR 2-98).
However, if the foreign licensor/owner is a resident of a country which has an existing tax treaty with the Philippines, royalties
paid to such licensor/owner are subject to the reduced tax rates on royalties under the relevant tax treaty, provided the conditions
prescribed therein are complied with by the licensor/owner.

2. By an End-user —
a. From local subsidiaries, resellers, distributors of resellers —
Payments made by the end-user to the local subsidiaries, resellers, distributors of resellers for the purchase of copyrighted
articles are business income subject to 32 percent income tax, based on the net taxable income of a domestic corporation (Section
27[A]), National Internal Revenue Code of 1997 [NIRC]). When making payments to the local subsidiaries, resellers, distributors of
resellers, the end-user shall withhold 2 percent income tax of the gross amount of the payments creditable against the taxable income
of the local subsidiaries, reseller or distributors (Section 2.57.2[E][4][m], Revenue Regulations [RR] 2-98, as amended by Section 2 of
RR 14-02), provided the end-user is any of the following persons (under Section 2.57.3. of RR 2-98, as amended by Section 3 of RR
14-02) required to withhold such tax:
(a) A juridical person, whether or not engaged in trade or business;
(b) An individual, with respect to payments made in connection with his trade or business; or
(c) A government office including a government-owned or controlled corporation, a provincial, city, or municipal government. EacHCD

b. Directly from the foreign owner and/or licensor of the software. —


A local end-user may acquire license to use software directly from the foreign licensor/owner of the software. Payments made
by the end-user to the licensor/owner are royalties subject to 32 percent income tax, based on the gross amount thereof, imposed on
royalties derived by a nonresident foreign corporation (Section 28[B][1], NIRC), which amount shall be withheld and collected by the
end-user making the payments (Section 2.57-1[I][1], RR 2-98).
However, if the foreign licensor/owner is a resident of a country which has an existing tax treaty with the Philippines, royalties
paid thereto are subject to the reduced tax rates on royalties under the relevant tax treaty, provided the condition prescribed therein are
complied with by the licensor/owner.

* SECTION 7. Value-Added Tax. —


A. The following payments for software transactions shall be subject to the 10% value-added tax (VAT) pursuant to Sections 106 and
108 of the NIRC:
1. Royalty payments for the use of a copyright over a software;
2. Payments made to resellers/distributors/retailers who are engaged in the trade or business of distributing or selling software; and
3. Payments for services rendered in the Philippine in connection with software purchased.
B. Withholding of the VAT for nonresident payees
The payor in control of the payment of VAT in the software transactions enumerated under (A) above shall be responsible for the
withholding of VAT on such fees on behalf of the nonresident payee, by filing a separate VAT return for and on behalf of such payee
using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR
Form No. 1600 and proof of payment thereof shall serve as sufficient basis for the claim of input tax to be applied against the output tax
that may be due from the payor. In addition, the payor is required to issue the Certificate of Creditable Tax Withheld at Source (BIR
Form No. 2307) in quadruplicate upon the request of the nonresident payee, the first three copies thereof to be given to the payee and
the fourth copy to be retained by the payor as its file copy.

SECTION 8. Repealing Clause. — All existing revenue issuances, including Revenue Memorandum Circular No. 77-2003, or parts
thereof which are inconsistent with the provisions of this Circular are hereby revoked or amended accordingly.

SECTION 9. Effectivity. — This Circular shall take effect immediately and shall cover software payments paid or payable starting said
effectivity date.

(SGD.) JOSE MARIO C. BUÑAG


OIC-Commissioner of Internal Revenue

Footnotes
1. Section 31, NIRC provides "The term 'taxable income' means the pertinent items of gross income specified in this Code, less
deduction and/or personal and additional exemption, if any, authorized for such types of income by this Code or other special
laws.

Common questions

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Royalty payments in software transactions arise when the payment is made for the use of or the right to use a copyrighted software. Specifically, these can include rights to make copies, prepare derivative works, display or perform the software publicly. Such payments are considered royalties and are taxed as income. If a transaction transfers all substantial rights to a copyright, it is not a royalty, but business income. Conversely, if the transaction mainly involves transferring a copy without any substantial copyright rights, it is classified as business income and not royalties. The distinction impacts tax obligations, such as subjecting royalty payments to withholding taxes and differing income tax rates depending on whether the entity is a resident or non-resident, and potentially applicable tax treaties .

Value-Added Tax (VAT) applies to software transactions such as royalty payments, software sold by businesses, and services related to software within the Philippines, at a rate of 10%. For non-resident transactions, the payor must withhold and remit the VAT on behalf of the non-resident entity using the appropriate BIR form. This ensures compliance with tax regulations and allows the payor to claim input tax credits against the output tax due .

Software license payments are considered business income rather than royalties when the transaction involves the transfer of a copyrighted article instead of the rights to the intellectual property. If the acquirer only receives a copy without substantial copyright rights—such as the rights to reproduce, distribute, or create derivative works—the payment is considered business income. This is further classified as a sale or lease, depending on if the benefits and burdens of property ownership have been fully transferred. Furthermore, licenses allowing limited reproduction within a business, such as site licenses, are typically treated as business income since they do not generally transfer substantial copyright rights .

Tax treaties can significantly impact the taxation of royalties by providing reduced tax rates on royalties paid to residents of a treaty partner country. If a foreign licensor or copyright owner is from a country with an existing tax treaty with the Philippines, the royalties paid to them may be subject to lower tax rates than the standard rates prescribed by the National Internal Revenue Code (NIRC). This concessional treatment intends to avert double taxation and encourage cross-border transactions, provided the foreign payee complies with the treaty's conditions .

The tax treatment of software transactions involving after-sales services depends on the principal purpose of the contract and the value of each component. The payment for software use is treated as royalties, while after-sales services such as installation or customization are considered service income. The payment must be reasonably apportioned between the components. If the services are incidental compared to the software usage, the entire transaction might be taxed based on the dominant element. This apportionment helps categorize the income appropriately for tax purposes .

The tax treatment of software bundled with computer hardware varies based on where the bundling occurs. When bundled locally, the tax implications are governed by local circular guidelines, treating the transaction according to whether the software or hardware comprises the principal part of the transaction. If the primary purpose is selling hardware with incidental software, the sale is generally subjected to business income tax. When the bundling occurs abroad, it is addressed by separate revenue issuances, which could involve additional considerations, such as import duties or different tax implications aligned with international transactions .

"Site licenses" allow a business to make multiple copies of a software program limited to its internal network or computers, facilitating operation within the business rather than distribution or public performance. Payments for site licenses are generally treated as business income rather than royalties because they do not transfer substantial copyrights. The taxation focuses on the transactional nature, aligning with business income tax criteria, rather than royalty frameworks, due to the limited rights granted by these licenses .

A transfer of software is considered a transfer of copyright rights if it grants the transferee one or more substantial copyright rights. These include the right to reproduce, distribute, or publicize the software, or to prepare derivative works. The determination of whether it’s a full transfer relies on whether all substantial rights have been transferred—if not, it is treated as a licensure which generates royalty income rather than as a sale or exchange of property .

When an end-user acquires software licenses directly from foreign licensors, the payment is treated as a royalty subject to a 32% income tax on the gross amount unless a lower rate is specified under a tax treaty. In contrast, payments to local distributors are considered business income and are subject to a 32% tax based on the distributor's net taxable income. Additionally, the end-user is responsible for withholding a 2% income tax on gross payments to local distributors, offset against the distributor's taxable income, whereas payments to foreign licensors require withholding the full royalty tax amount .

Mixed contracts, which include both the use of software and services like installation or maintenance, are taxed by dividing the payment according to each component's value. For example, payments for the software use are treated as royalties, while payments for services are considered as service income. Each part of the payment is then taxed accordingly. If the contract has a principal element and ancillary parts, the entire payment may be taxed based on the principal element. This means if after-sales services are minor compared to software use, the entire payment might be treated as royalties .

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