September 1, 2005

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

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 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;

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 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. cCTIaS

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
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 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.
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 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

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 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). ISHaTA

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

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 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.

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

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 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.

*(1) 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.

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 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
Bureau 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.

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 Endnotes

1 (Popup - Popup)

* Note from the Publisher: Copied verbatim from the official copy. Duplication of
Section 7.

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