TAX OPINION

SALE OF SOFTWARE CLASSIFIED AS TRANSFER OF COPYRIGHTED

ARTICLES BY A NONRESIDENT FOREIGN CORPORATION TO A
DOMESTIC CORPORATION

Under Revenue Memorandum Circular 44-05, transactions involving software

may include the following:

1. Transfer of copyright right

2. Transfer of copyrighted articles
3. After sales service
4. Site License/Enterprise License/Network License Agreement
5. Supply of information
6. Transfer of ownership

TRANSFER OF COPYRIGHT RIGHT

A transfer of software is classified as transfer of a copyright right if, as a

result of the transaction, a person acquires any one or more of the rights
described below:

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; or
E. Any other rights of the copyright owner, the exercise of which by another
without his authority shall constitute infringement of said copyright.

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.

TRANSFER OF COPYRIGHTED ARTICLES

A copyrighted article incorporating a software includes a copy of the 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 as business income
or business profits.

TAX CONSEQUENCES OF THE SALE OF SOFTWARE INVOLVING

TRANSFER OF COPYRIGHTED ARTICLES BY A NONRESIDENT
FOREIGN CORPORATION TO A DOMESTIC CORPORATION

INCOME TAX

This transaction involved the grant of a non-exclusive, non-transferable license

or right to use the software in specified locations using specified computers or
computer networks and only for the internal processing and computing needs of
the grantee. The grantee is prohibited from sharing the use of the software for a
fee or providing computer services to third parties using the software. The
grantee is not allowed to sublicense, transfer or assign its rights. There is no
transfer of ownership of the copyrights. Ownership remains with the licensor.
As mentioned earlier, the transfer of the copy of the software is classified solely
as a transfer of a copyrighted article and payments for which constitute as
business income or business profits

Section 7A2b of RMC 44 – 2005 is supplied below:

b. Transfer by a foreign corporation – The amount paid in consideration

of the copyright or portions thereof transferred by a resident foreign corporation
engage in trade or busines within the Philippines shall form part of the
copyright owner gross income (Sec 32, NIRC) from which his taxable income,
subject to 32% (now 30%) income tax under section 28 of the NIRC, shall be
computed.

The amount paid in consideration of the copyright or portions thereof

transferrred by a nonresident foreign corporation shall be subject to a final tax
of 32% (now 30%), based on the gross income (Section 28 NIRC). However, if
the foreign owner of the copyright is resident of a country which has an existing
tax treaty with the Philippines, royalties paid to such owner are subject to the
reduced tax rate on royalties under the relevant tax treaty, provided the
conditions prescribed therein are complied with by the owner.
 VALUE ADDED TAX

Section 8A of RMC 44 – 2005 is copied below:

A. The following payments for software transactions shall be subject to the

10% (now 12%) value added tax pursuant to Sections 106 and 108 of the
NIRC:

1. Royalty payments for the use of 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 Philippines in connection with
software purchased.

OPINION

Based on the foregoing, payments for software, acquisition of which is

characterized as transfer of copyrighted articles, constitute business profits
hence subject to income tax.

If the copyright owner is a nonresident foreign corporation, such business

profits are subject to a final tax of 30% based on the gross income. However,
said nonresident copyright owner may invoke the relevant provisions of a tax
treaty of his country of residence with the Philippines either to reduce or to
eliminate tax. This scheme for tax exemption can find support in Section 32B5
of NIRC, to wit;

(5) Income exempt under treaty – Income of any kind to the extent
required by any treaty obligation binding upon the government of the
Philippines.

In the case of E2E Technologies Ltd., the relevant provisions of the Philippine –
Switzerland tax treaty on business profits can be found in Article 7 thereof, as
follows:

“The profits of an enterprise of a Contracting State shall be taxable only in

that state unless the enterprise carries on business in the Other Contracting State
through a permanent establishment situated therein. If the enterprise carries on
business as aforesaid, the profits of the enterprise may be taxed in the Other
State but only so much of them as is attributable to that permanent
establishment”.
Permanent establishment is defined in Article 5 of the aforementioned tax treaty.

Simply put, the business profits of a Swiss Company shall be taxed only in the
Switzerland unless such Swiss company carries on business in the Philippines
through a permanent establishment, in which case the profits of that Swiss
company may be taxed in the Philippines.

In relation thereto, payments made to E2E Technologies Ltd., which does not
have permanent establishment in the Philippines, shall be exempt from the 30%
final withholding tax. This tax exemption have been confirmed by the BIR in its
several tax rulings. With respect to VAT, the same business profits are subject to
value added tax of 12% as VAT follows destination principle wherein VAT are
imposed in the place where the goods are consumed or where the services are
rendered.

However, under RMO No. 1- 2000 (superseeded by RMO 72-2010), the BIR
requires a tax treaty relief application (TTRA) before a nonresident can apply
the preferential treatment per tax treaty. Nevertheless, this requirement has been
negated by the Supreme Court in the case of Deutsch Bank vs. Commissioner of
Internal Revenue (GR No. 188550, January 29, 2013). In that case, the Supreme
Court decreed that the period of application for the availment of tax treaty relief
as required by RMO No. 1-2000 should not operate to divest entitlement to the
relief as it would constitute a violation of the duty required by good faith in
complying with a tax treaty. The denial of the availment of tax relief for the
failure of a taxpayer to apply within the prescribed period under the
administrative issuance would impair the value of the tax treaty. At most, the
application for a tax treaty relief from the BIR should merely operate to
confirm the entitlement of the taxpayer to the relief.