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 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;
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 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. 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
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 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
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 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:
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 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). 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 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,
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 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. —
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
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 licensor/owner.

SECTION 7. n 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.

n Note from the Publisher: Copied verbatim from the official document.

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