Which Software Payments attract withholding Payments?

The High Court in Income Tax Appeal No 8 of 2017:?Seven Seas Technologies Limited(the Appellant) v. Commissioner of Domestic Taxes(the Respondent), made a distinction between payments made to purchase copyrighted) and payments made to acquire the right to use copyright in a material. The distinction is crucial as it has implications for subjecting the payments to withholding tax payments.

In this article we discuss the background of the case, the arguments advanced and the Court’s determination of the issues.

Background

Seven Seas Technologies is a leading provider of integrated business and technologies. The appellant purchased software from Callidus Software, a United States based company, for internal use and for distribution to local customers.

After conducting an audit, the Respondent found that Seven Seas Technologies had not been paying withholding taxes on payments in respect of the software license agreement with Callidus. The payments related to payments for software purchased for resale to third party customers,

An assessment was issued by the respondent who found that these payments were royalties. A Royalty is defined as a “consideration for the use and right to use copyright in the literary work of another person” as defined in ?section 2 of the Income Tax Act and ?thus subject to withholding tax under Section 35 (1)(b) of the Income Tax Act.

Seven Seas Technologies contested the assessment before the Tax Appeals Tribunal where, in a judgement issued 8 December 2016, the tribunal held that Seven Seas Technologies had acquired rights to copyright in software that is commercially exploited and that the company on that basis should have paid withholding tax.

Unsatisfied with the decision of the tribunal Seven Seas Technologies Ltd appealed to the High Court.

The Appellant’s Position

The appellant argues that a payment may only be deemed a royalty where it results in the transfer of copyrights which grants rights as set out in Section 26 (1) of Copyright Act 2001. ?The appellant goes on to argue that when determining whether a payment is a royalty, one must consider the distinction between the subject of the “copyright” and “copyrighted material”. The Appellant purchased copyrighted material and not the use of or right to use the underlying copyright.

The appellant also relied on expert evidence to clarify the distinction between a mere sale, an assignment that refers to a transfer of ownership rights and a license that refers to a transfer of limited rights of the owner.?According to the Appellant, a payment can only constitute a royalty if it confers upon the purchaser rights in the underlying software inclusive of rights. The Appellant submitted that it’s agreements to purchase software from Callidus do not confer any intellectual property rights to the copyrighted software. Therefore, the payments do not amount to royalties.

The Respondent’s Position

The respondent was of the view that the appellant had purchased the copyrighted material for its own use and for resale and as such, exploited the rights to use the software, hence meeting the definition of royalty according to section 2 of the Income Tax Act. In addition, third party customers who purchased the software acquired the right to use the software when they purchased it from the Appellant. Accordingly, payments arising therefrom were also royalties and subject to WHT.

The Determination of the Court

The High Court has determined that, in order for a software-related payment to amount to a royalty that is subject to WHT, the payer must have acquired any or all of the rights that enable them to commercially exploit the software as envisaged under section 26 of the Copyright Act. These rights include the exclusive right to reproduce the software in any material form and the exclusive right to translate or adapt the software.

The Court therefore held that the appellant was not liable to pay withholding tax since the payment was not royalty.

Conclusion

The decision was a win for taxpayers as it provided much needed clarity on how to deal with the taxation of payments for transactions involving intellectual property rights. It also emphasizes the need for software agreements to always clearly define the rights conferred to the parties involved.