Review of the court practice in cases related to qualification of payments for the right to use the software as royalty
For the long period of time the topic on differentiation of payments for rendered services and royalty has been the matter of topical interest for any tax payer. Such issue quite often arises in the area of software (computer programs) distribution among the end users.
Both the Law of Ukraine “On Enterprises Profit Taxation”, which defines the term “royalty”, and the Tax Code of Ukraine indicate that the royalty is the payment for the right to use the copyright on computer programs. The list of copyrights is defined by Article 441 of the Civil Code of Ukraine and Article 15 of the Law of Ukraine “On Copyright and Allied Rights” and includes:
1) publication (issue);
2) reproducing in any way and by any means;
4) alteration, adaptation, arrangement and any other similar changes;
5) including into compilation, database, anthology, encyclopedia, etc. as a consisting part;
6) public performance;
7) sale, leasing, etc.;
8) import of the copies of work, copies of its translations, alterations, etc.;
9) other actions envisaged by the law.
This list does not contain actions which can be described as usage of the copy of the work (including computer program/software) according to its functional purpose. Irrespective of the fact that the end user indeed obtains some limited copyrights, such rights are given exclusively to provide the possibility to use this software, what is directly allowed by the Article 24 of the Law “On Copyright and Allied Rights”.
Hence, if the tax payer receives software exclusively for withdrawal of its useful properties as the end user, the payments for this shall not be considered as royalty.
During the period of existing of the term “royalty” in the tax legislation the tax authorities have been taking different approaches as for this issue. The recent explanations of the Ministry of Revenues and Duties of Ukraine and the State Fiscal Service of Ukraine may hardly be called clear.
Even some of well-known companies began to use the royalty scheme for distribution of their services related to software (database) usage. In agreement it is indicated that the payment is royalty, but it is not specified what copyrights are given to the end user.
For today the practice of the Higher Administrative Court of Ukraine in such category of cases is already available. For example, in the administrative case No. 0670/6316/11the courts considered the issue on qualification of payments related to receiving of computer system for usage. The tax authorities insisted that such payments should be considered as royalty as far as transfer or other ways of alienation of received computer system were forbidden by conditions of the agreement. However, in Decision as of November 7, 2012 (case No. К/9991/44625/12) the Higher Administrative Court of Ukraine explained that such position of tax authorities was false as far as the payer did not obtain the copyright or rights to use the copyright.
In the abovementioned Decision the Higher Administrative Court of Ukraine illustrated that a clear distinction shall be made between the receiving of the software and receiving of copyright on the software. It should be noted that the Higher Administrative Court of Ukraine still follows this approach.
In particular, on May and September of 2014 the stated court delivered two decisions in cases of such category:
1) Decision of May 26, 2014 in case No. 2а-6704/10/11/0170, and
2) Decision of September 30, 2014 in case No. 2а-0870/178/11.
According to factual circumstances of both cases one enterprise transferred the right to use the software/computer program to the other enterprise on the basis of license agreement. The Higher Administrative Court of Ukraine defined the following:
“It is perceived from the case materials that according to the provisions of the agreement the object of the copyright, but not the right to use the copyright on this object, has been transferred to the plaintiff. The selling of the copy of the software does not cause the alienation(transfer) of property rights on the software as a work – an object of the copyright…Considering the abovementioned, the conclusion of the defendant, where he identifies the payment made by the plaintiff with the “royalty” …is improper”.
Consequently, the approach of the Higher Administrative Court of Ukraine is permanent – if the copyright is not transferred, the payments for using software shall be the payments for services, and respective transactions shall subject to VAT. Qualification of such payments as royalty is not lawful.
The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.