Royalties or business profit: double taxation of software licence fees

20 December 2010

Krzysztof Tusiński, Luisa Żukowski

The problem of international double taxation arose as a result of different methods of taxation used in different countries. Bilateral and multilateral agreements on the avoidance of double taxation have been put into place in an attempt to resolve this problem and model conventions were implemented to standardise such agreements. The OECD Model convention is the most commonly used and various countries have signed conventions on the avoidance of double taxation based on the format provided by the OECD.

One of the more controversial issues connected with international double taxation is the classification of software licence fees. It is not clear whether software licence fees qualify as a royalty or as business profit. If software licence fees qualify as royalties, in accordance with the OECD Model convention the withholding tax rate is 5% (until 30 June 2013), whereas if they qualify as business profit, withholding tax is not applicable.

According to the OECD Model convention the term “royalties” 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, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. The question is whether a computer program qualifies as a literary, artistic or scientific work for the purpose of considering copyright or whether it is to be regarded as some other form of copyright.

In most of the cases the Polish tax authorities agree that computer programs do fall within the definition of a literary, artistic or scientific work. In the official interpretation issued on 3 September 2008, the Warsaw Tax Chamber stated that the fact that a computer program is a work which can be the subject of copyright is sufficient for it to be included in the part of the definition that states “any copyright of literary, artistic or scientific work” and to qualify relevant payments as royalties rather than business profit. This position has been adopted in many other decisions given by the Polish tax authorities.

The taxpayer does have recourse from the decision of tax authorities to the administrative court. However, the administrative courts have adopted a different approach to this problem. In a judgment handed down on 19 June 2009, the Supreme Administrative Court stated that there is no direct reference to computer programs in the double taxation convention between Poland and Germany, contrary to the view that a computer program falls within the scope of  “literary, artistic and scientific works” as supported by tax authorities.

According to the double taxation convention between Poland and Germany, any term that is not defined therein should have the meaning that it has at that time under the laws of that State for the purposes of the taxes to which this Convention applies. The Polish Copyright Act indicates that, although computer programs are primarily protected as literary works, they are not literary works and are a separate subject of copyright protection and, therefore, special provisions apply. As there is no presumption for taxation, software licence fees should not be treated as royalties. The court also stated that “software licence fees” are expressly included within the definition of “royalties” in other Polish double taxation conventions, for example, with Kazakhstan and Portugal. Therefore, if the signatories to the convention intended to include “software licence fees” in the definition of “royalties”, they would have expressly done so.

The administrative courts in Poland have adopted this position in several other judgments. The Regional Administrative Court in Gliwice recently ruled that a bank which had paid licence fees to a contractor located in the UK for a computer program had no obligation to pay withholding tax. In its decision, the court agreed in large part with the position adopted by the Supreme Administrative Court.

Currently the discrepancy between the position of the tax authorities and position of the administrative courts, as described above, remains. In each case, the taxpayer may be required by the tax authorities to pay withholding tax, with the option of issuing a complaint to the administrative court in the case of any disagreement.