When is payment for software a royalty?

Think back to when you last purchased a software package, was the transaction categorised as a "sale" or a "licence"? Typically, in order to restrict on‐sale, distributors prefer to categorise the transaction as a "licence".

However, the two types of transactions trigger different tax consequences: Assuming a foreign "seller/licensor", a sale would trigger customs on importation; whereas a licence would trigger withholdings tax on royalty payments.

According to the OECD guidelines (discussion on article 12): Where software is purchased for use by the purchaser, the transaction is regarded as a sale (and any payment is consequently categorised as Business Profits in terms of the double taxation agreement (DTA)); whereas, where software is purchased for reproduction and either on‐sale or on‐licence, the transaction is regarded as a licence (and any payment is consequently categorised as a Royalty in terms of the DTA). Only where payments are categorised as royalties is withholdings tax levied.

Furthermore, where the transaction is categorised as a sale, the purchaser may claim allowances in respect of s11(e) of our Income Tax Act over a period generally less than 5 years. Whereas, if the payment is categorised as a licence, allowances in respect of the upfront royalty payment may arguably only be claimed in terms of s11(f), which poses its own serious problems.

(Updated 2007)

Articles: Taxation