ABC, a domestic corporation, entered into a software license agreement with XYZ, a non-resident foreign corporation based in the U.S. Under the agreement which the parties forged in the U.S., XYZ granted ABC the right to use a computer system program and to avail of technical know-how relative to such program. In consideration for such rights, ABC agreed to pay 5% of the revenues it receives from customers who will use and apply the program in the Philippines.
Discuss the tax implication of the transaction. (5%)
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Payments made by ABC to XYZ constitute royalties from Philippine sources subject to final withholding tax. Under Sec. 42(A)(4), NIRC, royalties derived from the use of intangibles and technical know-how in the Philippines are
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Quick check
What determines the situs of royalty income for tax purposes under Section 42(A)(4) of the Tax Code?
Royalty income is deemed sourced within the Philippines if the intangible property or software is used or exercised domestically.
How is gross income derived by a non-resident foreign corporation from Philippine sources taxed under Section 28(B)(1)?
Non-resident foreign corporations are taxed on gross income from Philippine sources through final withholding tax at source.
What role does a domestic corporation play when remitting software license royalties to a U.S.-based non-resident foreign corporation?
The domestic payor acts as a withholding agent responsible for deducting and remitting the final withholding tax on foreign royalties.
Under Section 42(A)(4) of the Tax Code, which of the following constitutes Philippine-sourced royalty income?
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How may the final withholding tax rate on software royalties paid to a U.S. non-resident corporation be reduced?
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Learn more about these topics
1. Software Royalty Taxation
Under Section 42(A)(4) of the National Internal Revenue Code, royalties derived from the use of or the privilege of using in the Philippines any copyright, patent, trademark, secret process, or computer program constitute income from sources within the Philippines. The situs of royalty income is determined by the place where the intangible property or technical know-how is used or exercised.
2. Non-Resident Foreign Corporation
Non-resident foreign corporations are subject to Philippine income tax under Section 28(B)(1) of the Tax Code only on gross income derived from sources within the Philippines. When a domestic entity remits payments to a non-resident foreign corporation for software licensing rights exercised domestically, such gross income is subject to final withholding tax.
3. Final Withholding Obligation
Under the tax withholding rules, the domestic corporation making royalty payments to a non-resident foreign corporation acts as the withholding agent for the Bureau of Internal Revenue. The withholding agent must deduct and withhold the applicable final withholding tax at source before remitting the net proceeds abroad, subject to applicable tax treaty relief provisions.