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Kenyan High Court Holds Software Payments by Distributor Not Taxable Royalties Without Rights to Commercially Exploit the Software — Orbitax Tax News & Alerts

Kenya's High Court recently issued a judgment regarding the treatment of payments for copyrighted software as taxable royalties. The case involved Seven Seas Technologies Limited, which is a Kenyan company engaged in the distribution of software. In assessing Seven Seas, the Kenya Revenue Authority (KRA) determined that the payments made by the company for the purchase of software constituted taxable royalty payments subject to withholding tax.

The High Court, however, determined that not all software payments may be considered taxable royalty payments. In particular, a software payment can only be considered a taxable royalty payment if the agreement for the payment grants the payer any or all of the rights to commercially exploit the software, including the exclusive right to reproduce the software in any material form and the exclusive right to translate or adapt the software. In the case at hand, Seven Seas was only a vendor of the copyrighted software and did not acquire the right to exploit the copyright in the software. Rather, as a distributor, Seven Seas only purchased and resold the software without being granted tampering or modification rights. As such, the software payments were not royalties subject to withholding tax.

The High Court based its judgment on a judgment of the Indian Supreme Court that was issued in March 2021, which covered several cases involving the treatment of software payments as royalty payments. As previously reported, the Supreme Court determined that payments made by either an Indian resident distributor/reseller or an Indian resident end-user to a non-resident for the use of software do not constitute a royalty and do not fall under the Royalty article in India's tax treaties. The payments must be characterized as plain sales proceeds and, therefore, not subject to withholding tax.

The High Court also relied on the commentary to OECD Model Tax Convention (MTC) for Article 12 (Royalties). This provides that in transactions where a distributor makes payments to acquire and distribute software copies (without the right to reproduce the software), the rights in relation to these acts of distribution should be disregarded in analyzing the character of the transaction for tax purposes. Such transactions would be dealt with as business profits (under MTC Article 7) and not as royalty payments (under MTC Article 12).