The High Court has given its decision in Income Tax Appeal No 8 of 2017: Seven Seas Technologies Limited v. Commissioner of Domestic Taxes, upholding the taxpayer’s position that there is a distinction between payments made to purchase copyrighted material (such as copyrighted software) and payments made to acquire the right to use copyright in a material (such as a payment that results in a taxpayer obtaining rights to the source code in the software). Only the latter payments fall within the ambit of a "royalty" and are subject to Withholding Tax (WHT). 

The High Court has determined that, in order for a software-related payment to amount to a royalty that is subject to WHT, the payer must have acquired any or all of the rights that enable them to commercially exploit the software as envisaged under section 26 of the Copyright Act. These rights include the exclusive right to reproduce the software in any material form and the exclusive right to translate or adapt the software. 

In arriving at its decision, the High Court relied on the decision of the Supreme Court of India in Engineering Analysis Centre of Excellence Private Ltd v. Commissioner of Income Tax Civil Appeals No. 8733-8734 and established the following principles:

• an agreement between parties should shed light on the legal question as to the nature of rights conferred to a person making payments with respect to software;
• payment of a licence fee with respect to software does not automatically equate to a royalty unless copyright in the underlying software is transmittable by way of licence. If a licence only allows the payer to access the software, the licence fee paid is merely for the access of a copyrighted software; and
• a distributor dealing in software cannot be said to be commercially exploiting the software since, as a distributor, one purchases and resells the software without being granted tampering or modification rights, which vest in the copyright holder.

The High Court also considered and adopted international best practice by applying the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital. This states that software distributors only make payment to acquire copies of copyrighted software and do not exploit any copyright in the software. 

The High Court concluded that the taxpayer, who was a software distributor, was only a vendor of copyrighted material (the software) and it did not acquire the right to use the copyright in the said software. As a result, no WHT was payable by the taxpayer on payments it made to purchase the software.

What does this decision mean for taxpayers?

The decision by the High Court has clarified the interplay between the Income Tax Act and the Copyright Act, 2001. Not all software-related payments are subject to WHT. 

The decision stresses the need for parties concluding software agreements to ensure that the agreements clearly and expressly articulate the nature of rights conferred with respect to the software. Any limitations and exclusions should be expressly set out. The software agreements will be the first point of call in the event a dispute arises as to whether payments made under the agreement amount to a royalty for WHT purposes.  

The Kenya Revenue Authority has the right to appeal the decision to the court of appeal but, unless and until this decision is set aside, it is binding on any ongoing disputes before the Tax Appeals Tribunal. This should come as a relief to taxpayers with ongoing disputes.

For more information on this decision or any other tax matters, kindly get in touch with the key contacts.