Taxation of Intellectual Property: Should You Pay Taxes for Acquired Software?

Kenya’s legal space has recently witnessed a series of litigations centred upon the tax implications of acquired software. On the face of it, the issue does not seem complicated. If software is intellectual property, as indeed it is, then the usual tax implications attracted by intellectual property will obtain. Specifically, this will occur in much the same way as it would for other copyrighted works.

Historically, the question that has been addressed by the courts is whether payments for acquisition of software should attract taxes. A simple answer has been given – computer software payments are taxable as royalties, since software is copyrightable, and copyright is intellectual property. As intuitive as this may sound, the position is not as straightforward when it comes to acquisition of computer software.

Difficulties arise from the fact that the understanding of the legal implications of software-related sales lack common ground, compared to, for instance, sales of physical books. This is most pronounced for software embedded in a medium. The anatomy and nature of computer software forces a reconsideration, or at least a more nuanced analysis, of the components of a software transaction, and specifically, the nature of interest in question. A corollary of this is that therefore, a diverse range of transactions – all involving different and separate interests – are possible.

The efficacy of a taxation regime requires, of necessity, clarity as to what subject matter is subject to the tax treatment, be it a sale, licence, gift, and so on. Payments made with respect to acquisition of intellectual property will usually attract tax obligations, with such payments having generally been considered to be “royalties” for that purpose, in Kenyan jurisprudence.

The diversity of transactions possible with respect to a single copyrighted work, anticipate the possibility of varied subject matter. Specifically for tax purposes, this possibility, by definition, diminishes any immediate certainty of the subject matter involved. The crisis, accordingly, is that such certainty is a prerequisite for the employment of tax rules to a transaction. Therefore, if it is possible for various kinds of market transactions, all with different tax implications, to inhere with respect to a single work of software, then a more nuanced view has to be considered.

Kenyan jurisprudence has appeared to accept a broad characterisation of software-related transactions as attracting royalty payments. Recognising the obvious conceptual error in this view, other jurisdictions such as India have drawn a clearer line between “copyright” itself and “copyright-embodying” articles, which include compact discs, hard discs, and so on. These two categories, for instance, generate fundamentally opposing tax obligations once they become the subject matter of a market transaction. Several legal tools can be employed to introduce further clarity to this view and the challenges it portends.

The relevant conceptual tools, discernible from the wide array of legal authorities in India, America, and, to some extent, European jurisprudence, are personal property theory,[1] the first sale doctrine,[2] and shrinkwrap licenses.[3] The former two concepts have been shown to support the copyright and copyright article dichotomy, while the latter concept seems to stand at odds with such a dichotomy. On this front, the contest between the contrasting views is very close.

It is also critical to explore the owner-licensee conundrum in software licenses, and question, whether common law doctrines can be used to mount a substantive case for whichever preference (designation as owner or licensee), is adopted by local courts. Ultimately, therefore, this becomes a matter to be shaped by a country’s specific tax and IP policy objectives. If the goal is to increase the tax incidence obtaining for dealers in software, then the view most consistent with this approach is that against the characterisation of licensees as owners, and that which simultaneously recognises shrink wrap licenses as valid and enforceable.

Consequently, what is clear is that the present common law tools available, especially the law of sales, though applicable, exhibits a tenuous relationship with the challenging nature of software as IP. The key lesson here is that a more responsive regime has to be forged in Kenya, that transcends old sales models and incorporates the novelty engendered by computer software law. This will include responding to the limits of the first sale doctrine as well as adopting a stable position on shrink wrap licenses.

[1] Personal property law recognises movables (choses in possession) and intangibles (choses in action) as a category of property separate from real property.
[2] This doctrine is generally to the effect that the rightful owner of a copy of copyrighted material is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy, usually by sale.
[3] These are software licences that purport to bind the purchaser of computer software merely by the purchaser’s act of opening the package.