Italy: Can fees for the distribution of software to non-residents be qualified as royalties?

published on 27 October 2023 | reading time approx. 3 minutes

In its Circular No. 27 of 12 October 2023, Assonime examined the issues related to the conventional qualification of fees paid to non-residents for the granting of the right to use, reproduce and distribute software as royalties.

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From a tax point of view, the qualification as royalties of a remuneration paid to a non-resident entity is relevant in order to set whether or not an outbound withholding tax has to be paid pursuant to the combined provisions of Article 23, paragraph 3, letter c) of the TUIR and Article 25, paragraph 4 of Presidential Decree No. 600/73.

In fact, under Italian law, if the remunerations are qualified as royalties, they are subject to withholding tax (the rate of this tax depends on the provisions of the Double Taxation Conventions signed by Italy); otherwise, if the remunerations are classified as business profits, they are exempt from taxation in Italy and are taxed only in the country of residence of the foreign recipient.

The analysis set forth in Assonime's Circular No. 27 is based on the principle of law of the Italian Tax Authority No. 5 of 20 February 2023. With this principle, the Italian Tax Authority has reiterated that payments made to non-residents, without a permanent establishment in Italy, in exchange for the grant of the right to use, reproduce and distribute software are qualified as royalties and, therefore, to be subject to withholding tax in Italy.

The Italian Tax Authority has further clarified that the qualification of payments for transactions involving the transfer of software depends on the nature of the rights that the transferee acquires in reference to the use and exploitation of the program. The analysis of this principle, which has already been expressed and consolidated in previous practice documents of the Italian Tax Authority (i.e. R.M. 169/97, Resolution no. 119/2007, Resolution no. 128/2008, answer to questioning no. 361/2023) allows, in Assonime's opinion, to identify the following borderline hypotheses:

represent business profits, not subject to withholding tax in Italy, the fees paid for the purchase of the right of use on the software aimed at the purely personal and commercial use by the purchaser without there being any commercial exploitation of third parties;
fees paid for the purchase of the right of use for the economic exploitation of the software to third parties can be considered as royalties, and therefore subject to withholding tax. Economic exploitation is to be considered as the right to reproduce, distribute or modify the software itself.

However, there are also other cases than the above-mentioned borderline hypotheses, including the case of remunerations paid to non-resident entity, without a permanent establishment in Italy, for distributing a software to their customers without being able to make any modifications according to the instructions of the foreign licensor. Considering the various clarifications offered by the Italian Tax Authority, there should be no doubt that such remunerations do not qualify as royalties and do not have to be subject to outbound withholding tax.

Indeed, the mere software distributor does not contractually acquire the right to reproduce, modify and/or disseminate the software in public, but he is qualified as an intermediary in the marketing of the program. Consequently, the fees paid to the copyright holder are configurable as business profits regardless of whether the software is subject to minor customization for the purposes of its installation.

Anyway, it is necessary to ascertain in concrete terms the correct attitude of the negotiating will as it is precisely in this regard that the most relevant problems of interpretation may arise. Assonime notes that Italy has expressed a reservation by not agreeing with the qualification as business profits of all fees relating to license agreements having as their object the mere distribution of software, considering that a case-by-case assessment of the rights concretely granted in relation to acts of distribution is appropriate.

However, this position of the Italian Tax Authority raises some doubts and interpretative difficulties in defining the cases in which a subject may or may not qualify as a mere distributor. Therefore, it would be desirable for an official intervention by the Italian Tax Authority aimed at providing a detailed review of the qualification as royalties or business profits of the fees paid in reference to transactions involving the transfer of software.