The software regulations and subpart F.

• Author: Klahsen, Rick

Globalization of economies and explosions in the use and application of computer software have created significant need for global distribution networks for participants in the industry. To address this need, software developers have either acquired established foreign distributors or developed wholly owned foreign distribution networks. The proper U.S. tax treatment of a sale or license of computer programs through a foreign subsidiary is challenging and potentially expensive in cash taxes. A practitioner must consider a variety of aspects and value exchanged in transactions and transfers when assessing transactions in software.

Items include:

* Intangible value inherent in any transfer;

* The wide variety of methods by which the software can be transmitted; and

* The wide-ranging applications and uses of software programs.

U.S. tax treatment is dependent on classification of revenue under Regs. Sec. 1.861-18 (the software regulations), which have been effective since enactment on October 2, 1998. Accurate assessment and classification of software revenue coupled with planning are critical to software developers' international tax planning.

Application of the Software Regulations

The software regulations provide for the classification of transactions involving computer programs. The Code and regulations define "software" as a set of statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result (Regs. Sec. 1.861-18(a)(3)). Computer software transactions are one of the following revenue types:

* Transfer of copyright rights;

* Transfer of a copyrighted article;

* Provision of services relating to development or modification of a computer program; or

* Provision of know-how relating to computer programming techniques.

Regs. Sec. 1.861-18(c)(l)(i) classifies a transfer of a computer program as a transfer of a copyright right if, as a result of the transaction, a person acquires certain rights. These rights include:

* The right to make copies of the computer program for purposes of distribution to the public by sale or other transfer of ownership or by rental, lease, or lending;

* The right to make a public performance of the computer program; or

* The right to publicly display the computer program (Regs. Secs. 1.861-18(c) (2)(i)-(iv)).

If a person acquires a copy of a computer program but does not acquire any of the copyright rights as defined above, the transfer is classified as a transfer of a copyrighted article under Regs. Sec. 1.861-18(c)(2). Transactions involving computer programs can consist of both the transfer of a copyright right and the transfer of a copyrighted article and in such cases are subject to certain de minimis rules.

The transfer of a copyright right is a sale or exchange of property if there has been a transfer of all substantial rights in the copyright. A...