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INCOME TAX NOT PAYABLE ON FEES FOR OVERSEAS DATA PROCESSING SERVICES
The Taipei High Administrative Court has re-cently given its judgment in a 2001 tax dispute case, in which computer software purchased by a Taiwanese business entity was installed on the hardware of an overseas business entity that was commissioned by the Taiwanese entity to proc-ess data. The Taiwanese firm transmitted its data to the overseas firm by cable, and the overseas firm made back-up copies of the processed data and transmitted copies to the Taiwanese firm for the latter's use. The court held that the fees paid by the Taiwanese firm to the overseas firm under the above arrangement were not royalty pay-ments, but were composed of remuneration for service and of rental payments. Because the service was rendered overseas, the fees did not qualify as domestic income and were not subject to ROC corporate income tax.
The question of whether specific income should be defined under the Income Tax Law as "service income," "rental income," or "royalty income," decides which of the various criteria set out in Article 8 of the Law applies in order to determine whether the income derives from an ROC source. For example, in the case of service income, the determination is based on whether the service is rendered on ROC territory; in the case of rental income, it is based on whether the property rented is located on ROC territory; and in the case of royalties, on whether the location where the granted rights are used is on ROC territory. It is noteworthy that in this judgment, the court provided the following opinion as to the legal distinction to be drawn among service income, rental income, and royalty income:
"Service" is inherent in the person of the natural person who renders it. It is not objectively ob-servable or tangible, and cannot be stored. In view of these characteristics it must be received at the time when it is rendered, for when it ceases to be rendered it ceases to exist. Furthermore, when the party paying for the service receives it, in principle he does not need to expend effort himself, but merely to enjoy the benefit provided by the service.
Rent is an economic benefit paid in return for the use of a tangible thing. A tangible thing is something that occupies physical space, and it continues to objectively exist even if it is not made use of. Therefore the question of risk arises (i.e. the risk of the thing being destroyed or lost before it is used). Also, what is important at the time of use is actual control. Therefore, a person who pays for the use of a tangible thing must have possession of it, or must exercise le-gally meaningful usufructuary rights over it.
The major difference between intangible prop-erty rights and trade secrets on the one hand, and tangible things on the other, is that such rights or secrets do not occupy physical space. In this respect they are similar to service (like service, they result from human mental activity). But the most salient difference between service and such rights or secrets is that in the case of rights or secrets, the results of mental activity are fixed in law or in fact (by statutory registration, in the case of intangible property rights, or by written records, in the case of trade secrets). Thus for them to be practiced it is not necessary for the person who makes them available to again render service by personally repeating their implemen-tation or operation by his own labor and knowledge. The user needs only to put such rights or secrets into practice himself, on the ba-sis of the object in which the knowledge is fixed (such as written instructions, or in the case of a patent, the patent specification). This clearly differs greatly from the way in which service is received.
However, the court also stated that although the above analysis provides a jurisprudential framework for differentiation, when it is applied to economic activities in real society there may well be cases that cannot be completely catego-rized according to such clear distinctions, be-cause in the real world, the content agreed be-tween contracting parties on the basis of their actual economic needs is usually diverse and complex.
For example, the exploitation of a patent in-volves the licensing of an intangible property right, and in theory to exercise this right the user needs only to follow the method illustrated. But in most circumstances, in the interests of suc-cessful collaboration the licensor is likely to render service in the form of technical guidance. As another example, a person receiving service should not normally need to expend mental effort to understand the content of the service rendered. But sometimes the service rendered involves a certain level of technology that the recipient wishes to understand, or it may even be con-tractually agreed that the person rendering the service must disclose such technology to the re-cipient of the service. As a third example, in the case of a contract for work it is sometimes ex-tremely difficult to distinguish whether the party who orders and pays for the work is availing himself of the labor of the contractor, or the fruits of such labor (whether tangible objects or rights).
Therefore, judgment in individual cases requires a process of classification, in which the eco-nomic benefit obtained by the payer is compared with the content of each of the above concepts, to categorize and define such benefit according to the level of similarity. On this basis, in this judgment, the court that the fees paid by the plaintiff for data processing by an overseas business entity, using software purchased by the plaintiff and installed on the overseas entity's hardware, were of the nature of remuneration for service and rental, and were not of the nature of royalty payments. The service and facilities were provided outside the ROC, and therefore according to Article 8 of the Income Tax Law, the service fee and the rental paid were not ROC income, and were not subject to ROC corporate income tax.
The above judicial distinction between service income, rental income and royalty income should serve as a very useful guide for future cases.