Finland: Income on mobile games received from China as royalties

Income tax treaty between Finland, China

A decision concerning the elimination of double taxation on income received from China and the application of the income tax treaty between Finland and China was issued by Finland's Supreme Administrative Court. The issue in this case was whether payments to a Finnish company, from a Chinese company, constituted royalties (under treaty Article 12) or business profits (Article 7) for taxation purposes.

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Summary

  • The court, in order to determine the income classification, had to analyse the language of the agreement between the Finnish company and the Chinese company, and more specifically the nature of the rights granted to the Chinese company under the agreement. The underlying question was whether the rights granted to the Chinese company were copyrights within the meaning of Article 12 of the treaty.
  • The Supreme Administrative Court held that income received by the Finnish company from the Chinese company, under the agreement, constituted royalties in accordance with Article 12 of the treaty. Therefore, withholding tax had to be taken into account with respect to the taxation of the Finnish company in Finland.

Background

Article 12(2) the income tax treaty between Finland and China provides that royalties may be taxed by the source state. However, the withholding tax rate cannot be more than 10%. In subparagraph (3), royalties are defined as payments of any kind received as consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, or films or tapes for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information (know-how) concerning industrial, commercial or scientific experience, and for the use of, or the right to use, industrial, commercial, or scientific equipment.

The Finnish company had concluded an agreement on the provision of online content and services for mobile devices with a Chinese company under which the Chinese company made publicly available, a mobile game developed by the Finnish company to Chinese end-users. Those Chinese end-users were able to download the game from the Chinese company's own website and other local app stores for Android operating systems. Under the agreement:

  • The Finnish company held all the copyrights of the game.
  • The Chinese company was allowed to publicly display, make copies, and distribute copies of the game to end-users and sub-licence these rights to other Android app store providers in China.
  • It was unclear whether a preapproval from the Finnish company was required for usage of the rights by the Chinese company.
  • The rights granted to the Chinese company were revocable any time by the Finnish company.
  • The Chinese company’s payments to the Finnish company were based on a percentage of the payments collected from end-users in China.

The Finnish company applied in Finland for an advance ruling regarding the tax treatment of the payments in Finland. With reference to paragraph 13.1 of the OECD Commentary on Article 12 of the Model Tax Convention, the Finnish company argued that the payments constituted royalties because the Chinese company had the right to reproduce and distribute to the public together with the right to publicly display the software, which without the licence would constitute an infringement of the Finnish company’s copyright.

Initial determinations

The Finnish tax administration and the Helsinki Administrative Court each concluded that the payments were not royalties but were business profits under Article 7 of the Finland-China income tax treaty. Reference was made to paragraph 14.4 of the OECD Commentary on Article 12, and that paragraph states that in distribution agreements, when a distribution intermediary is granted a right to distribute copies of program without the right to reproduce the program, the rights acquired in relation to the copyright are limited to those necessary for the commercial intermediary to distribute copies of the software program.

Accordingly, in such transactions, distributors are paying only for the acquisition of the software copies and not for exploitation of any right in the software copyrights. This would be the case regardless of whether the copies being distributed are delivered on tangible media or are distributed electronically (without the distributor having the right to reproduce the software). Paragraph 14.4 instructs to treat these transactions in accordance with business profits.

Findings of the Supreme Administrative Court

The Supreme Administrative Court, on appeal, gave specific attention to the agreement and its provisions in light of the OECD Commentary. According to the high court, the rights granted under the agreement were specifically rights that were mentioned in paragraph 13.1 of the OECD Commentary on Article 12. Therefore, the rights licenced under the agreement constituted such copyrights and were regarded as royalties under Article 12 of the Finland-China income tax treaty in context of software.

KPMG observation

The appellate decision is viewed by tax professionals as a welcomed development, since its sheds light on the relationship of paragraphs 13.1 and 14.4 of the OECD Commentary on Article 12 in the context of digital platforms. The decision affirms that paragraph 13.1 may apply even in the digital context, and the right to reproduce copies of software on a digital platform is not such a right, which is discussed in paragraph 14.4. Moreover, in paragraph 14.4, it is specifically mentioned that the provision does not apply when the distributor also has a right to reproduce the program. 

Due to the nature of software, distributions via digital platforms (like mobile app stores) always require reproduction of the program. Therefore, there would not be a reason to treat the distribution of software on digital platforms differently from a distribution of physical copies when the physical copies are produced by the distributor.

Given this decision, agreements regarding the provision and distribution of online content need to be drafted carefully and in accordance with the intention of the parties in order to eliminate double taxation.

 

For more information contact a tax professional with the KPMG member firm in Finland:

Jussi Järvinen | +358 20 7603 077 | jussi.jarvinen@kpmg.fi

Hanna Höglund | +358 20 7603 278 | hanna.hoglund@kpmg.fi

Aki Kokko | +358 20 760 3000 | aki.kokko@kpmg.fi

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