International Taxation of Digital Services Royalties

Digital services royalties are reshaping how taxing rights are allocated between jurisdictions under double taxation treaties. Digital business models increasingly rely on software, applications, electronic platforms, cloud computing and other intangible assets, making intellectual property usage rights a fundamental component of a wide range of cross-border transactions.

Against this background, the classification of consideration paid for digital services has emerged as one of the most complex issues in international taxation, particularly where a transaction involves granting the customer the right to use software, an application or a digital platform owned by the service provider. In such cases, the payment may not merely constitute consideration for a technical or commercial service, but may instead represent consideration for the use of an intangible asset, thereby bringing it closer to the concept of royalties governed by Article 12 of the OECD Model Tax Convention.

Although the OECD’s 2025 update did not introduce a separate treaty article specifically addressing digital services, it highlighted the continued divergence among jurisdictions regarding the scope of royalties, particularly in relation to software, intangible rights and technical services. This reinforces the importance of examining the rights actually granted to the customer rather than relying solely on the description used in the contract.

Digital Services and the Classification of Income

The principal difficulty in classifying income derived from digital services lies in the fact that a single transaction may combine service elements with elements relating to intellectual property rights. A contract may involve the provision of software, a cloud-based application or a digital platform, together with storage, data processing, technical support and maintenance services. The decisive factor for tax classification is whether the customer merely receives the result of a service or is also granted the right to use the software or technology through which the service is delivered.

Where the service provider merely processes data or provides technical support without granting the customer an independent right to use or control the software, the consideration may be treated as business profits. By contrast, where the contract grants the customer access to the software, permits the customer to use its functions and allows the customer to benefit from it for a specified period in return for a subscription fee or recurring payment, an approach may be adopted under which the consideration is treated as a royalty, on the basis that it is paid for the right to use an intangible asset.

Accordingly, the mere description of an agreement as a digital services contract should not prevent the application of Article 12 where the true substance of the transaction is the grant of a right to use software, an application or a platform protected by intellectual property rights.

Distinction Between Business Profits and Royalties

The distinction between business profits under Article 7 and royalties under Article 12 requires an analysis of the legal and economic nature of the rights obtained by the customer.

Payments are generally treated as business profits where the subject matter of the contract consists of performing an activity or delivering a specific result without granting the customer the right to use an intangible asset owned by the service provider. In such circumstances, the profits are not taxable in the customer’s jurisdiction unless the service provider carries on business in that jurisdiction through a permanent establishment.

By contrast, where the transaction involves granting the customer the right to use software, an electronic system, an application or a digital platform, the consideration is directly connected to an intellectual property asset. The payment may therefore be classified as a royalty, even where the software is made available online or through a cloud environment and no physical copy is delivered to the customer.

This classification does not necessarily depend on whether the customer owns the software or has the right to resell it. It may be sufficient for the customer to be granted a contractual right to use the software during the subscription period, provided that such right constitutes a material element of the consideration paid.

The relevant distinction is therefore not merely whether the transaction is automated or electronically delivered. Rather, the central question is whether the customer is paying for the result of a service performed by the supplier or for the ability to use software or another intangible asset.

Software, Cloud Computing and Automated Digital Services

Software-as-a-Service models, cloud computing and automated digital services raise particular classification issues because they combine access to software, algorithms or digital platforms with the provision of the technical infrastructure required for their operation. The consideration paid may be regarded as a royalty where the principal element of the agreement is the grant to the customer of an actual and contractual right to use the software or digital tool and to benefit continuously from its functions. The fact that the software operates on the service provider’s servers or that no copy is delivered to the customer does not necessarily alter this analysis.

This may apply to enterprise resource planning systems, accounting and human resources software, data analytics platforms, customer relationship and sales management applications, design and engineering software, automated content-generation platforms, artificial intelligence applications, translation and automated analysis tools, forecasting and risk-management systems, advertising platforms and data extraction and analytics tools. In such cases, the consideration is not paid solely for hosting, server maintenance or technical processing, but also for enabling the customer to use software or a digital tool that performs specific functions within its business. This may bring the payment closer to the concept of royalties as consideration for the right to use an intangible asset.

However, where the transaction is limited to the provision of storage capacity, computing power or data processing, without granting the customer the right to use identified software, or where the customer does not interact with the digital tool itself and merely receives a report or final output, it may be more appropriate to classify the consideration as a service fee or business profits, depending on the rights granted and the wording of the applicable tax treaty.

Relationship Between Royalties and Permanent Establishment

The classification of digital payments as royalties has significant implications for the allocation of taxing rights. In the case of business profits, the customer’s jurisdiction generally has no right to tax the income of the foreign supplier unless that supplier has a permanent establishment in that jurisdiction.

Where the payment is classified as a royalty, however, the source jurisdiction may be entitled to impose withholding tax in accordance with the applicable bilateral tax treaty. This is particularly relevant in digital transactions, as a software provider may generate substantial revenues from a jurisdiction without maintaining an office, branch or employees there.

Treating payments for the right to use software as royalties may therefore grant the market jurisdiction or the customer’s jurisdiction a degree of taxing rights even in the absence of the supplier’s physical presence.

Nevertheless, where the relevant right or intangible asset is effectively connected with a permanent establishment of the service provider in the customer’s jurisdiction, the income may be treated as part of the profits attributable to that permanent establishment rather than being taxed separately under the royalty’s article.

Tax Treatment of Mixed Digital Contracts and Their Practical Implications

Digital contracts may include a number of interrelated elements, such as a software license or right of use, cloud hosting, maintenance and updates, training and technical support, data processing and technical consultancy. In such cases, the principal and substantive element of the agreement must be identified by reference to its legal and economic reality rather than the description used in the contract or invoice.

Where the grant of the right to use software constitutes the principal purpose of the agreement and the remaining services are ancillary or complementary to that right, the entire consideration, or the principal portion of it, may be treated as a royalty. Conversely, where the contractual elements are independent and a separate consideration can be identified for each element, the payments should be apportioned according to their respective nature. The portion relating to the right to use the software may be treated as a royalty where the relevant conditions are satisfied, while the portion attributable to technical support or consultancy may be treated as service income or business profits. Payments relating to equipment or infrastructure should be classified according to the nature of the right granted and the definition of royalties in the relevant tax treaty.

The 2025 update demonstrated that some jurisdictions adopt a broad interpretation of royalties that may extend to the use of equipment, certain technical and consultancy services and certain forms of disposition involving intangible rights. It is therefore essential to refer to the wording of the applicable bilateral tax treaty in each case.

This approach may expand the range of digital payments subject to withholding tax in the source jurisdiction. Tax authorities must therefore examine digital contracts and analysis the rights actually granted instead of relying on broad descriptions such as “cloud services,” “electronic subscription” or “technical support.”

Multinational enterprises should similarly determine whether the customer receives an independent right to use software or merely uses a platform or interface in order to receive a service managed and controlled by the supplier. They should also separate license fees from maintenance, support and consultancy fees, review the treaty definition of royalties, verify the application of withholding tax and the satisfaction of beneficial ownership requirements, and retain documentation demonstrating the nature of the rights granted to the user.

This analysis becomes particularly important where the agreement allows the customer to install the software on its systems, operate it within its business, integrate it with other systems, control certain functions or create multiple user accounts for its employees. Such features may indicate the existence of a right of use that goes beyond the mere receipt of a digital service. Contractual descriptions that do not reflect the true substance of the transaction should therefore be avoided.

Conclusion

The classification of income derived from digital services requires an examination of the true substance of the transaction and the rights obtained by the customer. Where the agreement is limited to the provision of a service or a digital result, without granting the customer the right to use the software or intangible asset, the consideration is more likely to constitute business profits governed by Article 7.

By contrast, where the transaction is principally concerned with granting the customer the right to use software, an application or a digital platform, the consideration may be classified as a royalty governed by Article 12, irrespective of whether the software is provided online or hosted on the supplier’s servers.

The right to use the software therefore becomes the principal criterion for distinguishing between the two categories. This requires a careful examination of the scope and duration of the right, the restrictions imposed on its exercise and whether the customer merely benefits from a digital service or obtains a contractual right to use an intellectual property asset.

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