Software development services: with or without VAT exemption

As you know, software (hereinafter – SW) supply operations, as well as SW operations which are not royalty in accordance with paragraph 14.1.225 pf the Tax Code of Ukraine (hereinafter – the Tax Code) are exempt from VAT under item 26¹ of section 2 of chapter XX of the Tax Code. In which cases can you expect VAT exemption and in which you will have to pay this tax in full?

This issue in not new, but still relevant.

Software development services are, at first glance, subject to VAT exemption. Contrary to this opinion, the tax service has different approach (STS letter No. 3390 of August 17, 2020). It deems that in cases where the customer’s intellectual property rights to the software arise immediately (and not transferred by the contractor), such operation cannot be considered as SW supply and it must:

• be subject to value added tax (hereinafter – VAT) at 20% rate on general grounds – if the customer is a resident;
• not be subject to VAT due to the fact that that SW is supplied outside the customs territory of Ukraine – in cases when the customer is a non-resident (item 186.3 of the Tax Code).

If under the contract the intellectual property rights arise for contractor and then are transferred to the customer, such operation can be regarded as SW supply. In this case the payment is not subject to VAT either under paragraph 196.1.6 of the Tax Code (if the payment is considered as royalty), or under item 26¹, section 2 of chapter XX of the Tax Code (if the payment cannot be).

It is not always possible to agree with customers/contractors such approach (especially, if the counterparty is a non-resident). In this case, given the mentioned position of tax service (note that it is formal and the STS adheres to it for many years), it makes sense to formulate the contract is such a way that it contains conditions for transfer of intellectual property rights from the contractor to the customer (even if, in fact, they immediately arise for the customer), in particular, it is necessary to prepare acts of acceptance and transfer of such rights.