Royalties are a significant form of income in today’s knowledge-based economy, especially in industries like software, media, publishing, and mining. In Pakistan, income from royalties is subject to specific tax treatments under the Income Tax Ordinance, 2001. Both residents and non-residents receiving royalty income must comply with the applicable withholding, declaration, and payment requirements.

This article provides an in-depth overview of how royalty income is taxed in Pakistan, relevant sections of the tax law, applicable rates, filing obligations, exemptions, and procedural requirements.

What Are Royalties?

Royalties are payments made by one party (licensee) to another (licensor) for the use of intellectual property, such as:

• Copyrights (books, software, music)

• Patents

• Trademarks

• Designs or models

• Know-how or confidential business information

• Natural resource rights (e.g., mining or oil extraction rights)

Royalties are often paid under licensing agreements and are considered a form of passive income.

Legal Definition Under Income Tax Ordinance, 2001

According to Section 2(44) of the Income Tax Ordinance, 2001, royalty means any amount paid or payable:

“For the use of, or the right to use, any copyright, patent, design, model, plan, secret formula, process, trademark or similar property or right; or for the use of, or the right to use, industrial, commercial or scientific equipment; or in respect of the supply of scientific, technical, industrial or commercial knowledge or information.”

This broad definition covers payments related to both tangible and intangible intellectual property.

Who Is Liable to Pay Tax on Royalties?

Tax liability arises on the recipient of the royalty income, whether a resident or non-resident person. The payer (licensee) has an obligation to withhold tax at source before making the payment.

Both natural persons and companies can be subject to royalty tax, depending on the nature of the transaction.

Withholding Tax on Royalties – Section 152

The main section governing tax on royalty payments to non-residents is Section 152(1)(c) of the Income Tax Ordinance.

For Non-Residents

• Withholding tax rate: 15%

• Final tax liability

• Applicable even if the non-resident does not have a permanent establishment (PE) in Pakistan

The payer (resident person) must deduct tax before making the royalty payment and deposit it with FBR using a CPR (Computerized Payment Receipt).

For Residents

For royalty income paid to residents, the general provisions of Section 151 or Section 153 may apply depending on the nature of the transaction and status of the recipient.

• Rate: Varies from 10% to 15% depending on the recipient’s tax status

• Adjustable tax

Applicable Tax Rates on Royalties

Note: If a Double Taxation Agreement (DTA) applies, the tax rate may be reduced.

Double Taxation Agreements (DTA) and Royalties

Pakistan has signed DTAs with over 65 countries. These treaties often cap the withholding tax rate on royalties and may shift taxing rights to the country of residence of the royalty recipient.

For example:

• UK: 10%

• UAE: 10%

• Singapore: 12.5%

• USA: 0% (royalties taxable only in the USA under treaty provisions)

In order to avail treaty benefits, the non-resident must provide a valid Tax Residency Certificate (TRC) from the foreign jurisdiction and file an application with FBR for treaty relief.

Filing and Compliance Obligations for the Payer

When a resident pays royalty to a non-resident, the following steps are required:

1. Deduct withholding tax at applicable rate

2. Deposit the tax with FBR via CPR using the correct withholding code

3. File withholding statement in Form 2 under Section 165 of the Income Tax Ordinance

4. Issue tax deduction certificate to the non-resident

Failure to follow these steps can result in penalties and disallowance of the expense in the payer’s own income tax computation.

Royalty Taxation in Case of Permanent Establishment (PE)

If the non-resident has a permanent establishment (PE) in Pakistan, then royalty income is treated as business income. In such cases:

• Tax is not final; it’s part of the income tax return of the PE

• Deduction of expenses is allowed

• PE is required to file annual tax return in Pakistan

Tax Treatment in Case of Software Royalties

The FBR has clarified that payments for software licenses, SaaS, or cloud services may be classified as royalties depending on the ownership of IP and usage rights granted.

If software is transferred with rights to use or modify, it is considered royalty.

If only access is granted (e.g., subscription-based SaaS), it may be considered a fee for technical services and taxed accordingly.

Recent Developments and Clarifications

FBR Circulars and Case Law

• FBR Circular 4 of 2013 clarified taxation on software payments

• Supreme Court and High Court rulings have held that software usage may be royalty or business income depending on contract specifics

OECD Guidelines

Pakistan generally follows OECD Model Convention principles for cross-border tax matters. According to OECD:

• Royalty is taxed in the country of source

• If taxed in both countries, relief is given under DTA

Common Issues in Royalty Taxation

1. Misclassification of royalty as service fee or vice versa

2. Non-availability of TRC from non-resident leading to denial of treaty relief

3. Failure to deduct tax at source resulting in disallowance of expense

4. Lack of awareness about DTA and its procedural requirements

How to Claim Tax Credit for Royalty Income

Resident individuals or companies receiving royalty income must:

• Declare royalty income under “Other Sources” or “Business Income” in the return

• Claim credit for tax withheld

• Disclose agreement details if required

Non-residents must ensure:

• Submission of TRC

• Availability of tax deduction certificate

• Correct classification of income under treaty terms

Exemptions and Special Cases

Royalty income may be exempt under specific laws, such as:

• Income from copyrights received by authors (limited exemption)

• Government-granted patents or licenses under certain incentive schemes

These exemptions are subject to conditions and must be declared in the return of income.

Tax Planning and Documentation for Royalties

To avoid tax disputes and ensure proper compliance:

• Maintain written agreements for royalty payments

• Clearly define rights granted (usage vs. ownership)

• Determine whether payment is royalty or service fee

• Review applicable DTA clauses

• Obtain professional advice for cross-border royalty payments

Tax Codes for CPR When Paying Royalties

When depositing tax with FBR, select the correct tax code on the CPR form:

• 640119 – Payment to non-resident for royalties under Section 152

• 640150 – Payment to residents under Section 153 (if applicable)

Choosing the wrong code can lead to non-credit issues or rejection of expense deduction.

Royalty Taxation in Special Sectors

Oil, Gas & Mining

• Royalties paid to government or landowners are governed by special statutes

• Deductible expense for licensees under the Petroleum Concession Agreement (PCA)

Music & Entertainment

• Royalties paid to artists, music labels, and streaming platforms fall under IP-based royalty rules

• Artists residing abroad must submit TRC to avoid full 15% tax

Academic Publications

• Royalties received by authors of textbooks, papers, or research may qualify for reduced tax under certain SROs

Importance of Professional Advice in Royalty Taxation

Since royalty payments often involve complex legal, contractual, and international tax considerations, working with a qualified tax consultant is essential. A professional will:

• Analyze the nature of the payment

• Evaluate DTA applicability

• Ensure proper withholding and filing

• Prevent double taxation

• Avoid costly tax penalties and audit issues

Conclusion

Royalty income in Pakistan is subject to defined tax rules based on the residency of the recipient and nature of the transaction. Withholding taxes, treaty relief, correct classification, and documentation are all crucial elements in royalty taxation. Businesses making or receiving royalty payments must exercise due diligence and consult tax professionals to ensure compliance and avoid disputes with tax authorities.