In addition to having a properly drafted agreement, an individual entrepreneur (FOP) developing software should understand the specifics of software taxation. The tax treatment of payments largely depends on the terms of software use and the scope of rights transferred.
How is a FOP software developer’s income taxed?
The most common tax model for Ukrainian software developers is to operate as an individual entrepreneur (FOP) under the third-group simplified taxation system.
At first glance, this model seems straightforward, with simple calculations and reporting requirements.
As a general rule, all FOP income, i.e. all amounts received into the FOP’s account, is subject to the single tax at a rate of 5%.
As of January 1, 2025, a military levy of 1% of income is additionally payable.
Thus, the overall tax burden is 6% of the income amount.
When do difficulties arise?
Difficulties may arise when intellectual property rights and royalties come into play. Royalties are not included in the income that may be taxed at the 5% rate under subparagraph 1 of paragraph 292.1 of Article 292 of the Tax Code of Ukraine.
Income in the form of royalties is included in an individual’s total annual taxable income. Such income is subject to personal income tax at a rate of 18% and a military levy at a rate of 5%.
Thus, the total tax burden already amounts to 23% of the royalty income.
Therefore, it is crucial for a FOP software developer to correctly determine the nature of the payment received. This determines the taxation of software and whether the relevant payment may be included in the FOP’s income and taxed under the simplified taxation system.
When is remuneration considered a royalty?
The rules for software taxation and the applicable tax burden depend on whether the payments received by the developer fall within the definition of royalties under subparagraph 14.1.225 of paragraph 14.1 of Article 14 of the Tax Code of Ukraine:
Royalty means any payment, including a payment made by a user of copyright objects, received as consideration for the use of, or for granting the right to use, an intellectual property right, including any literary works and computer programs.
The following payments are not considered royalties:
payments received as consideration for the use of a computer program, where the terms of use are limited to the functional purpose of such program and its reproduction is limited to the number of copies necessary for such use (“end-user” use);
payments for the purchase of copies of intellectual property objects, including in electronic form, for use for their functional purpose by an end consumer or for resale of such copy;
payments for the transfer of rights to intellectual property objects where the terms of the transfer grant the person acquiring such rights the right to sell or otherwise dispose of the intellectual property rights;
payments for granting the right to distribute copies of software products without the right to reproduce them, or where their reproduction is limited to use by an end consumer.
Thus, software taxation depends on the model of its distribution, the scope of the intellectual property rights transferred and the nature of the payment. Accordingly, depending on the specific circumstances, payments may be taxed at a rate of 6% or 23%.
Let us consider the most common models used by Ukrainian software developers operating as FOPs
I. Development of software on a commissioned basis
The standard model for a Ukrainian FOP is to enter into an agreement for the development of software on a commissioned basis.
Income received for software development constitutes income subject to the single tax at a rate of 5% and the military levy at a rate of 1%.
Depending on the terms and manner in which the software is used by the client, as well as on whether intellectual property rights to the software are transferred, the income may be treated either as FOP income or as royalties excluded from FOP income.
Model A – transfer of rights
Where a FOP develops software and transfers (assigns) the intellectual property rights in it to the client, the payment for such development and transfer of rights is not a royalty.
The payment for the development is undoubtedly FOP income. At the same time, the developer is entitled to remuneration for the transfer of intellectual property rights to a work created on commission pursuant to Part 3 of Article 15 of the Law of Ukraine “On Copyright and Related Rights.”
Is remuneration for the transfer of intellectual property rights to a work FOP income or income of the individual who authored the work?
This issue has been considered by the courts. In case No. 813/207/16, the FOP provided computer programming and information-related consulting services. The parties agreed that the intellectual property rights to all intellectual property objects would belong to the client, while the remuneration for their transfer (assignment) was included in the total price of the services.
The State Tax Service took the position that a FOP could not be the author of a work because a work is created exclusively through the creative efforts of an individual. Accordingly, the remuneration received under the service agreement could not be included in the income of a single-tax payer.
However, in its judgment of February 21, 2020, the Supreme Court stated that Article 292.11 of the Tax Code of Ukraine establishes an exhaustive list of amounts of money and value of property that are excluded from income, and author’s remuneration is not included in this list.
The Court also noted that the claimant was an author within the meaning of applicable law and, in addition, had the status of an individual entrepreneur. His business activities included the creation of copyright objects. The services provided by the FOP included information-related consulting and computer programming, the results of which were intellectual property objects. Therefore, the author’s remuneration received by the claimant was related to his business activities and was included in the income of the FOP as a single-tax payer.
Model B – granting a licence
The FOP develops software, remains the owner of the intellectual property rights to it and grants the client the right to use the software (i.e. grants a licence). Under this model, several variations are possible:
1. End user
The developer provides a copy of the software for installation on the client’s device, and the client is the end user of the software. The client uses the software in its own business activities for its intended functional purpose and, therefore, no royalty arises.
2. Use as part of another product / sublicensing
The client is not limited to using the software in its own business activities but uses it as part of another product or grants it to third parties for use (sublicensing). In such cases, the payments are royalties.
3. Resale of copies to end users
The client transfers copies of the software for resale to end users. Such payments are also not royalties.
Thus, to determine whether a payment is a royalty and whether the developer may include it in income subject to the single tax, it is necessary to analyse the terms of the agreement between the developer and the client. In particular, it is important to determine whether intellectual property rights are transferred, the scope of rights granted to the client, and the term and territory for which such rights are granted.
II. Distribution of software through marketplaces and digital platforms
App Store: an agency model
Most marketplaces and digital platforms operate under an agency (commission-based) model (e.g. App Store, Google Play).
Income received from software distribution under such a model is, in most cases, not a royalty but income subject to the single tax. However, the terms of the agreement with each platform should be assessed on a case-by-case basis, as they may differ in terms of the scope of rights transferred by the developer to the platform.
Why are these payments not royalties?
Let us consider the example of the App Store and analyse the Apple Developer Program License Agreement.
For a Ukrainian developer, Apple acts as a commission agent: it enters into agreements and sells the application to end users in its own name but on behalf of the developer, and transfers the proceeds to the developer less its commission.
The developer grants Apple the following rights and powers:
- to market the application;
- to provide hosting services, store the application and make it available to end users;
- to copy, format or otherwise prepare the application for purchase and download by end users, including implementing security measures and other optimisations;
- to organise access by end users to copies of the application;
- to distribute the application for use by end users;
- to process payments;
- to use screenshots or fragments of applications, trademarks or logos associated with the application for marketing purposes;
- to take other actions necessary for marketing and distributing the application.
Apple does not acquire any intellectual property rights in the software. Such rights remain with the developer.
Thus, the payment received from Apple is a payment for granting the right to distribute copies of software products without the right to reproduce them and without transferring intellectual property rights in the software.
Income received from similar marketplaces and digital platforms raises another question:
What amount of income is subject to tax?
What amount should be included in the income subject to the single tax: the amount received from end users before deduction of the platform’s commission and withholding tax, or the amount actually credited to the developer’s account after the commission and taxes have been deducted?
According to the position of the State Tax Service of Ukraine:
- “the income of an individual entrepreneur is the full amount, including the commission” (Individual Tax Ruling dated January 26, 2024, No. 452/IPK/99-00-24-03-03 IPK);
- “the income of an individual entrepreneur — a third-group single-tax payer — is the amount specified in the primary document (invoice, payment instruction, etc.), converted into hryvnias at the official exchange rate of the hryvnia to the foreign currency established by the National Bank of Ukraine on the date the funds are received into the account opened in the Payoneer system. At the same time, an individual entrepreneur who is a third-group single-tax payer may not reduce the amount of the single tax by the taxes withheld directly by the marketplace” (Individual Tax Ruling dated August 3, 2026, No. 4444/IPK/99-00-24-03-03 IPK).
Therefore, the FOP’s income includes the full amount paid by the end user through the platform before deduction of the platform’s commission and withholding tax, if applicable in the relevant jurisdiction.
Envato Market: a different distribution model
However, the mere fact that software is distributed through a marketplace does not mean that the payments received are not royalties. The terms of the licence and the scope of rights granted to the user are decisive.
Envato Market offers two types of licences under which developers may list their products: a regular licence and an extended licence.
Let us examine the terms of these licences, as well as the Author Terms and Conditions, to determine whether the payments received fall within the definition of royalties.
Both the regular and extended licences allow a platform user to:
- use the object, including the code, to create an end product;
- modify and combine the code with other works and create derivative works based on the code;
- transfer the licence together with the end product;
- remove unnecessary components.
The end product is a work that incorporates the relevant object together with other elements in such a way that it is larger in scope and differs in substance from the original object. In other words, the end product is a derivative work.
The licences prohibit:
- distributing the code as a standalone product;
- extracting individual elements from the code and using them separately.
The difference between the licences lies in the scope of rights regarding the further use and distribution of the end product.
The regular licence allows a platform user to transfer the end product to one end user for a fee and to make more than one copy of the end product only where it is distributed free of charge.
The extended licence, on the other hand, allows the end product to be sold to end users, with an unlimited number of copies permitted for this purpose.
Thus, the developer remains the owner of the intellectual property rights in the code.
The developer grants the platform user a perpetual, non-exclusive, worldwide licence to use the code. The Envato platform itself is not a party to the licence agreement.
In consideration for the licence, the developer receives a fee — a one-time or lump-sum payment.
When the end product is transferred to an end user, that user receives a licence to use the code from the platform user, with no additional payments due.
The income received from such a grant of rights for use will, with a high degree of probability, be treated as royalties.
The use of the code by a platform user to create a derivative work for an end user does not constitute use of a computer program for its functional purpose or “end-user” use.
Since the licences expressly prohibit the distribution of the code as a standalone work, the use of the code will not qualify as the purchase of a copy of an intellectual property object or as the granting of a right to distribute copies of a software product.
Accordingly, the exceptions provided by the Tax Code of Ukraine, under which a payment is not considered a royalty, do not apply.
We therefore conclude that a payment received from the distribution of software through the Envato platform is a royalty. It is not included in the FOP’s income and is subject to personal income tax at a rate of 18% and a military levy at a rate of 5%.
Conclusions
Thus, software taxation requires an assessment not only of the payment itself but also of the terms of the agreement and the actual scope of rights granted to the client or user. The distinction between a payment that a FOP may include in income subject to the single tax and a royalty can be quite subtle.
Therefore, before entering into an agreement, it is important to analyse which rights in the software are transferred, to what extent, for what term and territory, and how the client or user may use and distribute the software.
The difference in tax burden — 6% versus 23% — is too significant to rely on guesswork. If you have difficulties determining the nature of payments under your agreement, our lawyers are always ready to help.
Author: Yuliia Khalaim
Our lawyers and patent attorneys are always ready to assist you in addressing the taxation of transactions involving intellectual property and developing agreements tailored to your business model.