Exporting Software,
Sorting Out the Details
By R. Clay Woods
Office of Information
Technologies and Electronic
Commerce, Trade Development
Globalization is receiving
a lot of attention these days.
The widespread availability of
the Internet, rapidly
declining telecommunications
costs, transitions to market
economies overseas, and trade
liberalization are bolstering
the progress of globalization.
As a key ingredient of the
Information Age, computer
software has been both an
agent and beneficiary of these
phenomena. The software
industry is critical to the
American economy as a major
contributor to the balance of
payments, job creation,
productivity, and economic
growth, and even though the
U.S. market currently
represents one-half of global
spending on software, U.S.
companies are increasingly
dependent on foreign markets
to increase sales. This
underscores the importance of
U.S. industry working with the
federal government to open
markets and create fair
opportunities to expand
business overseas.
While the worldwide sale
and development of software
has mushroomed over the last
two decades, its national
importance and unique nature
has spawned new concerns and
policy issues, especially in
the trade arena. There are
various ways to transmit and
distribute software. It can be
shipped as a tangible product
(on optical and magnetic disks
or tape), increasingly as an
intangible product
(transmitted electronically
via the Internet). It can be
exported pre-loaded on a
computer or embedded in
electronic devices, such as
medical equipment and
automotive controls. It also
can be conveyed abroad by
software programmers and
engineers as part of an
information technology (IT)
service, or disseminated via
licensing mechanisms that
authorize foreign buyers to
use a particular program, or
to increase the number of
users, who can access a
program that is already
installed.
There are many types of
programs operating systems,
network management programs,
middleware, databases,
Internet software, programming
tools, security solutions, and
myriad applications, as well
as utilities, device drivers,
updates, program patches, and
free demos. There are two
categories of software:
packaged or shrink-wrapped
programs are aimed at a mass
market, while customized
programs are written for a
particular user or
organization.
Software is the fastest
growing segment of the global
IT market. Packaged software
and IT services (which
includes customized software
development and systems
integration and
implementation), represent
almost 60 percent of total IT
spending according to the
International Data
Corporation. Sales have been
expanding 11 percent annually
since 1991. The tables below
show world software and IT
services markets, U.S. exports
of software, U.S. receipts of
royalties and licensing fees
from foreign software sales,
and U.S. IT services receipts
from abroad.
When you look at the global
market for software without
the United States, Western
Europe represents two-thirds
of demand and Asia/Pacific
one-fourth, but U.S. software
exports show a different
regional apportionment, with
large shipments going to
Canada and Latin America. This
can be partially explained by
geographic proximity, which
makes tangible software
exports more economically
feasible in the Western
Hemisphere, whereas a greater
portion of U.S. sales to
Western Europe is fulfilled by
replicating licensed software
from master disks sent from
the United States. Disks can
be replicated in high volumes
at minimal cost and with no
loss of quality. The
apportionment of U.S.
licensing fees and IT services
receipts, on the other hand,
corresponds more to world
market shares, in that, the
largest percentages belong to
Western Europe and
Asia/Pacific.
A glaring anomaly in the
numbers is the wide
discrepancy between the size
of world software markets, of
which U.S. vendors have
majority shares, and official
U.S. export data, which are
significantly undervalued.
This is due to the following
reasons: (1) some U.S.
exporters report only the
value of the carrier media
(disks or tape), disregarding
the software content on
Shippers Export Documents (SEDs)
from which the trade data are
taken; (2) a good portion of
software is replicated in
foreign markets from master
disks; (3) an increasing
amount of software is
transmitted and sold
electronically, much of which
is not captured in the data;
(4) only the value of the
media has to be reported for
customized software exports;
and (5) shipments valued at
less than $2,500 and software
license documents do not
require a SED.
The unique features of
software that make it
difficult to accurately
measure U.S. trade and payment
flows also generate
contentious trade policy
issues. Countries vary widely
with regard to software trade
regulations. Some governments
consider software essential to
running critical business and
government operations, so they
minimize import costs and
trade barriers. Other
governments, especially in
less developed countries, view
software as a luxury item, so
they subject it to revenue
generating duties and taxes,
like other discretionary
products. Some governments are
content to buy software from
foreign vendors to satisfy
societal needs, while others
seek to create indigenous
software industries to meet
local demand. In the 1980s,
Brazil attempted to create a
domestic software industry to
satisfy local demand but was
unsuccessful. However, India
has become the leading
supplier of offshore
programming and IT services.
Restrictive import,
investment, and technology
transfer policies emerge when
indigenous software production
becomes official economic and
industrial policy.
Almost any customs or trade
regulation can become a trade
barrier, if it is excessively
burdensome or discriminates
against foreign imports.
Similarly, unenforced
regulations can become trade
impediments, especially
intellectual property
protection laws. Customs
regulations, which are not
uniform globally, can be
arbitrarily or inconsistently
applied, which is more likely
with a unique product like
software. Countries also can
have complex and confusing
trade regimes, which can
create administrative problems
for U.S. companies.
Import Tariffs
Some countries still levy
tariffs or duties and customs
fees on imported software,
which are assessed on an ad
valorem basis. This increases
the landed cost of products
and affects competitive
pricing strategies in foreign
markets where customs levies
can be substantial, especially
on more expensive programs.
Even moderate duties make it
more difficult for legal
software products to
successfully compete with
pirated copies in a given
market. If the software is
pre-loaded or embedded on a
piece of equipment, then the
duty is usually assessed on
the total value of the
equipment.
Today, most developed
markets have zero tariffs on
software; the tariffs were
eliminated as a result of the
Information Technology
Agreement (ITA) concluded in
December 1996. The ITA has 61
signatories, and Russia may
join upon its accession to the
World Trade Organization (WTO).
So average tariffs are
relatively low around the
world, with some notable
exceptions. They can be as
high as 20 percent in Latin
America where only three
countries–Costa Rica,
El Salvador and Panama–are
ITA signatories. (Duties on
U.S. software are also zero in
Mexico and Chile as a result
of bilateral free trade
agreements with the United
States). Tariffs are in the 10
to 20 percent range in Russia
and the Newly Independent
States and are even higher in
Africa, where there are no ITA
signatories. Country specific
tariff and customs information
on software is available on
the Office of Information
Technologies and Electronic
Commerce's Web site www.export.gov/infotech.
Taxes
Even if there are zero
tariffs, most governments
assess taxes and other fees on
software imports. Like
tariffs, these can
substantially increase the
price of software and present
U.S. exporters with
administrative burdens and
legal uncertainties, when
complying with complex and
non-transparent tax
procedures. The most common
are value-added taxes (VATs),
which are similar to sales
taxes. VATs are assessed on
the full commercial value of a
product and are applied to all
such goods sold in a country,
whether imported or produced
locally. VATs range between 10
to 20 percent, however most
European countries have higher
rates and the Asia/Pacific
region lower rates.
VATs are currently a source
of contention with respect to
the European Union. The EU VAT
Directive, which became
effective on July 1, 2003, has
the potential to discriminate
against U.S. software that is
sold online. Under the ruling,
non-EU vendors of digitally
delivered products to
consumers are required to
register in the EU and collect
and remit EU taxes based on
the location of the customer.
(Sales to businesses are
treated differently.) For EU
vendors, the applied VAT is
based on where the vendor is
located. Thus, if a U.S.
company sells a program to a
Swedish consumer, the U.S.
company would charge a VAT of
25 percent (Swedish rate),
while a UK company selling the
same product to the same
consumer would charge only
17.5 percent (UK rate).
U.S.-based providers of
downloadable software will
have three options in
complying with the new rules,
including establishing a
factory in the EU, registering
in EU member states, or using
a special scheme set up by the
Directive, which involves
choosing a single VAT
authority with which to
conduct their VAT affairs.
Some countries treat
cross-border payments for
software as royalties, which
are subject to income taxes
that are assessed on the
exporter. For example, in
Brazil, software remittances
are subject to a 15 percent
withholding tax plus a
recently instituted 10 percent
surcharge on certain royalty
payments, which are related to
technical services involving
the transfer of technology.
Forty-eight countries have
bilateral income tax treaties
with the United States that
can simplify how withholding
and other taxes are treated,
by allowing U.S. exporters to
pay taxes in the United States
on foreign sales. When there
is no applicable tax treaty,
vendors may be eligible for a
U.S. tax credit on taxes paid
abroad. For information on
bilateral tax treaties, visit
the Treasury Department’s
Web site www.treas.gov/offices/tax-policy.
Customs Valuation
The amount of tariffs and
taxes assessed on a software
program depends on how customs
officials value the product.
Should governments assess
duties only on the value of
the media, or should it be
based on the full commercial
value of the software? This
has been a key issue for the
industry, since it can make a
substantial difference in
foreign sales prices. For
years, the U.S. Government,
supported by industry, has
requested that foreign
governments assess tariffs on
the value of only the media,
which is why exporters are
told to specify the value of
the media separately on export
documents. Today, most of the
principal trading countries
either assess duties only on
the media or have zero tariffs
on software. Exceptions
include Mexico, which has a 13
to 18 percent duty on the full
value of software that is
imported from non-NAFTA
countries, and Russia, which
has a 15 percent duty on full
value. In many developing
markets, customs regulations
and practices regarding this
issue are vague.
Customs Classification
The specific classification
of a software program by
customs officials determines
the applicable duties and
taxes. Authorities may dispute
the classification of a
product based on different
interpretations of its purpose
or form. Should packaged
software be treated
differently than customized
software? Are programs that
contain audio-visual content
different from traditional
software? Is software a good
or service? Should software
delivered online be treated
the same as software sold on
disks?
Most countries, including
the United States, classify
exports and imports according
to standard Harmonized System
(HS) codes. Software falls
under HS heading 8524
(Records, tapes and other
recorded media and user
manuals HS heading 4901. Since
only the first six digits of
HS codes are standardized
globally, a country may
designate more specific
product classifications beyond
those six digits. Generally,
the codes categorize software
by the media and not by its
function or format, so most
customs authorities treat
customized software the same
as packaged software. However,
the rapid evolution of
information technologies is
making the process of
classifying products more
difficult and is outpacing
updates to the HS coding
system. For a list of U.S.
export (Schedule B) codes for
software, visit the U.S.
Census Bureau/Foreign Trade
Division website at (http://www.census.gov/foreign-trade/schedules/b/index.html).
Some countries treat
multimedia software that
includes audiovisual
components, such as
entertainment and game
software, differently from
traditional programs. Egypt,
for example, assesses tariffs
on entertainment software
products, especially those
played on game consoles, which
are classified under HS
heading 9504 (toys and games)
instead of HS 8471 (automatic
data processing machines or
ADP). The ITA, which includes
Egypt as a signatory, has
eliminated duties on ADP or
computer equipment.
The issue of whether to
classify software as a good or
service is important since it
determines which trade
agreement provisions are
applicable. Some provisions
might be more favorable to
certain types of software than
others. Traditionally,
software has been treated as a
good, which is subject to the
General Agreement on Tariffs
and Trade (GATT), but the
increasing use of online
delivery systems raises the
question of whether to
reclassify online software as
a service under the General
Agreement on Trade in Services
(GATS), which came into force
in January 1995. The
liberalization of services
trade has been a major topic
of discussion during recent
WTO deliberations.
Free trade agreements also
raise classification issues
because it is necessary for
the parties involved to
determine which imports should
receive preferential
treatment. These questions are
subject to rules-of-origin
provisions, and products must
go through substantial
transformation in a signatory
country before receiving lower
tariffs and other tax
benefits. For example, under
NAFTA, U.S. software exports
to Mexico only receive
duty-free treatment, if the
software is burned onto disks
in the United States,
regardless of where the code
is written.
Export Licensing
Regulations
The U.S. Department of
Commerce's, Bureau of Industry
and Security (BIS) is the
primary licensing agency for
dual use exports (commercial
items that could also have
military applications).
Software programs that utilize
encryption technologies are
included in this category. In
June 2002, BIS published a
rule updating its export
control regulations on
cryptography. The rule allows
mass market-encryption
products using symmetric
encryption algorithms with key
lengths exceeding 64 bits,
classified under Export
Control Classification Numbers
(ECCNs) 5A992 and 5D992, to be
exported and re-exported to
most destinations after a
30-day technical review. There
are no licensing or
post-export reporting
requirements related to the
export of these products once
the review is completed.
BIS also administers the
Deemed Export Rule, which
covers the release of
U.S.-origin technology or
source code to foreign
nationals in the United States
as an export to that
individual's home country.
This rule applies even if the
individual never leaves the
United States and is
particularly important to
companies employing foreign
nationals as programmers and
software engineers. Exporters
should become familiar with
BIS regulations. For
information, visit the BIS Web
site at (www.bis.doc.gov)
or call (202) 482-4811 to talk
to a BIS representative.
However, even if companies
have satisfied domestic
licensing regulations,
depending on the destination
of the export, there could be
import restrictions. Russia,
for example, requires an
import license for encryption
software and ciphering
equipment. France has
requirements on the
importation of encryption
software and requires prior
authorization for systems that
incorporate 128 bits or
higher.
Government Procurement
Regulations
Governments are significant
buyers of computers and
software. In some countries,
they are the largest
customers, so the rules that
govern public sector
procurements can substantially
impact IT markets. China, for
example, is reportedly
considering publishing
guidelines to restrict
government purchases of
foreign software, in an
attempt to reduce dependence
on foreign vendors and to
stimulate its domestic
software industry. These kinds
of policies always raise
questions concerning what
constitutes domestically
produced products and what
happens when local companies
cannot meet customer needs.
The proprietary software
versus open source software (OSS)
issue is another example of
governmental intervention in
the marketplace. A number of
governments around the world,
both at the federal and
sub-federal level, are
considering initiatives and
regulations to promote the use
of OSS and more specifically
the open source Linux
operating system. Some
governments have proposed
requiring public agencies to
use OSS, unless proprietary
software is the only option.
The open source movement
appears to be growing as
governments seek to cut IT
expenditures, reduce
dependence on foreign software
companies, and exercise more
control over their own IT
systems, since the source code
for open source software is
freely available. By contrast,
U.S. Government procurement
policies do not specify a
preference for either mode of
software and prescribe
technological neutrality.
Both the U.S. Government
and the domestic software
industry promote the WTO
Government Procurement
Agreement as a means to
encourage more transparent and
non-discriminatory purchasing
procedures. To date, the
Agreement has 28 signatories,
who agree to treat the
suppliers of goods and
services from other signatory
countries no less favorably
than domestic suppliers,
regarding procurements covered
under the Agreement. For
information, visit the WTO Web
site at www.wto.org.
Intellectual Property
Protection
Software code is a
developer's principal asset
and must be protected from
unauthorized use, so the
protection of copyrights,
patents, trademarks, and trade
secrets should be a primary
goal of exporters, at least
for those with products
subject to piracy. The lack of
strong intellectual property
protection rights (IPR) laws
and lax enforcement are
significant trade and
investment barriers. U.S.
companies are more likely to
engage in technology-intensive
ventures in countries that
have meaningful IPR
protection; likewise,
countries with lax enforcement
are less likely to stimulate
local software development and
technological innovation. This
issue is particularly
important in the emerging
digital world, since the
Internet makes it relatively
easy to download and share
pristine copies of protected
works.
The illegal use of
intellectual property is an
on-going global problem,
especially for software and
other digital products. The
Business Software Alliance has
determined that the worldwide
piracy of business software
applications amounted to $13
billion in 2002, but as a
result of on-going efforts by
the public and private
sectors, the global piracy
rate has declined from 49 to
39 percent since 1994. The
highest regional piracy rates
are in Eastern Europe, Latin
America and Asia/Pacific. The
U.S. Government and the
domestic software industry
continue to promote strong IPR
laws and enforcement around
the world through instruments
such as the Special 301
process and the WTO Agreement
on Trade-Related Aspects of
Intellectual Property Rights
(TRIPS). See the United States
Trade Representative Web site
at www.ustr.gov
and the U.S. Patent and
Trademark Office site at www.uspto.gov.
The world's software
markets offer great potential
opportunities for U.S.
companies, but given the wide
variety of trade policy issues
regarding software, it is
important to check with
national customs authorities
when there is uncertainty
about particular regulations.
Companies can also contact one
of the U.S. Commercial Service
offices located in 108 U.S.
cities and over 80 countries.
To locate your nearest office,
visit http://www.export.gov/comm_svc/.
When it comes to exporting
software, there are also other
important topics, such as
market planning, pricing,
financing, distribution
strategies, packaging and
labeling requirements,
obtaining temporary work
permits abroad, and software
localization. A good place to
start with export questions is
the Trade Information Center
(TIC) in the U.S. Department
of Commerce where analysts can
direct you to useful public
and private sources of
information. Contact the TIC
at (800) USA-TRADE or visit www.export.gov/tic.
To Learn More
Please see the ICT Team
website: http://www.emich.edu/ict_usa
Date Updated: March 27, 2007
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