ATO finalises its software royalty ruling and opens consultation on a new risk framework

On 4 September, the Australian Taxation Office published its long-awaited final view on when cross-border payments made by software distributors are royalties in Taxation Ruling TR 2026/2. At the same time, the ATO released draft Practical Compliance Guideline PCG 2026/D4, which sets out a five-zone risk framework that taxpayers are expected to use to self-assess their royalty withholding tax risk. The draft PCG is open for an initial period of consultation until 2 October 2026, and introduces an entirely new ‘residual risk assessment calculation’ to test apportionment concepts.

TR 2026/2 finalises draft ruling TR 2024/D1 and applies to payments made both before and after its date of issue. The Commissioner has not offered a transition period, and has declined stakeholder requests that were made during consultation for prospective application on the basis that the ruling reflects a longstanding practice rather than a change of view. The finalised ruling removes the commercial rental arrangement analysis and the computer games apportionment scenario, with the practical guidance on apportionment risk now sitting in PCG 2026/D4 instead. However, the non-binding explanation to the ruling suggests the ATO has expanded their view of in-scope rights arising from ‘technological protection measures’, where such measures provide an intermediary with the ability to control end user access, including by the ability to control log-on or a payment portal that precedes the end user’s access to software.

The ATO also published a Decision impact statement on the Full Federal Court’s decision in Oracle Corporation Australia Pty Ltd v Commissioner of Taxation [2025] FCAFC 145. The Court stayed the substantive proceedings pending the completion of the Australia-Ireland mutual agreement procedure, which means the judicial test of the ATO’s royalty position has been deferred.

What TR 2026/2 says

TR 2026/2 considers when a payment made under a software intermediation arrangement is a royalty for Australian income tax purposes and is therefore subject to royalty withholding tax. It applies to cross-border payments made by an Australian resident, or by a non-resident where the payment relates to an Australian permanent establishment, and it focuses on software distributors and other intermediaries rather than end users.

The ruling is framed around what the ATO calls the standard tax treaty definition of royalties, which is used in most of Australia’s treaties. Where a payment is a royalty under that definition, the ATO considers it will also be a royalty under the broader domestic definition. The ruling flags that Australia’s treaties with the Netherlands, Italy, Singapore, the United States and Mexico depart in material ways from the standard definition, so some of the principles in the ruling may not apply to arrangements with counterparties in those jurisdictions.

The characterisation exercise is heavily fact dependent. The ruling adopts the principles established by the High Court in Commissioner of Taxation v PepsiCo Inc [2025] HCA 30, namely that:

• 'consideration' is what moves the payment - that is, its purpose, basis or condition;

• the enquiry looks to the express and implied terms of the agreement, the surrounding circumstances and the conduct of the parties;

• the totality of what moved the grantor to provide the rights is relevant, rather than isolating the performance of a single promise and treating it as the consideration for everything received, and this should reflect consideration of the wholistic undertakings between the parties under the relevant agreements (monetary and non-monetary) ; and

• labels are not decisive - describing a party as a 'distributor', or describing rights as 'royalty-free', does not determine the character of the payment.

The binding part of the ruling identifies payments that are royalties, including consideration for the grant of a right to use intellectual property (whether or not the right is exercised), the use of an intellectual property right (including the exclusive right to authorise others to do acts comprised in copyright), the supply of know-how, ancillary assistance, the use of intellectual property in software embedded in tangible goods, and forbearance (where relevant in certain treaties). It also identifies payments that are not royalties, including consideration solely for the right to distribute copies of a computer program made by the copyright holder, consideration wholly for an assignment of all copyright rights, payments wholly for tangible goods or physical media where no intellectual property right is used or granted, and payments wholly for services unrelated to intellectual property or know-how. Where an amount is consideration for several things, apportionment on a fair and reasonable basis may be required.

Three examples in the ruling illustrate the approach:

1. The first example involves an Australian distributor that grants end user licences and enters into cloud services agreements with customers. It cannot do either without exercising copyright rights, including the right to authorise reproduction and the right to communicate the software to the public, so it is treated as using those rights. The whole payment is a royalty, subject to withholding tax at the treaty rate of 10 per cent, and there is no apportionment.
2. In the second, the agreement says nothing about intellectual property at all, but there is still a royalty because the arrangement cannot be performed without the relevant rights. Apportionment is possible here, though only where the distributor can show that the distribution rights have value independent of the intellectual property rights, so the evidentiary burden sits with the taxpayer.
3. The third example is new and sits in the non-binding part of the ruling. It deals with when the right to authorise an act comprised in the copyright is actually exercised, as opposed to merely facilitated. On the ATO's view the example is very broad: giving customers the credentials or even just the instructions needed to download and install is enough, and it makes no difference that the copyright rights are only implied, that someone else provides the licence key, or that the end-user licence agreement setting out the right to download a copy is between the customer and the IP owner rather than the distributor.

Key changes from the draft ruling

A compendium released with the ruling responds to some of the issues raised during the consultation period for the earlier draft ruling TR 2024/D1. The ATO amended and expanded its position in important areas and clarified its position in a number of others, but held firm on the points of greatest commercial focus for taxpayers.

On scope, the draft term 'software arrangement' has been replaced with a tightened definition of 'software intermediation arrangement', reinforcing that the ruling is directed at intermediaries and not end users. The final ruling no longer defines 'software', although a description remains in the non-binding explanation.

The most substantive change is the removal of the commercial rental arrangement analysis. The ATO accepted that a commercial rental arrangement under the Copyright Act 1968 is less likely to be found in the kinds of software intermediation arrangements contemplated, and the discussion has been removed from the ruling. Example 3 of the draft ruling, which dealt with the distribution of physical copies of computer games and included the ATO's views of reasonable apportionment, has also been dropped, with the ATO pointing to PCG 2026/D4 as the appropriate place for guidance on apportionment risk. Requests for prescribed apportionment methodologies were not taken up, and the PCG expressly declines to prescribe any particular approach.

Other clarifications include an expanded discussion of access control technological protection measures, recognition that the right to publish or perform the work in public under the Copyright Act may be relevant, a simplified treatment of the international copyright regulations, and the addition of Example 3 on authorisation. Although framed as clarifications, these are likely to expand the practical reach of the ruling: for example, the ATO regards routine controls such as requiring an online account, a licence key or an activation step before software can be downloaded or used as access control measures, and treats the publication right as engaged where copies are supplied to the public. The ATO suggests that the activation step may be as simple as the creation of an online user account to download or activate the software or requiring users to input payment details, such as a credit card, before access to the software is made available. On that view a distributor may be found to use copyright rights even where its agreement is silent about intellectual property, and the same access controls separately trigger an amber zone indicator under PCG 2026/D4. The final ruling also removes the draft's reliance on goods and services tax concepts of consideration, relying instead on the PepsiCo case.

In spite of several submissions, the ATO’s view did not result in change on many other important issues. The ATO maintained its broad reading of ‘other like property or right’, its position that paragraph 14.4 of the OECD Commentary depends on facts that are usually not present in modern software arrangements, and its view that where a payment is un-dissectable the entire amount may be characterised as a royalty. 

Importantly, the retrospective date of effect has been retained, on the basis that the principles in the ruling reflect how the ATO has sought to apply the law as a longstanding practice. TR 93/12 continues to apply to periods before its withdrawal in 2021 to the extent it was appropriately relied upon, but no transitional relief has been offered for taxpayers who now wish to restructure, and the ATO declined to rule out the application of the general anti-avoidance provisions while providing caution in relation to relevant restructures in the practical guidance (discussed below).

The new compliance framework in PCG 2026/D4

PCG 2026/D4 replaces and expands the earlier draft guideline PCG 2025/D4 issued in August 2025 and, when finalised, is proposed to apply to arrangements entered into both before and after its date of issue. It is intended to be read together with TR 2026/2, and it allocates arrangements to one of five risk zones which reflect the likelihood of the ATO applying compliance resources rather than the likelihood that the law has been applied incorrectly.

In the absence of a PCG risk zone self-assessment (or where such an assessment cannot be evidenced), a taxpayer will automatically fall in the 'medium to high risk' amber zone.

The residual risk assessment calculation is a quantitative test of apportionment. It compares the royalty with the residual amount, being the payment less the offshore supplier's costs of manufacturing, intermediation or distribution on its sales to the Australian taxpayer, plus a 5 per cent mark-up on those costs. Related party royalties, amortisation of intangibles, stock-based compensation and costs unrelated to Australian sales are left out of that cost base, and costs must be reasonably allocated where the supplier also sells to others. A reasonable and best efforts calculation is accepted, and the ATO has flagged that the 75 per cent threshold will be confirmed after consultation.

In practice this is likely to be difficult to apply, because it requires cost data for the offshore supplier traced to Australian sales and split between manufacturing, intermediation and distribution activities, with specific categories stripped out. This information is unlikely to be currently maintained in a relevant form, and which the Australian taxpayer may not control or be able to verify. The practical question about how many years back this cost analysis can go is also relevant.

The PCG warns separately that a change to, or restructure of, agreements that reduces or avoids Australian royalty withholding tax may attract compliance attention regardless of the risk zone, and that the transfer pricing rules in Subdivisions 815-B and 815-C and Part IVA including the diverted profits tax (DPT) and the multinational anti-avoidance law (MAAL), may also be relevant. The example given is a restructure under which Australian customers contract with an offshore subsidiary while the Australian activities continue.

The nine worked examples at the back of the PCG show where the ATO sees the boundaries. Seven of the examples land in green, one in amber and one in red, and there is no yellow zone example, despite yellow being where a recognised royalty that falls short of the thresholds is expected to sit. Three are worth noting:

• Example 1 is the only related party distributor that reaches green. An Australian subsidiary resells its parent's downloadable and cloud software with no express licence to any intellectual property, and qualifies only because the parties recognise part of the payment as a royalty, withhold on it, document the rate, self-assess above 75 per cent of the residual amount and have not restructured to reduce the royalty.

• Example 8 is amber and is closest to a mainstream reseller: an exclusive right to market and distribute enterprise software, expressly no right to copy or modify it, with customer subscription fees remitted offshore less a distribution margin. Customers contracting with the Australian entity for access, and paying a subscription rather than a one-off perpetual price, are enough to keep it out of green.

• Example 9 tips into red where the distributor holds a limited right to copy and the recipient is resident in a specified jurisdiction, on facts involving 97 per cent of net product revenue paid offshore for rights described as royalty-free.

The ATO's response to the Oracle decision

The Oracle proceedings are the vehicle through which the position now expressed in TR 2026/2 was to be tested. The dispute concerns whether payments by Oracle's Australian entities to an Irish group licensor for the right to distribute software in Australia are royalties under the Australia-Ireland treaty and the domestic definition. Oracle sought to stay the Federal Court proceedings pending completion of the mutual agreement procedure between Australia and Ireland, including any arbitration. The Commissioner successfully opposed the stay at first instance on the basis of the broader public interest in a judicial determination.

On 21 October 2025, the Full Court allowed Oracle's appeal and stayed the substantive proceedings. It found that the Commissioner had not led sufficient evidence that Oracle's arrangements were similar enough to those of other taxpayers for a decision to provide broader guidance, and that correspondence from the United States Treasury was not sufficient evidence of broader uncertainty about the meaning of 'copyright' in Australia's treaties. The decision does not determine how software payments are characterised.

In its Decision Impact Statement, the ATO accepts that the findings on the evidence meant Oracle was not a suitable case in which to seek special leave to appeal to the High Court. The Commissioner recognises the mutual agreement procedure as an important mechanism for resolving double taxation, but states that where bilateral or administrative processes do not deliver sufficient clarity for consistent treaty administration, judicial consideration remains appropriate. Notably, the ATO acknowledges the extensive feedback received on TR 2026/2 and the complexity of applying established royalty principles to modern business models, and says a court decision would provide welcome guidance. It will continue to look for opportunities to obtain judicial clarification, and where it opposes a stay on public importance grounds in future it will have regard to the Full Court's comments about the need for more detailed evidence, including evidence of other taxpayers' arrangements.

The finalisation of TR 2026/2 removes the uncertainty about whether the ATO would proceed with its position, but it does not resolve the underlying legal question, and the stay in Oracle means an authoritative answer from the courts is now some way off. In the meantime, the ruling applies to past as well as future payments, so any Australian business that pays an offshore related party or supplier for the right to distribute, resell or provide access to software should revisit its position for periods already lodged as well as for the current year, having regard to the updated ruling including the ATO’s broader views in relation to technological protection measures.

The practical work now sits with PCG 2026/D4, albeit this remains subject to a further consultation process. Self-assessment against the PCG risk zones is effectively expected rather than optional, given that a failure to self-assess risk zones results in an amber rating. Taxpayers can map their arrangements against the draft PCG zone criteria, gather the evidence needed to support the rating, and, where a royalty is recognised, test the amount against the 75 per cent and 50 per cent thresholds for undissected payments for the purposes of quantifying risk. Groups that are considering changing their contractual arrangements should do so with care, as the PCG signals that restructures which reduce Australian withholding tax will attract attention under the transfer pricing and anti-avoidance provisions.

The draft PCG consultation period is a genuine opportunity to shape the final framework, particularly the residual risk threshold, the operating margin exception and the scope of the simple distribution category in the green zone. Comments on the draft PCG are due by 2 October 2026, and comments on the Oracle Decision impact statement are due on the same date.