Software royalties: the ATO view on relevant Court decisions in TR 2026/2

On 4 September 2026, the Australian Taxation Office (ATO) finalised its long-awaited ruling on when payments for software and intellectual property (IP) are royalties that attract Australian royalty withholding tax. Taxation Ruling TR 2026/2 (the Ruling) replaces the earlier draft rulings on this topic and applies both before and after its date of issue. 

In the context of domestic case law analysis, the Ruling draws primarily on the High Court's 2025 decision in Commissioner of Taxation v PepsiCo Inc [2025] HCA 30 (PepsiCo). It also references the Seven Network decisions of the Federal Court ([2014] FCA 1411) and Full Federal Court ([2016] FCAFC 70) and the International Business Machines Corporation (IBM) decision, also heard by the Federal Court ([2011] FCA 335). 

For businesses that distribute, resell or provide access to software in Australia, it will be important to read the Ruling alongside the reasons of the Courts in these decisions. This Tax Alert focuses on the ATO’s view of these cases next to the relevant judicial reasoning so that taxpayers can consider both when reviewing their arrangements. Read our earlier Tax Alert for a summary of the Ruling and accompanying draft risk framework.

In several places in the Ruling, the ATO view builds on particular passages from those judgments to support a broad approach to identifying what a payment is "for". 

What the Ruling covers

TR 2026/2 considers when a cross-border payment made under a "software intermediation arrangement" is a royalty. Broadly, this is an arrangement under which an entity that does not own the IP in software (such as a local subsidiary or reseller) pays the owner or licensee so that it can earn income from the use of that software. Where a payment is a royalty, the non-resident recipient is generally subject to royalty withholding tax under section 128B of the Income Tax Assessment Act 1936, and the Australian payer is generally required to withhold.

The Ruling focuses on the royalty definition that appears in most of Australia's tax treaties. It notes that the treaties with the Netherlands, Italy, Singapore, the United States and Mexico contain material differences, so the ATO view may not apply in the same way to payments to residents of those countries. The Ruling does not deal with transfer pricing or the general anti-avoidance rules in Part IVA, which may also be relevant to these arrangements. As the Ruling applies both before and after its date of issue, it may be relevant to past as well as future payments.

The PepsiCo decision

PepsiCo concerned payments made by an unrelated Australian bottler to a concentrate manufacturer and supplier. These payments formed part of arrangements that also licensed the bottler to use PepsiCo's brands and other IP, for which no separate royalty was charged. The Commissioner argued that part of the price paid for concentrate was, in substance, a royalty for the use of the IP.

The High Court was divided on this question. Justices Gordon, Edelman, Steward and Gleeson (the Majority) concluded that the payments for concentrate were not consideration for the use of the IP. Chief Justice Gageler and Justices Jagot and Beech-Jones (the Minority) concluded that the payments did include a royalty component but agreed that royalty withholding tax was not payable because the income was not derived by the non-resident IP owner. The Commissioner's appeals were dismissed.

TR 2026/2 draws on the reasons from the Majority and the Minority. The key areas where it does so are outlined below.

What "consideration for" means

What the Majority said: The Majority accepted that "consideration for" in the royalty definition extends beyond its narrow contract law meaning to the purpose, basis or condition of a payment (at [160] to [161]). Their Honours said that whether a payment is "for" the use of IP "will always depend upon what the parties have agreed", and that the required causal connection is satisfied when the promise to pay "can be seen to be the basis for, or a condition of" receiving the right to use the IP. On the facts in PepsiCo, their Honours found that it could not (at [161]).

The ATO's view in the Ruling: The Ruling broadly agrees with the Majority position (paragraphs 15, 64 and 71). However, the Ruling extends the Court’s reasoning in two aspects. 

First, the Ruling states that the purpose, basis or condition of a payment must be established objectively (rather than “always” depending on what the parties have agreed). 

Secondly, the Ruling states that this formulation does not limit the principles developed in the stamp duty cases (paragraph 65); broadly, that “consideration” should receive the wider meaning that belongs to it in conveyancing rather than the precise meaning of the law of simple contracts. The Majority did not include such an express reservation in distinguishing the facts in PepsiCo from each of the leading stamp duty cases (at [165], [172]-[173]).  

Pricing, valuation and arm's length dealing

What the Majority said: At [174], the Majority noted that the Commissioner did not dispute that the concentrate price was an arm's length price, a fair price and not disproportionately high. Their Honours outline the principle that, where a price paid for goods has those characteristics, "it cannot be said that a part of the price paid for those goods is payment of a royalty". In that passage, the arm's length character of the price was the basis for concluding that no part of it was a royalty.

The ATO’s view in the Ruling: In contrast, the Ruling leaves open the possibility of finding an embedded royalty even where the relevant payment is demonstrably a fair, arm’s-length price for the goods that are supplied. The Ruling states that what a payment is for is ultimately a question of fact that is determined objectively: that the terms of the agreement are the starting point, and that other matters may also be relevant, including pricing and payment terms, valuation evidence and whether the parties are dealing at arm's length (paragraphs 12 and 68). 

The significance of an integrated arrangement

What the Majority said: The Majority accepted that the overall bottling arrangement was comprehensive and that the bottler's many commitments under it were what the IP owner received in return for granting the licence. Their Honours did not treat part of the separate concentrate price as a royalty, finding that the basis for the concentrate payments "was only the receipt of the concentrate" (at [173]). They described the Commissioner's approach as one which "oversimplifies what the parties agreed and misconceives the overall arrangement" (at [166]).

The ATO’s view in the Ruling: The Ruling favourably cites the Minority in PepsiCo in identifying whether an agreement is a “single, integrated and indivisible transaction” as relevant to determining what a payment is for (paragraph 15). Both the Majority at [166] and the Minority at [51] treated the arrangements in PepsiCo as integrated. Their disagreement concerned whether, on a proper construction of those arrangements, the concentrate payments included consideration for the IP rights.

Implied licences

What the Majority said: At [141], the Majority recorded that it was common ground between the parties that the bottling agreement contained an implied licence to use the IP, as the agreement could not otherwise operate. 

The ATO’s view in the Ruling: The Ruling cites the same paragraph [141]. However, its conclusion is that whether the use of an IP right is an implied term of the contract forms part of the starting point for working out what a payment is for (paragraph 68), omitting that the Majority’s end point of that inquiry was that the concentrate payments were not consideration for that implied licence.

Payments to intermediaries and related parties

What the Majority said: At [157], the Majority in obiter outlined the principle that a direction by a creditor to a debtor to pay a third party can be a payment to the creditor, but that there can be no payment by direction unless there is an antecedent monetary obligation. In PepsiCo, no such obligation was owed by the bottler to the IP owner, so the IP owner did not derive the amounts paid by the bottler to the seller of concentrate.

The ATO’s view in the Ruling: With reference to the same paragraph [157], the Ruling states that a payment need not be made to the IP owner directly and could be made to an intermediary or related party on behalf of the IP owner, but omits both the qualification of the antecedent obligation and that the Court found that this had not occurred in PepsiCo.

The Seven Network decisions

The Ruling also draws on the Seven Network decisions, which concerned payments for a live broadcast signal of the Olympic Games. The ATO's summary of several findings in those cases closely reflects the judgments, including that a live signal was not a cinematograph film in which copyright subsisted, and that the way the parties describe a subject matter does not determine its legal character. However, in two instances, the Ruling seems to extract a broader proposition from the Court’s fact-specific reasoning. 

On forbearance, the ATO view is that the payments were not for forbearance because they were merely for commercial exclusivity or contractual constraints unrelated to another element of the royalty definition (paragraph 88). However, the Full Federal Court's reasoning was framed more specifically. It found there could be no relevant forbearance simply because, under the Australian broadcasting licence regime, only Seven had the legal right to broadcast in Australia, and the payment was expressly for the signal rather than for any forbearance by another party (Commissioner of Taxation v Seven Network Limited [2016] FCAFC 70 at [97] to [98]).

The Ruling also cites the Full Federal Court in support of the general treaty interpretation principle that an undefined treaty term takes its meaning from the domestic law of the country applying the treaty (paragraph 92). However, in the relevant passage, the Court decided that whether copyright subsisted in the broadcast images and sounds had to be determined, in that case, under the Copyright Act 1968 (at [63]) and made no reference to this interpretation provision found in all of Australia’s comprehensive tax treaties.

The IBM decision and apportionment

In TR 2026/2, the ATO accepts that where a single payment covers both royalty items (such as intellectual property or know-how) and other things, the payment can generally be split ("apportioned") so that only the royalty part is treated as a royalty. The exception is where the other things are merely ancillary to, and provided to enable use of, the IP or know-how. 

The ATO points to the IBM case as an example of where no split was needed. In that case, although the Australian subsidiary was in practical terms a distributor of IBM software, the agreement only granted IP rights, know-how and ancillary rights, so there was nothing outside the royalty to separate out. However, the ATO goes further than IBM by suggesting that where IP rights are inseparable, from a practical and business perspective, from the other things being paid for, the whole payment may be treated as a royalty. In our view, this reaches beyond what IBM decided. It also sits uneasily with the PepsiCo and Seven Network cases, where apportionment was either assumed or accepted by the ATO without dispute. In Seven Network, for example, the ATO agreed that only 10% of the payment for exclusive Olympic broadcast rights was a royalty.

TR 2026/2 provides the ATO's final view on the character of software and IP payments, and taxpayers who rely on it correctly are protected. The Ruling draws on the reasons of the High Court in the PepsiCo, and the Full Federal and Federal Courts in the Seven Network and the IBM decisions to support its approach. Reading the relevant passages of those judgments alongside the Ruling shows the context in which each principle was expressed, and how the Court applied it to the facts before it.

Businesses that make cross-border payments for software, including local distributors, resellers and cloud service providers, should consider reviewing their arrangements to understand how the Ruling and the judicial reasoning in the case law may apply. Areas to focus on include what the contracts objectively provide the payment is for, whether there are separate agreements for different supplies, how prices are set and whether there is evidence that they are at arm's length. 

Because the Ruling applies to past as well as future years, and related party arrangements may also raise transfer pricing questions, it would be prudent to review both existing positions and new agreements.

Please contact us if you would like to discuss how TR 2026/2 may apply to your business.