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Updated draft software tax ruling published by ATO

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  • 4 minute read
  • January 19, 2024

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The ATO has published its updated view on the character of payments made under software arrangements in a new draft Taxation Ruling. The draft ruling (TR 2024/D1) will be relevant to software distributors and software owners and includes coverage of arrangements involving digital software distribution, cloud computing arrangements, including software-as-a-service, and packaged software. It also has the potential to cover a broader range of scenarios, such as other technology-based enterprises, and circumstances where software is ‘embedded’ within tangible goods. 

19 January 2024

In Brief

The Australian Taxation Office (ATO) has released draft taxation ruling, TR 2024/D1: Income tax: royalties – character of payments in respect of software and intellectual property rights (the draft ruling), which sets out the Commissioner of Taxation’s (Commissioner’s) views on when amounts paid from Australia under a ‘software arrangement’ are subject to royalty withholding tax. 

The draft ruling is a comprehensive rewrite of a previous draft taxation ruling (TR 2021/D4) issued in June 2021, although the Commissioner’s underlying proposition to apply a ‘rights based’ approach does not appear to have changed. TR 2021/D4 itself replaced a widely used and accepted taxation ruling issued in 1993 dealing with computer software (TR 93/12). 

The draft ruling will be relevant to software distributors (broadly defined) and software owners with coverage of arrangements involving digital software distribution, cloud computing arrangements, including software-as-a-service, and packaged software. The draft ruling has the potential to cover a broader range of scenarios, such as other technology-based enterprises, and circumstances where software is ‘embedded’ within tangible goods. 

In Detail

In summary, the draft ruling: 

  • Applies to cross-border payments made under a ‘software arrangement', which is defined as: 

    ‘an agreement, arrangement or scheme under which a distributor makes payment or payments directly or indirectly to the owner or licensee (as the case may be) of the copyright (or other IP) for the right to be in a position to earn income relating to the use of, or right to use, software’

    and with software taking its ordinary meaning. The draft ruling goes on to state that the payment need not be direct to the IP owner, but could be to an intermediary or related party of the IP owner and still be in scope. 
  • Adopts a technical approach to the identification of payments as royalties for the use of, or right to use, copyright with a focus on whether distributors have rights to undertake (or otherwise undertake) acts in respect of software, which are the exclusive rights of the copyright owner under the Copyright Act 1968 (such as the acts of reproduction, communication, adaptation, etc). This includes commentary of the Commissioner’s view relating to those acts and the Commissioner’s view that the authorisation of end users to undertake those acts is itself an exclusive right (for example, where an intermediary enters into a licence agreement with an end user). 
  • Considers that payments for the following will be royalties where they are paid as consideration for: 
    • the grant of a right to use copyright (or other IP), regardless of whether that right is exercised; 
    • the use of copyright (or other IP); 
    • the supply of know-how in relation to the above; 
    • the supply of assistance furnished as a means of enabling the application or enjoyment of the supply; or 
    • the sale by a distributor of hardware with embedded software, where the distributor is granted or uses rights in the IP of the software. 
  • Considers that payments for the following will not be royalties: 
    • consideration that is wholly for the grant of a right to distribute copies of a computer program, without the use of, or right to use, the copyright or another IP right;  
    • consideration for the transfer of all rights relating to the copyright in software; 
    • payments from a distributor that are consideration wholly for the acquisition of hardware with embedded software (provided that the distributor does not use, and is not granted the right to use, any copyright or other IP right in the embedded software);  
    • payments from a distributor that are consideration wholly for the acquisition of physical carrying media on which software is stored (provided that the distributor does not use, and is not granted the right to use, any copyright or another IP right in the embedded software); or  
    • consideration for the provision of services that are unrelated to copyright (or other IP) right or any scientific, technical, industrial or commercial knowledge or information. 
  • Now considers the overlay of Australia’s tax treaties, which will be critical in many cases. This includes an acknowledgement of the relevance of commentary on the model tax treaty from the Organisation of Economic Cooperation and Development (OECD) and consideration of some relevant parts of the OECD commentary. Aside from a very specific scenario in the OECD commentary on the distribution of copies of a computer program (being the scenario in Paragraph 14.4 of the commentary to Article 12), the Commissioner’s view is that ‘the term ‘copyright’ in this Ruling has the meaning that it has under the Copyright Act for the purposes of the tax treaty and the domestic tax law definition of royalty’ because copyright is not defined in Australia’s ‘standard’ tax treaties. The ruling can be viewed as selective in the OECD commentary it refers to, it does not consider the changes in the OECD commentary over time, and seems to take the approach that the current commentary applies to all treaties, even though Australian court decisions indicate that the starting point is the commentary as it stood at the time the particular treaty was signed. 
  • Notes that the terms of the Licence Agreement are relevant to, but not determinative of, the characterisation of the payment. The payments under the Agreement are characterised from a practical and business point of view. 
  • Considers, in detail, the components of the definition of a royalty under both Australian domestic law and the common wording used in Australia’s tax treaties. This includes the terms ‘however described or computed’, ‘consideration’, ‘for’, ‘to the extent’ and ‘use’. 
  • Removes all previous eight examples contained in TR 2021/D4 and replaces them with three scenarios. The first two scenarios are very detailed and both suggest that the full amount of the payment is a royalty. The third scenario covers a consideration of an apportionment under fairly simple circumstances. 
  • Does not appear to provide significant commentary to assist in a fair and reasonable apportionment of a payment to determine a royalty component. However, the Commissioner’s position suggests that the full amount of a payment will be a royalty where rights to use copyright (or other IP) are ‘inseparable, from a practical and business point of view any other things for which consideration is paid’. This comment is based on the 2011 Federal Court IBM decision and the features of a 1987 contract, and therefore may warrant comparison to contemporary agreements.  
a group of people testing AI drone software

Once finalised, the draft ruling is proposed to apply both before and after its date of issue. However, it is recognised that TR 93/12 can apply prior to its withdrawal (on 1 July 2021) where it has been ‘appropriately relied upon’. No comments were made in respect of how the ATO will apply its resources in reviewing historic positions and whether it will pursue royalty withholding tax over multiple previous income years. 

A compendium to TR 2024/D1 was also published. The compendium sets out the ATO’s responses to matters provided in submissions following the release of TR 2021/D4. 

The ATO has invited comments on the draft ruling, particularly inviting comments on what further guidance the ATO could issue in respect of its compliance approach and apportionment broadly, to be made by 1 March 2024. 

The Takeaway

Foreign companies and local distribution entities involved in the software industry, technology-based enterprises, and distributors of tangible goods with a software component should consider the potential application of the draft ruling and the impact of the revisions from TR 2021/D4. This may require a detailed analysis of existing legal agreements, the rights provided to the relevant parties under those agreements, the relevant tax treaty, and consideration of how Australian intellectual property law applies to arrangements. It may also be necessary to consider whether TR 93/12 has been appropriately relied upon and whether apportionment of a payment is relevant.

Contact us

If you would like to further discuss the draft ruling, reach out to our team or your PwC adviser.

Jonathan Malone

Partner, Global Tax, Sydney, PwC Australia

+61 408 828 997

Email

Chris Hogger

Director, Melbourne, PwC Australia

+61 413 239 513

Email

Angela Danieletto

Partner, Sydney, PwC Australia

+61 410 510 089

Email

Ross Malone

Partner, Tax, Sydney, PwC Australia

+61 2 8266 5033

Email

Bianca Wood

Partner, Global Tax, PwC Australia

+61 (2) 8266 2792

Email

Clementine Thompson

Partner, Global Tax, PwC Australia

+61 413 089 431

Email

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