''But we'll never be royalties, royalties!'' ATO expands characterisation of software payments

The Australian Tax Office (ATO) has recently updated its draft Taxation Ruling TR 2024/D1, which deals with the characterisation of payments in respect of software and intellectual property rights.

The updated draft ruling broadens the circumstances in which the ATO considers payments relating to software and other intangible property rights to be 'royalties', thereby expanding the number of payments under software arrangements that may be subject to royalty withholding tax in Australia.

This article provides an overview of the new draft ruling and summarises the types of payments the ATO will consider to be a royalty, as well as the broader implications of the ruling for businesses dealing with software and other intellectual property rights.

Stephen Dyason

What does Draft Taxation Ruling 2024/D1 cover?

Draft Taxation Ruling 2024/D1 (the Draft Ruling) addresses circumstances in which the Commissioner will consider payments which are made under software arrangements as royalty payments. If such payments are considered to be royalties, they will therefore be subject to royalty withholding tax in Australia.

Royalty withholding tax applies to payments of royalties which are made either by Australian resident entities, or by non-residents who operate in Australia through a permanent establishment, to non-residents.

As such, the Draft Ruling deals with cross-border payments made under software arrangements where the relevant payment is flowing out of Australia. Where applicable, the relevant tax must be deducted from these payments and remitted to the ATO.

How does the Commissioner classify payments?

The Draft Ruling expands the types of payments under software arrangements that could be deemed to be a royalty.
The Draft Ruling includes a list of the types of payments which will and will not be characterised as royalties. These items are set out in the below table:

Payments which are Royalties Payments which are NOT royalties
Grant of IP Rights: The grant of a right to use Intellectual Property (IP), regardless of whether that right is exercised. Software Distribution: 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.
Use of IP Rights: The use of an IP right. Software Copyright Transfer: Consideration for the transfer of all rights relating to the copyright in software.
IP Right Know-how: The supply of 'know-how' (that is - scientific, technical, industrial or commercial knowledge or information) in relation to an IP right. Services not related to IP: 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
Embedded Software with grant of IP Rights: The sale by a distributor of hardware with embedded software, where the distributor is granted or uses rights in the IP of the software. Embedded Software without grant of IP Rights: 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)
Enabling Application or Enjoyment: The supply of assistance furnished as a means of enabling the application or enjoyment of the relevant property or right, or knowledge or information. Acquisition of media with software storage: 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)

What is the significance of the Draft Ruling?

In light of the views expressed by the ATO in the Draft Ruling, a broad range of electronic software arrangements may potentially be subject to royalty withholding tax, including some which might otherwise have been thought not to include royalties.  Other types of software related agreements which will potentially fall within the scope of the Draft Ruling, include payments made in relation to software licencing, as well as cloud-based, subscription-based software as a service (SaaS) distribution models.

A large number of parties may be effected by this updated approach, including software distributors and owners, and taxpayers that provide software embedded within other transactions, such as intangible goods or services. There are also implications for Australian subsidiaries of global groups that make copyright related payments in order to earn income relating to the use of, or right to use, certain software.

The Draft Ruling therefore has significant tax implications and merits close attention as to how certain payments are likely to be treated by the ATO.

How can business dealing with software and other IP rights best manage these developments?

With the Draft Ruling in mind, it is in the interests of businesses engaged in software distribution to thoroughly review agreements to establish how rights and obligations are allocated between parties.   
Australian companies that work with multinational groups, where software is sold to Australian end-users need to plan ahead and carefully consider how the payments for these rights are structured in future agreements.

If you think that you will be impacted by the developments discussed in this article, you should consider how your circumstances apply to the new classifications of payments under software arrangements in order to mitigate potential tax implications.

More Information from Maddocks

For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Tax and Structuring team.

More Cleardocs information on related topics

You can read earlier Clear Law articles on a range of topics, such as:

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Last revised on : 03-04-2024

Lawyer in Profile

Stephen Dyason
Stephen Dyason
+61 3 9258 3247

Qualifications: LLB, Deakin University

Stephen is a member of Maddocks Commercial team. He is a corporate and commercial lawyer, who assists clients across a diverse range of industries including financial services, consumer markets and manufacturing in a wide variety of legal matters.

His experience includes:

  • mergers and acquisitions,
  • corporate reorganisations, and
  • general commercial law work.

He focusses on drafting, advising on and negotiating contracts, transactions and agreements for clients and also assists with providing general corporate advice.

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