''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.

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:

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:

• Highway to the 'low-risk zone': a new approach for foreign companies and Australian tax residency
• Commissioner changes guidance: how amendments to Taxation Ruling 2022/4 impact the role of tax planners and financial advisors with regard to reimbursement agreements
• Crackdown! ATO ramps up pursuit of unpaid taxes

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