Australia: ATO revises guidance on tax treatment of software royalties
ATO guidance on tax treatment of software royalties
ATO guidance on tax treatment of software royalties
The Australian Taxation Office (ATO) released a draft ruling dealing with the circumstances when a payment made in connection with the licensing and distribution of software is a royalty for Australian income tax (including royalty withholding tax) purposes.
The draft ruling TR 2021/D4 Income tax: royalties – character of receipts in respect of software considers issues in the context of current software distribution models and of cloud-based distribution models in particular. The draft ruling provides eight examples of when payments are either likely to be classified as royalties or are not to be classified as royalties. These examples are intended to cover the majority of commercial arrangements that involve the distribution of software licenses and related services.
The draft ruling suggests many payments made by software distributors to software copyright owners could be royalties for Australian tax purposes. Relevantly, such distributors can include:
- Distributors that have solely the right to sub-license simple use software to end-user customers
- Distributors of software-as-a-service product offerings
Notably, the tax outcomes for some of the examples provided in the draft ruling may be different to the tax positions global groups may have taken to date based upon a prior, now withdrawn tax ruling (TR 93/12 (withdrawn)). Consequently, in light of the ATO’s views expressed in the draft ruling, global groups that pay software-related distribution fees to offshore entities may need to review their tax position as it relates to the tax classification of those payments.
Summary of ATO’s position in the draft ruling
The draft ruling outlines when the ATO considers a payment would, or would not, be a royalty and has particularly focused on what would constitute a payment for “the grant of a right to do something in relation to software that is the exclusive right of the owner of the copyright.” Broadly, the concept of what is the “exclusive right of the owner” of the software copyright is the underlying basis of the ATO’s approach in determining whether a payment is a royalty or not.
The ATO appears to have taken a strict legal position in interpreting what is a payment for the “right to use copyright” and the draft ruling references the exclusive rights of the owner of the copyright for the purposes of the Copyright Act 1968 to determine whether a payment would be a royalty for Australian tax purposes. Consequently, the draft ruling indicates payments for the following are generally royalties:
- A right to reproduce or modify a computer program (including a right to make an adaptation of the program)
- Certain rights relating to communicating a copyright work to the public
- A right to sub-license the use of the software (regardless of whether the software is distributed by way of physical carrying media, digital download or cloud-based technology)
- The supply of know-how in relation to software (such as the supply of source code)
- The supply of assistance in enabling the application or enjoyment of a computer program or software, other than assistance relating to the simple use of the software
The draft ruling states that payments for the following are not royalties:
- Simple use rights in relation to software (a “simple use license”)—this may typically be pursuant to a shrink wrap, clip wrap, click-through or browse-wrap end-use license agreement, where the end user either accepts or rejects the terms by selecting “accept” or “cancel” (or the like)
- Services relating to the modification or creation of software
- The sale of goods where hardware and software are sold to an end user in an integrated form without being separately priced and the end user is only granted a simple use license in the embedded software
- The sale of physical carrying media on which software is stored, where the end user only obtains a simple use license
The draft ruling indicates that the finalized ruling will apply both prospectively and retrospectively. However, the ATO acknowledges that TR 93/12 (withdrawn) can apply prior to 25 June 2021 to the extent that a taxpayer has relied on it.
All distributors of software that have made payments in the past to non-residents under software distribution agreements, particularly if they have not treated the payments as royalties, need to review their position (both existing and past) with regard to the draft ruling. Considerations may include the following:
- Under certain distribution agreements, when the distributor obtains no rights to use the copyright in the software, the distributor needs to review whether the payments it makes to the copyright owner or software licensor may be treated as not being royalties under the draft ruling.
However, taxpayers also need to consider whether such agreements in fact reflect the actual commercial relationship between the various parties (e.g., for highly specialized software programs, the distributor may acquire rights to modify the source code of the program to enable it to integrate or customize the software to meet specific needs of the customer). Taxpayers also need to consider whether any other Australian income tax law could apply to the arrangement, such as the Multinational Anti-Avoidance Law.
- Groups that may be restructuring their Australian business model need to review whether a different royalty treatment may arise having regard to the guidance provided in the draft ruling that may involve consideration of consultation with the ATO in relation to any proposed new Australian business model.
For more information, contact a KPMG tax professional in Australia:
Paul Sorrell | +61 2 9335 8613 | firstname.lastname@example.org
Malcolm Gordon | +61 2 9335 7037 | email@example.com
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