In draft Taxation Ruling TR 2024/D1, released Jan. 17, the Australian Taxation Office takes a wide view of when royalty withholding tax applies to payments made to foreign copyright owners for intellectual property rights. This view is based on a broad interpretation of when there is “use” of IP.
The ATO’s views are considered to be a significant change in position that is out of step with the international community. If the ATO’s draft view is finalized, it will likely have a significant impact on international arrangements for the delivery of software (and potentially other forms of IP) into the Australian market.
Potential financial exposure could be retrospective due to no time limits applying to the ATO’s ability to impose an obligation to pay royalty withholding tax.
Submissions regarding the ruling close March 1, but it seems unlikely that the ATO will change its position.
As the ruling is an expression of the ATO’s views (and not law), it will be important for multinational groups with Australian subsidiaries to consider whether to modify their arrangements to address ATO concerns or prepare to defend their current positions.
Change in Position
The new draft ruling is a revised version of an earlier draft published in 2021, TR 2021/D4. Both drafts represent a significant change in position compared to the ATO’s previous ruling on the subject, TR 93/12.
In broad terms, the main change has been that whereas the ATO formerly seemed to accept that there wouldn’t be a royalty where there was only “simple use” of software copyright, it now takes a more legalistic approach to the concept of “use” based on the rights that are exercised under the Australian Copyright Act.
This broadens the circumstances in which the ATO thinks a royalty will apply. It also leads to an approach that seems to favor legal form over substance and appears to give rise to inconsistent outcomes—for example:
- The ATO concludes that royalty withholding tax applies to payments made by a distributor to the copyright owner, whereas there would be no withholding tax if the end user made the equivalent payments directly to the copyright owner.
- The ATO’s conclusions differ based on the technology used to distribute software where the distributor is in substance performing the same role/function. A distributor of software packaged in a physical medium doesn’t pay a royalty, whereas a distributor that provides access to the software via the internet will.
After two years, the updated draft ruling is twice as long. The ATO has added further details to its reasoning and analysis, but there has been no change in its more controversial conclusions.
Also, the ATO has removed the examples that clarified when it thought royalty withholding tax doesn’t apply, which potentially introduces additional uncertainty.
The ATO has expanded its consideration of Australia’s tax treaties. However, this is confined to Australia’s “standard” treaties. The US, Mexico, and Singapore treaties aren’t considered “standard” for these purposes.
Further, the ATO has indicated that it hasn’t consulted with the other competent authorities. Rather, the purpose of the ruling is to express its own view, which other competent authorities can then consider. This doesn’t provide much assistance to taxpayers if the other competent authority ultimately disagrees with the ATO and the matter can’t be resolved under the relevant treaty (assuming there is one in place between the relevant jurisdictions).
The ATO’s view on the amount to be recognized as a royalty is that “if the software arrangement has no value or substance without the use of IP rights, then all the payments under the arrangement will be royalties.” The ATO will consider apportionment: However, it will be up to the taxpayer to establish through evidence the basis for apportionment.
These issues were raised in submissions on the earlier draft and likely will be repeated in submissions on the new draft ruling. However, it is unlikely that the ATO’s positions will change significantly.
Other Developments on Intangibles
The new draft ruling should be viewed in conjunction with other recent developments in the Australian tax landscape, which demonstrate the increasing focus of the ATO and the Australian government on intangibles.
On Jan. 17 the ATO published practical compliance guideline PCG 2024/1. This puts taxpayers on notice that the ATO will review arrangements it sees as high risk, such as where intangible assets have moved offshore and/or the value of Australian activities connected with the intangible assets aren’t appropriately recognized.
Taxpayers should review their intangibles arrangements and self-assess their risk under the ATO’s framework. While not all taxpayers will be required to proactively disclose their self-assessment to the ATO, it will help them prepare for a potential ATO review.
On Nov. 30, 2023, the Federal Court gave its decision in PepsiCo, Inc v Commissioner of Taxation. Payments made by an Australian bottler to an unrelated Australian concentrate distributor were found to include an embedded royalty that was subject to withholding tax.
The court deemed that legally there was a payment to the foreign brand owner—even though no funds were ever received by that entity.
The case is also noteworthy as being the first to consider Australia’s diverted profits tax (although it wasn’t decided on that basis). PepsiCo has appealed the decision and we can expect more cases in this area in the years to come.
Finally, the ATO appears to have the support of the Australian government to collect more tax in relation to intangibles. Draft legislation was released in June 2023 that, if enacted, would deny deductions for certain payments that relate to intangible assets connected with low corporate tax jurisdictions.
The draft legislation is working its way through the consultation process. However, it demonstrates the government’s willingness to propose new legislation to support the ATO’s views on the taxation of intangibles arrangements.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Annemarie Wilmore is partner with Johnson Winter Slattery and is experienced in Australian tax issues including international tax, anti-avoidance provisions, transfer pricing, and the taxation of intangible assets.
Kathryn Bertram is tax partner with Johnson Winter Slattery, specializing in tax risk management, including reviews, audits, alternative dispute resolution, and litigation, at federal and state level.
Don Spirason is special counsel with Johnson Winter Slattery, advising clients on all areas of tax including transfer pricing, tax policy and transparency, transactions, tax disputes, and engagement with regulators.
Write for Us: Author Guidelines