The recently released ATO draft taxation ruling TR 2024/D1 has significant impact on taxpayers once finalised.
If you have a software arrangement with an overseas provider, and:
1. distribute or resell software in Australia
2. pay a subscription fee for a software as a service (SaaS) solution
3. are granted or have a right to use intellectual property (IP)
4. sell hardware with embedded software
then review your software arrangements as the payments you make could be characterised as “royalties” attracting withholding tax.
Once the ruling is finalised, it will apply retrospectively and prospectively.
If your payments are characterised as “royalties”, then you could be liable for increased tax liability either at the prevailing treaty rate, or otherwise at the domestic royalty withholding tax rate of 30% if there is no tax treaty.
This is a significant implication for overseas software and technology providers with existing or proposed new software licencing, distribution or SaaS agreements with their related parties or end-users in Australia.
Payments that constitute a “royalty” for software arrangements has been broadened with significant tax impacts.
Royalties
The ATO is seeking to characterise payments as “royalties” for software arrangements in Australia and will be reviewing the terms of any agreement between the parties and their conduct.
There are 5 key components in determining whether a payment is a “royalty”, namely:
1. “However described or computed”. The way a payment is described or computed does not determine its character as a royalty. An objective assessment is required under which the substance of the agreement prevails over its legal form.
2. “Consideration”. The term “consideration” incorporates a wider notion having regard to the whole software arrangement and “consideration” is the thing (or things) that move the payment.
3. “For”. In determining what a payment is “for”, the ATO will look at relations between the parties and the manner in which rights will be used.
4. “To the extent”. Apportionment can apply but will not apply if the use of rights is neither “separate nor severable” from other rights granted which could result in deeming all payments as a “royalty”.
5. “Use”. The “use” of an IP right covers all forms of exploitation of the right or property short of an outright sale of the right.
Other factors
Other factors to be considered include:
1. An expansion of the interaction between taxation law and intellectual property law, with a particular focus on the Australian copyright law but also the copyright law of foreign countries. Additionally, ‘non-copyright’ rights such as trademarks, patents, know-how and services ancillary to the use and enjoyment of those rights or property will be considered.
2. OECD commentaries will be used to aid interpretation and reliance on OECD model where a tax treaty is ambiguous.
3. Focus will be on treaty definitions of “royalties” where the “royalty” definition in that tax treaty is given priority over domestic tax law definition.
The broad approach taken by the ATO together with what intangible migration arrangements are considered “high risk” (read our blog at https://www.pvlegal.com.au/post/intangible-migration-arrangements), is highly complex.
Accordingly, software arrangements should be reviewed including:
legal agreements and the substance of their arrangements
IP and copyright law which can be highly technical and complex
If you wish to review your software arrangements or have any concerns, contact PV Legal.
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