On 17 January 2024, the Commissioner of Taxation published TR 2024/D1 ‘Income tax: royalties - character of payments in respect of software and intellectual property rights’ which outlines the Commissioner’s views on whether receipts from the distribution and licensing of software are characterised as royalties and therefore subject to royalty withholding tax.
The draft ruling replaces the initial draft ruling TR 2021/D4 issued in June 2021, which had replaced the heavily relied upon TR 93/12. With the withdrawal of these rulings, multinational groups will no longer be able to rely on previous advice and will need to review its existing software arrangements in light of TR 2024/D1.
Where a payment has been made directly or indirectly to the foreign owner and/or owner or licensee of the copyright (or other IP) for the right to earn income relating to the use of, or right to use, software, withholding tax must be deducted from these payments and remitted to the Australian Taxation Office (‘ATO’). If an Australian taxpayer pays royalty payments offshore but fails to withhold and remit the Australian withholding tax, the Australia taxpayer will be denied an income tax deduction and general interest charges and penalties may accrue until the withholding tax has been paid.
The key issues discussed in TR 2024/D1 are:
- The interaction between the domestic tax law definition of royalty and the definition in double tax agreements and that adopted by the OECD.
- What is considered a copyright, the use of copyright, non-copyright rights, embedded software and the rights-based approach.
- Payments in scope only include software distribution arrangements, and not payments made by the end user to the IP owner or licensee of the IP, or payments to a distributor acting as agent for the owner or licensee of the IP.
- Apportionment may be required to determine the extent to which a payment is a royalty if an undissected amount is paid as consideration for matters all of which are sufficiently connected with the things mentioned in the definition of royalty, with apportionment to be done on a “fair and reasonable basis” considering all the relevant facts and circumstances of the particular case.
The Commissioner of Taxation characterises the following payments as a royalty where they are paid as consideration for one or more of the following:
- The grant of a right to use IP;
- The use of an IP right;
- The supply of know-how in relation to an IP right;
- The supply of assistance to enable the application or enjoyment of the supply; and
- The sale by a distributor or hardware with embedded software, where the distributor is granted or uses rights in the IP of the software
Mazars’ identifies the following risks and recommends the following next steps:
- The final ruling is proposed to apply both before and after its date of issue. However, the ATO have stated the ruling will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the ruling and the final ruling does not prevent TR 93/12 applying prior to its withdrawal to the extent that it has been appropriately relied upon. As a result, TR 93/12 can only be relied upon for payments made to 30 June 2021, and TR 2021/D4 until 17 January 2024.
- The Commissioner argues that Australian taxpayers cannot rely upon examples and commentary made by the OECD in its commentary to Article 12 of the OECD Model, but rather taxpayers need to review their existing arrangement(s) since all facts and circumstances of their particular case needs to be considered in light of the revised draft ruling.
- The Commissioner has not specified interest & or penalties which may be imposed if Australian taxpayers are found to have not withheld & remitted the royalty withholding tax on arrangements giving rise to royalty payments, or where Australian taxpayers amend prior activity statements in light of the revised ruling.
- The Commissioner has not provided any guidance for the basis of apportionment other than being done on a “fair and reasonable basis” for undissected amounts paid as consideration for matters all of which are sufficiently connected with the things mentioned in the definition of royalty.
- As a result, Mazars recommends Australian taxpayers review their existing and proposed software arrangements and document its positions against all 3 opinions, as well as the associated ruling TA 2018/2 Mischaracterisation of activities or payments in connection with intangible assets – including whether the ruling applies.
- All payments that include an element of software, IP or copyright be now specifically split out in invoices and agreements, in accordance with its market value to avoid the whole payment being considered a royalty.
- A review of whether business activity statements should be amended and potentially application to the Commissioner for remission of any interest and penalties.
It should be noted that the Commissioner has also published an accompanying compendium TR 2021/D4EC addressing a number of issues raised during the consultation process for the earlier draft TR 2021/D4, as well as finalising Practical Compliance Guideline Intangibles migration arrangements (PCG 2024/D1).The draft ruling TR 2024/D1 is open for consultation until 1 March 2024.
For more information and to discuss how TR 2024/D1 may impact you, please contact your usual Mazars adviser or alternatively one of our specialists via the form below or on:
Author: Lauren Hill & Deepra Sen
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