Same old Aussies, always taxing

By Bart de Gouw, Melanie Meyer & Liam O’Brien

New Zealand-headquartered technology companies with Australian subsidiaries beware - the Australian Taxation Office (ATO) has doubled down on its position on when an amount paid under a software arrangement is subject to royalty withholding tax.

On 17 January 2024, the ATO withdrew Draft Taxation Ruling TR 2021/D4 (TR 2021/D4) and replaced it with an updated Draft Taxation Ruling (TR 2024/D1), setting out the ATO’s position on when an amount paid by an Australian entity for the “use of, or the right to use or other like property or right” copyright under a software arrangement is subject to royalty withholding tax.

The structure of TR 2024/D1 has fundamentally changed when compared to TR 2021/D4, however, the ATO’s position continues to be bold, and it is clear that the ATO intends to continue with an approach that characterises the nature of payments with primary reference to legal form and exchanged rights.

Reliance on copyright law

The ATO’s position is heavily based on an analysis of the Australian Copyright Act, noting that the tax treaty definition of “royalty” contemplates payments made for the “use of, or the right to use, any copyright or other like property or right”. The ATO’s position in TR 2024/D1 is that the use of, or the right to use, a copyright right consists of doing an act in respect of a copyrighted work (in this case, software) that is the exclusive right of the copyright owner. Per the Copyright Act, the exclusive rights of a copyright owner include:   

• Reproducing the work in a material form;
• Communicating the work to the public;
• Making an adaptation of the work;
• Entering into a commercial rental agreement; and
• Authorising a person to do an act.

The scenarios included in TR 2024/D1 suggest that the ATO’s position is intended to capture most common software distribution/resale models (including software-as-a-service models), and payments made by Australian software distributors to the relevant copyright owner are, in many cases, likely to be characterised as royalties and therefore subject to royalty withholding tax.

TR 2024/D1 also sets out the ATO’s reasoning for distinguishing the OECD Commentary on Article 12, which suggests that payments for the supply of software will only be royalties where the rights to reproduce and modify the software are granted. The ATO’s view is that the facts contained in the example in paragraph 14.4 of the OECD Commentary on Article 12 “place a significant qualification and limitation on its application”. As such, under some fact patterns, there may still be instances of being able to support a “no-royalty” characterisation for payments made by Australian software distributors, notwithstanding the ATO’s strict interpretation of the guidance included in the OECD Commentary (which the ATO acknowledges is relevant in interpreting Australia’s tax treaties).

Apportionment

Somewhat helpfully, TR 2024/D1 does acknowledge that apportionment is required and appropriate to ascertain the extent to which a payment is a royalty, and any apportionment should be done on a “fair and reasonable basis.” There is, unfortunately, no additional guidance on how a fair and reasonable apportionment exercise should be performed.

Concerningly, the Commissioner has expressed a new view in TR 2024/D1 at [18] and at [107], being that the Commissioner does not accept that a payment for multiple “things” (i.e., IP rights and other, non-IP rights) necessarily results in that payment being paid, in part, for each of those things equally or in some proportion. In other words, the Commissioner is of the view that an amount that is paid for multiple things may not necessarily warrant apportionment if those things (being both royalty and non-royalty items) are, from a practical and business point of view, inseparable, as follows (emphasis added): 
107…For instance, where a payment is principally for the grant of IP rights and the other rights granted are ancillary or incidental, the consideration is properly characterised as being entirely for the grant of IP rights. To illustrate this point, if the software arrangement has no value or substance without the use of IP rights, then all the payments under the arrangements will be royalties.

Status

The public consultation phase completed on 1 March 2024. It is now with the ATO to consider the various submissions made and determine whether any changes are needed to be made to TR 2024/D1 prior to being published as a final Taxation Ruling. As TR 2024/D1 is currently a draft ruling, it is potentially subject to change prior to finalisation. However, if taxpayers rely on the draft ruling reasonably and in good faith, interest or penalties will not apply if the draft ruling turns out to be incorrect. It is noted that TR 2024/D1 will not take effect until it is finalised. Once finalised, the ruling is proposed to apply both before and after its date of issue and the ATO will be legally bound by the position adopted. It is not clear how the ATO will apply its resources in reviewing historical positions and whether it will pursue royalty withholding tax over multiple previous income years. 

Impact on New Zealand businesses

Noting that the ATO’s position is not yet finalised, potentially impacted New Zealand companies with Australian software distribution arrangements should review those arrangements considering the ATO’s analysis and position as articulated in TR 2024/D1. Such a review at this stage might involve: 

• Determining whether any existing software payments from Australia are subject to withholding tax based on the ATO’s position;
• Assessing the financial impact of such an outcome (the withholding tax rate on royalties between New Zealand and Australia is 5% per the New Zealand Australia Double Tax Agreement); and
• Considering potential courses of action in response (e.g. apportionment, preparing and collating additional evidence to support current positions, etc.).

Inland Revenue (along with other tax authorities around the world) will be monitoring developments in this area closely. New Zealand businesses will be particularly interested in Inland Revenue’s position on foreign tax credit relief in New Zealand for any Australian withholding tax paid. This would require Inland Revenue to effectively agree with the ATO’s position, which could then have implications for how Inland Revenue treats similar payments made by New Zealand companies to overseas copyright owners. It is unlikely that Inland Revenue will communicate its view until TR 2024/D1 is finalised.

Additionally, if the New Zealand copyright owner is in a tax loss position any Australian withholding tax on payments received from Australian entities that use or have the right to use the New Zealand-owned copyright will simply create an additional cash cost.

This is an evolving and complex area but has the potential to have a significant financial impact on in-scope New Zealand businesses. New Zealand businesses should carefully consider their Australian software distribution/resale arrangements and supporting documentation.

For further guidance on preparing for and responding to this measure, please reach out to your usual Deloitte advisor.