While the ruling sets out the ATO’s interpretation of the law, the draft Practical Compliance Guideline is arguably the more important document for many taxpayers because it provides a roadmap for understanding how the ATO intends to allocate its compliance resources. In simple terms, taxpayers can self-assess their arrangements into a risk zone ranging from white (lowest compliance risk) to red (highest compliance risk).

For CFOs, financial controllers, and technology businesses, the key question is often not whether software payments exist, but whether the ATO might consider part of those payments to be royalties that should be subject to royalty withholding tax. The new framework is intended to provide greater certainty around that issue.

Why has the ATO released this guidance?

The framework follows the High Court’s decision in PepsiCo and reflects the ATO’s view that economic substance and examining the totality of the arrangement may be relevant in identifying an embedded royalty, even where no royalty is expressly stated in the contract.

The guidance currently applies to software intermediation and distribution arrangements, with further schedules expected for other industries and transaction types.

Understanding the risk zones

Particular focus on restructures

The draft guidance includes a clear ATO warning on restructures.

The ATO may review changes to contractual or operating structures that reduce or eliminate Australian royalty withholding tax, even where the arrangement otherwise falls within a lower-risk zone. Transfer pricing, MAAL, DPT, and Part IVA may also be relevant.

Multinational groups undertaking software licensing or distribution restructures should therefore consider royalty withholding tax alongside transfer pricing.

Amber Zone example

A foreign software provider licenses ERP software to AU Software Co, an Australian related-party distributor, for supply to Australian customers. The agreement with the software owner grants AU Software Co the exclusive right to market and distribute the ERP software to Australian customers. However, it does not grant AU Software Co the right to make copies of, or modify, the ERP software. AU Software Co enters into customer contracts and receives payments from those customers, while the offshore supplier owns the software and provides the underlying platform and support. AU Software Co does not recognise any part of its payment to the offshore supplier as a royalty for Australian tax purposes.

On the facts in Example 8, the ATO would treat the arrangement as falling within the amber zone. The key risk indicators are that the Australian distributor is selling software-related products or services to Australian customers, the software and associated intellectual property are held offshore, and no Australian royalty has been recognised or subjected to royalty withholding tax.

The example illustrates that, where the relevant software rights and economic value sit offshore but Australian customer-facing activities are carried on locally, the ATO may expect taxpayers to undertake and document a more detailed royalty risk assessment.

By contrast, the risk assessment changes to the red zone where AU Software Co is also granted rights to make copies of, or modify, the ERP software. A red zone outcome may also arise where the software owner is located in a specified jurisdiction, or, generally speaking, is otherwise shielded from tax on the relevant income.

How SW can help

Businesses with cross-border software, SaaS, platform or technology distribution arrangements should review their existing arrangements against the framework. Even where no royalty has historically been recognised, the ATO expects taxpayers to be able to explain and support that position.

SW can assist in the following assessment:

• assessing where your arrangement is likely to sit within the ATO’s risk framework
• whether the undissected payments contain a royalty component
• whether sufficient documentation exists to support your position
• identifying whether practical steps are available to mitigate the relevant royalty withholding tax risk.

The release of TR 2026/2 and PCG 2026/D4 signals that software royalty arrangements will remain an area of significant ATO focus. Early assessment of risk positions and supporting documentation may help reduce the likelihood of future disputes and compliance costs.

The post What the ATO’s finalised software royalties ruling & draft guidance means for businesses appeared first on SW Accountants & Advisors.

The over-arching view remains that payments made for vast majority of software arrangements may be royalties when made by an Australian entity to an offshore entity. This includes cloud-based distribution, distributors of tangible hardware with a software component licensing, software-as-a-service.

The current draft is in essence a comprehensive rewrite, notably removing the concept of a ‘simple use of software’ but further considers the interactions and applications of the royalty definitions in domestic tax laws and Double Tax Agreements (DTAs). It replaces draft ruling TR 2021/D4 (issued in June 2021), which replaced TR 1993/12 (withdrawn effective 1 July 2021).

What has changed?

Under the current draft:

• The ruling applies to all cross-border payments relating to ‘software agreements’, defined as

an agreement, arrangement or scheme under which a distributor makes payment(s) directly or indirectly to the owner or licensee…of the copyright (or other intellectual property (IP)) for the right to be in a position to earn income relating to the use of, or right to use, software.

• Removed notion of payment for simple use will not constitute royalty i.e. using a software as designed or intended to be used
• Substantial emphasis placed on substance over (legal) form – Contractual terms of an agreement are relevant but not determinative of the payment characterisation. Rather, the ATO will undertake an objective assessment of the agreement and consider the commercial and practical context. Where distribution agreements cannot be performed or without using the IP rights granted, the entire consideration will be characterised as a royalty.
• Where a distributor is granted more than one right, (e.g. to distribute, use of copyright, etc.) under a single contract, the ATO accepts a ‘reasonable’ method of apportionment if the rights are independent. However, no further deliberation is provided in the ruling as to how to achieve this.    
• The ATO takes a narrow interpretation of the example in the OECD Commentary and does not accept the a distributor could obtain certain rights for distributing the relevant software, without utilising the software copyright.
• As the term ‘copyright’ is not defined in DTAs, the Commissioner will take a ‘liberal interpretation’ of the meaning under the Copyright Act 1968. The copyright laws of foreign countries participating in various international copyright conventions may be considered.

Royalty ‘defined’

The table below sets out the ATO’s distinction when consideration constitutes a royalty payment.

How does the ruling apply in practice?

To illustrate its view the ATO has replaced the eight high-level examples with two detailed scenarios.

In one scenario, the Australian entity (AusCo) is granted a non-exclusive right to resell its foreign parent’s (ForCo) software products in Australia. Whilst the agreement does not set out all the necessary rights and obligations to give effect to the software arrangement, certain key terms are provided, including:

• AusCo does not have any right / licence to any IP owned by ForCo
• End users enter into sales contracts with and pay AusCo
• Consideration for granting of non-exclusive right to distribute is determined based on sale of products, less an arm’s length fee for distribution services
• The products are stored in servers owned by the ForCo – for download / cloud-based access
• AusCo is required to maintain and enhancing the branding of ForCo.

The ATO considers payments made by the AusCo to ForCo is royalty because the rights and entitlements to use the software cannot be provided with the authorisation or communication by the ForCo (the copyright owner). Furthermore, AusCo has obtained other rights (e.g. use of ForCo’s trademarks, brands, enter into commercial rental arrangement (recurring licensing fee), etc.) under the agreement.

Reasonable apportionment may be applicable if sufficient evidence is provided to support the notion that the distribution right had substantial value independent of any right to use copyright or IP rights.

What is the (potential) impact?

The ATO is currently seeking comments on the draft ruling, with the consultation period closing on 1 March 2024. Once finalised, the ruling will apply to both prospective and retrospective arrangements.

Where a payment is royalty, it is subject to royalty withholding tax in Australia – either at the treaty rate (where there is a DTA) or the default rate of 30 percent. If the Australian resident makes overseas payments but failed to withhold and/or remit, deduction of these payments will be denied for income tax purposes until such time the withholding tax is remitted.

Whilst the draft ruling concerns payments relating to ‘software arrangements’, the ATO may also potentially extend its application to distribution / licensing arrangements to other industries (e.g. pharmaceutical), where the rights to distribute, copyright, technical know-how and/or provision of ancillary services may also typically be ’bundled up’ under a single agreement.

How SW can help

Our experts can assist with:

• further clarification regarding the draft ruling
• assessing and advising how the ruling may affect your existing and prospective cross-border arrangements.

Reach out to your SW advisor for support from our specialist tax team.

Contributors

Anthony Cheung

Emily Lowe

The post Updated Tax Ruling on character of software payments appeared first on SW Accountants & Advisors.

During this time, I’ve specialised in migration and software adoption, guiding and assisting dozens of clients on the latest and most reliable software stack for their specific needs. We are assisting with the internal processes to see you operating in a totally paperless office, achieving maximum efficiency and automation, and having real time visibility and data that many talk of, but rarely have.

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Reporting processes

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This process requires manual effort and processing at every turn as well as regular duplication. Most of these platforms do not give you the layers of reporting to breakdown your data as required on demand.

In this space, we very regularly see shortfalls in operational efficiencies and are charging ourselves with the responsibility to bring this to life for junior exploration companies.

The Solution

Get your processes in the Cloud. We would recommend migrating to Xero and utilising it’s open API and multitude of direct partner integrations to fulfil the various requirements.

We have identified the ideal software stack on page three of the download below and the processes to automate and streamline the entire end-to-end financial, accounting and taxation processes of your business.

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• Online BAS lodgement within the accounting software
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The Cost

The software subscription costs detailed in the download below would typically equate to $150 to $300 per month. A no-brainer isn’t it?

* We also capture the notoriously difficult aspect of statutory reporting through cloud-based software for interim and annual reporting and streamline this process. Please reach out if you would like to explore this to facilitate an easier statutory reporting framework.

Contact us

Get in touch via our experts below to discuss how we can help streamline your business.

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Complete Tax Solutions (CTS) is an intelligent and automated tax solution that improves accuracy and delivers increased efficiency to a diverse range of businesses and industries.

The CTS suite of products enable businesses to streamline and automate the entire tax reporting and compliance process. This includes accounts integration, tax management, accounting for income taxes, consolidated tax return preparation and generation of tax journals and disclosures for the financial statements.

Excel-based and fully compatible with all current accounting systems, CTS is a fast and user-friendly interface with desktop, network and cloud options available.

Are you ready for 30 June reporting deadlines?

Significant Global Entities (SGE) with a 30 June balance date will have their first reporting deadline on 30 June 2018, which means the time to prepare is now. Such groups may also look to their tax advisors to assist with the completion and lodgement of the Country-by-Country files.

We can do the hard work for you

Whether you are an SGE or advising your clients, we can assist you with your software or lodgement needs.

Designed by ShineWing Australia – the CTS Country-by-Country Reporting (CbCR) software enables the compilation, risk analysis and lodgement of your master file, local file and Country-by-Country report with the Australian Taxation Office (ATO).

CbCR has its genesis from Action 13 of the G20 and Organisation for Economic Co-operation and Development’s (OECD’s) Action Plan on Base Erosion and Profit Shifting (BEPS).

SGEs in Australia, regardless of their size, have an annual obligation, unless exempt by the Commissioner, to submit:

• A master transfer pricing file which provides a high level description of the global operations of the group
• A local file which describes the Australian operations of the group together with relevant intra-group agreements
• A CbC report which includes the following information by entity and by jurisdiction:

• • Revenue (split between related and unrelated parties)

• • Profit before tax

• • Income tax paid and accrued

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• • Any further information which may assist with understanding the CbC report submitted 

CTS CbCR allows you to:

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If you would like a FREE demonstration of CTS CbCR, or if you have any tax queries, please email our CTS team and we will be in touch with you within the next business day.

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