Draft Taxation Ruling TR 2021/D4 (TR 2021/D4) discusses the Australian Taxation Office’s revised views regarding the circumstances where receipts from the licensing and distribution of software will be considered royalties. The new ruling replaces Taxation Ruling TR 93/12 which was withdrawn from 1 July 2021.
TR 2021/D4 provides that whether a payment is a royalty is dependent on the terms of the agreements between the parties, taking into account all the relevant facts and circumstances of the particular arrangement. The release of TR 2021/D4 is required given the continually evolving concept and nature of software, which has significantly changed since the release of TR 93/12.
TR 2021/D4, which is proposed to have retrospective application, focusses on three software distribution models:
- Packaged software;
- Digital downloading of software; and
- Cloud computing services (including software-as-a-service (SaaS)).
The Draft Ruling provides extensive guidance on when an arrangement is considered to be a royalty by way of examples dealing with:
- Licenses to reproduce, modify and provide simple software;
- Software distribution arrangements; and
- Ancillary services.
Where an arrangement concerning the licensing or distribution of software meets the definition of a royalty payment to a non-resident, this potentially creates exposure to Australian royalty withholding tax (RWT). Below is a high level summary of the common scenarios considered in the draft ruling:
|1. License to reproduce and modify software||1. License for simple use of software (by end user)|
|2. Software distribution agreement with end user license agreement / enter cloud services agreement||2. Software distribution agreement – right to distribute shrink-wrap software|
|3. Services ancillary to the modification of software||3. Services ancillary to the simple use of software|
- Businesses with foreign related companies involved in the software industry and other “digital” businesses should immediately review their existing arrangements involving the licensing or distribution of software as they may have a requirement to withhold RWT on amounts they did not previously apply withholding on. This may result in an increased cost for taxpayers where their arrangements have gross up clauses.
- Consideration should be had to interaction and implications of TR 2021/D4 with other Australian tax rules including the principles of apportionment and the transfer pricing rules.
- The proposed retrospective application may be a significant tax risk issue for certain taxpayers as a result of the expansion of the scope of the previously understood royalty definition. Taxpayers should consider whether TR 93/12 provides protection from the intended retrospective operation.
- While the Draft Ruling specifically applies to computer software arrangements, there is uncertainty whether the principles could be deemed by the ATO to have potential application to broader areas or transactions (e.g. other intellectual property transactions or other “digital” businesses).
Should you have queries about how these changes affect your individual circumstances, please don’t hesitate to reach out to your ESV Engagement Partner.