Edited version of private advice

Authorisation Number: 1012629329522

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Ruling

Subject: Royalty withholding tax

Question 1

Are the licence fees within the meaning of royalty under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Will subparagraph 128B(2B)(b)(i) of the ITAA 1936 apply to the licence fees?

Answer

Yes

Question 3

Will Article 12(2) of the Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 (the United Kingdom Convention) apply to the licence fees?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 20X4

Income year ending 30 June 20X5

Income year ending 30 June 20X6

Income year ending 30 June 20X7

Income year ending 30 June 20X8

The scheme commences on:

On or after 1 July 20XX

Relevant facts and circumstances

In July 20XX, B Co AUS, a wholly owned subsidiary of A Co AUS, entered into a Licencing, Distribution and Services Agreement (the Agreement) with X Co, a company registered overseas. The Agreement has an effective date of month 20XX and was amended the same day.

X Co does not have a permanent establishment in Australia, nor does it own or control any other Australian resident company for the purpose of this enterprise.

The server is owned and controlled by X Co and is situated in the overseas country.

C Co AUS will not be making any copies of the application software for its or the end users' benefit.

All access will be by login via the portal to X Co's server.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1).

Income Tax Assessment Act 1936 Subparagraph 128B(2B)(b)(i).

United Kingdom Convention Article 12(2)

United Kingdom Convention Article 12(3)

International Tax Agreements Act 1953 Subsection 4(1)

Reasons for decision

Question 1

Summary

The licence fees are within the meaning of royalty under paragraph (c) of the definition of royalty in subsection 6(1) of the ITAA 1936.

Detailed reasoning

Subsection 6(1) of the ITAA 1936 provides a definition of royalty or royalties which extends the ordinary meaning of these terms to include certain types of listed payments. Paragraph (a) relevantly includes:

(a) the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trademark, or other like property or right;

The definition of royalty in subsection 6(1) of ITAA 1936 is an inclusive definition which extends the ordinary meaning of the term. It is possible that the ordinary meaning of royalty would include the payments made by C Co AUS to X Co separately and without recourse to the items listed in the definition in subsection 6(1). However, for reasons that will become obvious below, it is unnecessary to consider that possibility.

The payments made by C Co AUS to X Co do not fall within paragraph (a) of the definition of royalties in subsection 6(1) of the ITAA 1936.

Paragraph (b) of the definition of royalty in subsection 6(1) of the ITAA 1936 relates to the use or the right to use certain equipment. It clearly does not apply to this case.

Paragraph (c) of the definition of royalty in subsection 6(1) of the ITAA 1936 includes in the definition of royalties amounts paid for:

(c) the supply of scientific, technical, industrial or commercial knowledge or information;

IT 2660 provides an explanation of paragraph (c), at paragraph 19:

In this context, the main type of knowledge or information intended to be covered by this paragraph is what is generally referred to as "know-how", i.e., undivulged technical knowledge, information, experience or technique that is necessary for the industrial reproduction of a product or process. Examples of this would include technical data, samples or patterns, or details of processing or production methods.

At paragraph 21 of IT 2660:

The words "the supply of ... knowledge or information" are used in their usual sense and imply the communication or imparting of knowledge or information gained in any way - whether by purchase, experience, learning, research, or otherwise. The definition does not require that any special means of communication be employed. It will be effective whether the knowledge or information is supplied in a verbal, written, electronic or other form, whether it is supplied directly or through an agent or employee, and whether it is supplied at regular or irregular intervals or on an ad hoc or once and for all basis.

The payments by C Co AUS to X Co are for the supply of information fitting the description in Paragraph (c) of the definition of royalty in subsection 6(1) of the ITAA 1936. The payments and the supply are in accordance with the Agreement between the two parties.

It does not matter that the payments are not for the supply of information directly to C Co AUS itself for its own use (the Agreement separately allows access to this information free of charge). Paragraph (c) does not require the supply to be to the person making the payment. It is sufficient that the payment is consideration for the supply, which would include supply to any other person. This is supported by paragraph 14 of IT 2660 which notes:

It is important to note that the definition encompasses a payment … for the supply of knowledge or information or assistance, even though the…knowledge etc., is not used physically by the person making the payment or is not supplied directly by the person to whom the payment is made.

The payments made by C Co AUS to X Co are royalties by reason of paragraph (c) of the definition of royalty in subsection 6(1) of the ITAA 1936.

Question 2

Summary

Subparagraph 128B(2B)(b)(i) of the ITAA 1936 will apply to the licence fees.

Detailed reasoning

Subparagraph 128B(2B)(b)(i) of the ITAA 1936 provides that royalty paid by a resident to a non-resident is subject to withholding tax, except where it is wholly incurred by the payer in carrying on business outside Australia at or through a permanent establishment.

In this case, C Co AUS is liable to pay licence fees when it is carrying on business in Australia. The licence fees are within the meaning of royalty under paragraph (c) of the definition of royalty in subsection 6(1) of the ITAA 1936. Accordingly, subparagraph 128B(2B)(b)(i) of the ITAA 1936 will apply to the licence fees.

Question 3

Summary

Article 12(2) of the United Kingdom Convention will apply to the licence fees and therefore a withholding rate of 5% will apply.

Detailed reasoning

Double taxation agreements to which Australia is a party are given legal effect under the International Tax Agreements Act 1953 (Agreements Act). Subsection 4(1) of the Agreements Act provides that the tax treaties are to be interpreted and read as one with the Assessment Acts, being the ITAA 1936 and Income Tax Assessment Act 1997 unless the provision in the tax treaties is inconsistent with that in the Assessment Acts.

Article 12(2) of the United Kingdom Convention provides that royalties may be taxed in Australia but the tax so charged shall not exceed 5% of the gross amount of the royalties.

The definition of royalty is provided under Article 12(3) of the United Kingdom Convention. Relevantly, royalty in Article 12(3)(b) of the United Kingdom Convention has the same meaning as that under paragraph (c) of the definition of royalty in subsection 6(1) of the ITAA 1936. Article 12(3) reads as below:

The term "royalties" in this Article means payments or credits, whether periodical or not, and however described or computed, to the extent to which they are made as consideration for:

…

(b) the use of scientific, technical, industrial or commercial knowledge or information;

...

In this case, the meaning of royalty under Article 12(3)(b) of the United Kingdom Convention is consistent with that in paragraph (c) of the definition of royalty under subsection 6(1) of the ITAA 1936. The licence fees are, therefore, royalties under Article 12(3)(b) of the United Kingdom Convention for the same reasons as discussed under question 1, pursuant to subsection 4(1) of the Agreements Act.

Accordingly, Article 12(2) of the United Kingdom Convention will apply to the licence fees and therefore a withholding rate of 5% will apply.

Indemnification clause

The indemnified amount payable by C Co AUS may fall under paragraph (c) of the definition of royalty in subsection 6(1) of ITAA 1936. Accordingly, withholding tax may be payable on both the initial royalty and the indemnified amount pursuant to paragraph 22 of Taxation Ruling TR 2004/17 Income tax: indemnification of royalty withholding tax. This advice does not form part of the ruling but is provided solely as guidance for your consideration.

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