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Edited version of your written advice
Authorisation Number: 1051368909790
Date of advice: 8 May 2018
Ruling
Subject: Withholding from royalties paid to foreign residents
Question
Are you required to withhold an amount from a lump-sum payment you make to a Franchisor?
Answer
Yes, you are required to withhold tax on a portion of the lump-sum payment you make to a Franchisor to the extent that the payment represents a payment of royalty.
This ruling applies for the following period:
Year ending 30 June 20XX
The scheme commences on:
1 July 20XX
Relevant facts and circumstances
The Franchisor is a company incorporated in a foreign country.
The Franchisor licenses the right to use its know-how, operation manuals, equipment, brand and intellectual property to third parties to enable them to carry on a business in a specified territory, through the use of their Franchise Agreement.
You intend to enter into the Franchise Agreement with the Franchisor. A copy of the draft agreement (referred to as the ‘Franchise Agreement’ hereafter) has been provided to us.
The Franchise Agreement requires you to make a lump-sum payment to the Franchisor. The lump-sum payment is for the following items:
● Equipment, marketing materials and other materials necessary for you to carry on the franchise business
● Shipping of the above equipment and materials
● Preparation of legal documents
● The cost of paying a designer to design point of sale advertising for your business
● Initial training for you
If the Franchise Agreement ends, you are required to return the operation manuals to the Franchisor and offer the Franchisor the right to purchase your equipment, marketing materials and other materials.
Relevant legislative provisions
Subsection 6(1) of the Income Tax Assessment Act 1936
Section 128B of the Income Tax Assessment Act 1936
Section 12-280 of Schedule 1 to the Taxation Administration Act 1953
Section 12-300 of Schedule 1 to the Taxation Administration Act 1953
Taxation Administration Regulations 2017 Subdivision B
Reasons for decision
Withholding tax
Section 12-280 of Schedule 1 to the Taxation Administration Act 1953 (TAA) imposes a withholding obligation on taxpayers in respect of royalty payments.
However, section 12-300 of Schedule 1 to the TAA provides that no withholding is required from a royalty payment where no withholding tax is payable pursuant to Division 11A of the Income Tax assessment Act 1936 (ITAA 1936).
Contained within Division 11A of the ITAA 1936 is subsection 128B(2B) which applies to income that consists of a royalty derived by a non-resident that:
● is paid by a resident and is not an outgoing wholly incurred by the payer in carrying on business in a foreign country at or through a permanent establishment (PE) in that country, or
● is paid by one or more non-residents and is, or is in part, an outgoing incurred by the non-resident(s) in carrying on business in Australia at or through a PE in Australia.
Taxation Administration Regulations 2017 paragraph 42(a) provides that if a royalty is paid to a person that is a resident of a country to which a tax treaty applies, the amount withheld will be the amount calculated using the withholding rate specified in that tax treaty.
Royalties
For the purposes of section 128B, royalty is defined by subsection 6(1) of the ITAA 1936 to mean:
royalty or royalties includes any amount paid or credited, however described or computed, and whether the payment or credit is periodical or not, to the extent to which it is paid or credited, as the case may be, as consideration for:
(a) the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trade mark, or other like property or right;
(b) the use of, or the right to use, any industrial, commercial or scientific equipment;
(c) the supply of scientific, technical, industrial or commercial knowledge or information;
(d) the supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b) or any such knowledge or information as is mentioned in paragraph (c);
(da)...
The definition of royalty and royalties in subsection 6(1) is inclusive as it extends the meaning of royalty to include the specific amounts mentioned without excluding amounts that would be considered to be royalties within the ordinary meaning of the term.
Taxation Ruling IT 2660 Income tax: definition of royalties sets out the Commissioner’s views on the definition of royalty and royalties in subsection 6(1) and various double tax agreements.
Paragraph 22 of IT 2660 provides some examples relating to the definition contained within paragraph 6(1)(d) of the ITAA 1936:
For example, in a contract for the supply of relevant property or know-how, payments under the contract covering ancillary assistance given as a means of enabling the application or enjoyment of the property or know-how are royalties irrespective of the extent of such payments in relation to the "pure" property or know-how payment. Ancillary and subsidiary services could be performed, for example, in promoting the transaction by demonstrating and explaining the use of the property, or by assisting in the effective implementation of the property transferred, or by performing services under a guarantee relating to such effective implementation.
Tax treaties
Australia has tax treaties in place with many of its trading partners, including the Franchisor’s country of residence. Where payments are made by an Australian payer to a resident of a country that has a tax treaty with Australia, the terms of the relevant treaty must be considered.
Australia’s tax treaty with the Franchisor’s country of residence contains a definition of royalties, and provides that the maximum tax charged for royalties is five per cent in the country in which they arise.
Application of the law to your circumstances
Is the lump-sum payment a payment of royalties?
In deciding whether the lump-sum payment is a payment of royalties, consideration must be given to the items you receive in return for the lump-sum payment in light of the definition of royalty and royalties provided by subsection 6(1) of the ITAA 1936 and the tax treaty with the Franchisor’s country of residence.
The components are set out above of the Relevant Facts and Circumstances and discussed individually below.
● Equipment, marketing materials and other materials necessary for you to carry on the franchise business
● Shipping of the above equipment and materials
● Preparation of legal documents
● The cost of paying a designer to design point of sale advertising for your business
● Franchise training for you
1. Equipment, marketing materials and other materials
2. This item includes equipment, marketing material, and other items that are necessary for the franchise business to operate. The Franchise Agreement requires you to use the equipment that is provided by the Franchisor in return for the lump-sum payment in carrying on your franchise business. The franchise business cannot operate without this supply of equipment.
3. As such, the equipment, marketing materials and other materials constitute assistance that is furnished as a means of enabling your application and enjoyment of the use of Franchisor’s know-how, operation manuals, equipment, brand and intellectual property. The payment for the equipment, marketing materials and other materials would fall within the definition of royalty and royalties.
4. Shipping of the equipment and materials
5. This item is the transport of the equipment and materials from the Franchisor to you. Whilst the equipment and materials are required in order for you to carry on your franchise business, it is purely a shipping service provided by a transport company.
6. We do not consider this is assistance that enables your application or enjoyment of the use of the Franchisor’s know-how, operation manuals, equipment, brand and intellectual property.
7. As such, payment for shipping of the equipment and materials would not be a royalty or royalties.
8. Preparation of legal documents
9. This item is the preparation of relevant legal documents between the Franchisor and you to enter into the Franchise Agreement.
10. These legal documents form the basis of the agreement between you and the Franchisor. We do not consider the preparation of legal documents relating to your agreement with the Franchisor is assistance that enables your application or enjoyment of the use of the Franchisor’s know-how, operation manuals, equipment, brand and intellectual property.
11. Therefore, payment for the preparation of legal documents would not be a royalty or royalties.
12. The cost of paying a designer to design point of sale advertising for your business
13. This item is for amounts paid to a designer for the preparation of artwork for point of sale advertising.
14. Whilst the advertising will be used in carrying on your business, we do not consider that the payment is for assistance provided in enabling your application and enjoyment of the right to use the Franchisor’s know-how, operation manuals, equipment, brand and intellectual property.
15. Therefore, payment for the cost of an advertising designer would not be a royalty or royalties.
16. Franchise training for you
This item is for appointment of a trainer to train you as a franchisee.
The training will deliver you the skills and knowledge necessary to effectively operate the franchise business using the know-how, operation manuals, equipment, brand and intellectual property of the Franchisor.
On this basis, we consider that this training is assistance that is furnished a means of enabling your application and enjoyment of the use of such know-how, operation manuals, equipment, brand and intellectual property. The payment for the training would fall within the definition of royalty and royalties.
Does an amount have to be withheld from the lump-sum payment?
Section 280-280 of Schedule 1 to the TAA requires an amount to be withheld from royalty payments.
As part of the lump-sum payment, a portion of which representing the equipment, marketing materials and other materials, and training, is a payment of royalties, an amount must be withheld from the lump-sum payment to the Franchisor.
Conclusion
The payment for the equipment, marketing materials and other materials, and training is a payment of royalties under the definition in subsection 6(1) of the ITAA 1936 and tax treaty with the Franchisor’s country of residence.
Section 12-280 of Schedule 1 to the TAA imposes a withholding obligation on you in respect of royalty payments.
The tax treaty limits the maximum tax that can be charged to be five per cent for royalties that arise in Australia and paid to a resident of the of the Franchisor’s country of residence.
As such, you are required to withhold five per cent of the royalty payments you make to the Franchisor, being the amounts referable to the equipment, marketing materials and other materials, and training.
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