Edited version of private advice

Authorisation Number: 1052117384446

Date of advice: 10 May 2023

Ruling

Subject: Royalties and withholding tax

Question 1

Are any of the payments made under clauses XX and XX of the franchise partnership agreement (the Agreement) by Company X a royalty as defined in subsection 6(1) of the Income Tax Assessment Act 1936?

Answer

Yes.

Question 2

If any of the payments made under the Agreement are considered to be royalty payments are these payments subject to a withholding tax obligation under section 12-280 or 12-285 of Schedule 1 to the Tax Administration Act 1953 (TAA 1953) and, if so, who is required to withhold the tax?

Answer

For royalty payments made to Foreign Co, Company X will have an obligation to withhold under section 12-280 of the TAA 1953.

For royalty payments made to Company Y to its Australian bank account, Company X will not have an obligation to withhold under section 12-280 of the TAA 1953, unless information was available to Company X which indicated that Company Y was receiving the payments on behalf of a foreign resident, then Company X will have an obligation to withhold under section 12-280 of the TAA 1953.

Question 3

Regarding the payments referred to in question 2 that are royalties, what is the rate of withholding from these payments?

Answer

30%

Question 4

Whether agent and principal are liable together to account for and make disclosures necessary to closely associated third parties to determine the respective party's correct amount of Australian tax payable?

Answer

The Commissioner is not able to rule on this question.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

10 June 20XX

Relevant facts and circumstances

1.            In 20XX, 2 international student recruiting agents, decided to incorporate Company W to commence a business of recruiting international students to study in Australia

2.            In 20XX, they, decided to incorporate Company X after meeting with another international student recruiting agent, with the aim of cooperating and pooling their resources and establishing an Australian branch for Person A's existing international student recruitment business. Person A was not a resident of Australia, and the business was offshore that held established contracts with Australian Education Providers (AEPs) to recruit international students to study in Australia via the AEPs.

Franchise Partnership Agreement

3.            Company Y and Foreign Co (Party A) and Company X (Party B) entered into a 'Franchise Partnership Agreement' (Agreement) for a period of X years.

4.            Clause X of the Agreement sets out the 'Aims of cooperation'.

5.            The Agreement between Party A and Party B sets out the responsibility and liability of both parties under clauses X(A) and X(B).

6.            Under the Agreement, Company X paid a one-off franchise fee of $XX to Party A for the rights under the Agreement and to conduct business in one Australian capital city. Company X a paid a further amount for those rights to conduct business in a second Australian capital city, and another amount for those rights to conduct business in a third Australian capital city. The full amount was paid by Company X solely to Company Y as at the time the payment was made, all the cooperation agreements with AEPs were with Company Y.

7.            Over the entire term of the Agreement, Company X paid 20% of the commission paid by the AEPs to Company Y under clause X(B)(x).

8.            No commissions were paid under clause X(B)(y) of the Agreement by Company X, as Party A did not provide Company X with the names of any students from their client list.

Cooperation Agreements

9.            Company X did not pay the franchisor a fee for service, rather, Company X sourced and serviced international students and then, with the rights granted by the franchisor to access the electronic portals established with the AEPs under the franchisor's cooperation agreements, enrolled the international student in the relevant courses directly, collected commission directly and provided international students' the services and ongoing support services.

10.          A cooperation contract is an agreement between a specific AEP and an education agent to enter into a working relationship to source international students for that AEP.

11.          AEPs who offer courses to international students are governed by the Education Services for Overseas Students Act (2000) (ESOS Act) and related National Code of Conduct. Amongst other things, the Act provides that AEPs must have written agreements (cooperation agreements) with every education agent they engage with.

12.          At the time of entering the Agreement, Company Y was the education agent who had entered into cooperation agreements with specific AEPs.

13.          The cooperation agreement also set out that payments under this agreement would only be paid to the agent after a completed Representative Payment Details form was submitted to them. This form included bank account details.

14.          The AEPs would only pay any amounts due to this bank account.

15.          After entering into the Agreement, Company Y and Company X were both listed as agents on the cooperation agreements with the AEPs.

16.          During the term of the Agreement, the AEPs and their agent changed the ownership of the cooperation agreements between Company Y, an Australian resident corporation, to a related entity, Foreign Co, a non-resident corporation. Both of these entities are listed as Party A in the Agreement. Neither the AEP nor their agent informed Company X of the change in education agent.

17.          With the change in education agent, the cooperation agreements were between Foreign Co and the AEPs.

18.          Under the Agreement, Company Y provided Company X copies or an electronic version of the cooperation agreements.

19.          From 1 July 20XX to 30 September 20XX, the AEPs paid Company X commission for the international students it enrolled directly into Company X's Australian bank account, except for 4 AEPs:

20.          In 20XX, 2 of these AEP's agreed to pay Company X directly.

21.          During the period 1/7/20XX to 30/9/20XX, the 4 AEPs paid $XXX,XXX to the franchisor agent's (Foreign Co) overseas bank account .

22.          The payments would subsequently be settled between Company X and the franchisor agent (Foreign Co) either via an exchange of payments or a setoff.

23.          In 20XX, Party B decided to terminate the Agreement early and gave 6 months' notice that the contract will terminate on 30/6/20XX.

24.          Once the agreement terminated Company W commenced trading.

25.          The majority of the AEPs deposited money into the nominated bank account of Company X until 1/10/20XX when the bank details held with the AEPs was changed to an Australian bank account in Company Y's name.

26.          From 1/10/20XX, all the AEPs were directed by their franchisor agent, to pay all further commissions under the Agreement to the Australian bank accounted owned by Company Y.

27.          In XX/XX/20XX an employee of Party B to complete the on-line enrolment applications for students recruited for enrolments in 20XX courses and with the help of other employees, separate Company W and Company X and do the invoices.

28.          No commission from these invoices were deposited into either Company X or W's business account by the AEPs.

Information provided

29.          You have provided information in a number of documents in relation to your private ruling request, including:

(a)          your private ruling application.

(b)          supplementary information.

Assumptions

30.          Company Y is a resident of Australia for income tax purposes and does not carry on a business at or through a permanent establishment in any country outside Australia.

31.          Foreign Co does not have a permanent establishment in Australia.

32.          Company X is not a branch office of Company Y or Foreign Co.

33.          The relationship between Company X and Company Y and Foreign Co is not agent and principal, nor is it one of partners or of a partnership.

34.          The relationship under the Agreement is Franchisor (Company Y and Foreign Co) and Franchisee (Company X).

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 128A(2)

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1936 subsection 128B(2B)

Income Tax Assessment Act 1936 subsection 128B(2C)

Income Tax Assessment Act 1936 section 128C

Income Tax Assessment Act 1997 subsection 6-5(4)

Tax Administration Act 1953 section 11-5

Tax Administration Act 1953 section 12-280

Tax Administration Act 1953 section 12-285

Tax Administration Act 1953 section 12-300

Tax Administration Act 1953 section 16-25

Tax Administration Act 1953 section 16-30

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1936 unless otherwise stated.

Question

Are any of the payments between Party A and Company X made under clauses X(B)(x) and X(B)(y) of the franchise partnership agreement (the Agreement) royalties for the purpose of subsection 6(1)?

Summary

The payments made between Party A and Company X under these clauses of the Agreement are considered to be royalties for the purpose of subsection 6(1).

Detailed reasoning

1.            You have advised that the payments are royalties due to the following:

(a)          a lump sum has been paid for a right or privilege to use an asset

(b)          the asset is not a tangible thing nor is it property in the ordinary sense

(c)           the asset is owned and already in existence and require no further expenditure nor does the owner incur any outgoings. The owner is not receiving payment for any service. Enrolments, collection of commission and services are provided entirely by Company X.

(d)          the payments do not change the ownership of the asset and, nor can the asset be further exploited or sold by Company X, or the use diminish its value in any way and remains the property of the owner.

(e)          the liability to pay only arises as when and if the asset is used and the amount paid is determined by use.

(f)            distinguished from the provision of a service, there would be the supply of an asset or a product or skill by a seller whose creation of the asset or a benefit involving an ongoing outgoing or a particular personal skill or service and the payer would pay for that asset or benefit as brought into existence. The asset value to the payee would diminish according to the assets use by the payer.

2.            The Commissioner's view on the definition of a royalty is set out in Taxation Ruling IT 2660: Income tax: definition of royalties. This Ruling examines the distinction between royalty payments and payments for services in 3 stages:

(i) by considering the ordinary meaning of the term 'royalty'

(ii) then, by looking at how the definition in subsection 6(1) extends the ordinary meaning, and

(iii) by focussing on the differences between royalty payments and payments for services.

3.            The ordinary meaning of the term 'royalty' has been considered by the Courts on many occasions. In Stanton v. FC of T (1955) CLR 630, the High Court of Australia described the essence of a royalty and stated that:

...the modern applications of the term seem to fall under two heads, namely the payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken.

4.            The key characteristics of a common law royalty (i.e., a royalty within the ordinary meaning of the term) were outlined by R. H. Woellner, T.J. Vella and R.S. Chippendale in Australian Taxation Law, CCH Australia Ltd, 1989 at pages 272- 273. They identified that a common law royalty will normally have all of the following features:[1]

(a)          it is a payment made in return for the right to exercise a beneficial privilege or right, for example to remove minerals or natural resources such as timber (McCauley v. FC of T (1944) 69 CLR 235);

(b)          the payment is made to the person who owns the right to confer that beneficial privilege or right (Barrett v. FC of T (1968) 11 CLR 666)

(c)           the consideration payable is determined on the basis of the amount of use made of the right required (McCauley, Stanton) and

(d)          the consideration will usually be paid as and when the right acquired is exercised. However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired (IR Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272).

5.            Subsection 6(1) expands the meaning of royalty to include certain amounts which may not be royalties within the ordinary meaning of that term. Many payments covered by the definition will be royalties on general principles, e.g., a payment for use of a patent. Others, however, are royalties only by reason of their inclusion in the definition, e.g., payments for use of scientific equipment.[2]

6.            Payments for services rendered and work done are not royalties unless the services are ancillary to, or part and parcel of, enabling relevant technology, information, know-how, copyright, machinery or equipment to be transferred or used. Whether the payment is a royalty payment or a payment for services depends on the nature and purpose of the arrangement giving rise to the payment. Only those payments which are for the use of, or the right to use, property or a right belonging to another person are 'royalties' within the definition.[3]

7.            At the time of entering into the Agreement, Company Y owned the rights to the cooperation agreements with the AEPs. Later, Foreign Co replaced Company Y as the education agent in the cooperation agreements with the AEPs.

8.            As part of the Agreement, Company Y and Foreign Co added Company X as an Agent to these cooperation agreements. By doing this, it gave Company X the right to access the electronic portals established with the AEPs under the franchisor's cooperation agreements, enrol the international student in the relevant courses directly, collect commission directly and provide international students' the services and ongoing support services. Without access to rights owned by Company Y and Foreign Co pursuant to entering into the cooperation agreements, Company X would be unable to provide services to AEPs due to the operation of the ESOS Act.

9.            Payments made by Company X under clause X(B)(x) and X(B)(y) of the Agreement for use of rights granted by Company Y and Foreign Co (the rights under the cooperation agreements) will fall within the definition of a common law royalty.

(a)          Company X pays a commission under the Agreement for use of rights to provide services to the AEPs under the cooperation agreements held by Party A with the AEPs.

(b)          Company X pays the commissions to the right holder, Party A for the right to use this asset.

(c)           the amount Company X pays Party A is determined by how much Company X uses the asset. Company X is paid commission directly from the AEPs for the students it enrols with them. Company X then pays 20% of this commission received from the AEPs to Party A.

(d)          Company X received a payment from the AEPs every 3 months and at this time it would settle the commission with Party A. If Company X did not exercise their right to enrol students using the cooperation agreement it would not receive any commission.

10.          As the payments made by Company X to Party A under clauses X(B)(x) and X(B)(y) of the Agreement meet the common law definition for royalties, such payments are also considered to be royalties for the purpose of subsection 6(1).

Question 2

If any of the payments made under the Agreement are considered to be royalty payments, are these payments subject to a withholding tax obligation under section 12-280 or 12-285 of Schedule 1 of the Tax Administration Act 1953 (TAA 1953) and, if so, who is required to withhold the tax?

Summary

Royalty payments made by Company X to Party A may be subject to withholding tax.

Detailed reasoning

11.          Section 12-280 of the TAA 1953 states:

An entity must withhold an amount from a *royalty it pays to an entity, or to entities jointly, if:

(a) the recipient or any of the recipients has an address outside Australia according to any record that is in the payer's possession, or is kept or maintained on the payer's behalf, about the transaction to which the royalty relates; or

(b) the payer is authorised to pay the royalty at a place outside Australia (whether to the recipient or any of the recipients or to anyone else).

12.          Subsection 12-285(1) of the TAA 1953 states:

An entity that receives a payment of a *royalty must withhold an amount from the payment if:

(a) the entity is a person in Australia or an *Australian government agency; and

(b) a foreign resident is or becomes entitled:

(i) to receive the royalty or part of it from the entity, or to receive the amount of the royalty or of part of it from the entity; or

(ii) to have the entity credit to the foreign resident, or otherwise deal with on the foreign resident ' s behalf or as the foreign resident directs, the royalty or part of it, or the amount of the royalty or of part of it.

13.          Subsection 12-285(2) of the TAA 1953 states:

The entity must withhold the amount:

(a) if the foreign resident is so entitled when the entity receives the payment - immediately after the entity receives the payment; or

(b) if the foreign resident becomes so entitled after the entity receives the payment - immediately after the foreign resident becomes so entitled.

14.          Notwithstanding anything in the above sections, section 12-300 of the TAA 1953 provides that a withholding obligation only exists for the payer of a royalty if the recipient has a withholding tax liability (which is determined under sections 128B and 128C):

This Subdivision does not require an entity:

(a) to withhold an amount ... from a *royalty if no *withholding tax is payable in respect of the ... royalty; or

(b) to withhold ... from a royalty more than the withholding tax payable in respect of the ... royalty (reduced by each amount already withheld from it under this Subdivision).

15.          Section 128B sets out when an entity has a liability to withholding tax while section 128C provides the timing of payment. In the context of the facts of this ruling, an entity will have a liability to royalty withholding tax under subsections 128B(2B) or (2C) where income:

(a)          is derived by a non-resident, or by an Australian resident carrying on business in a country outside Australia at or through permanent establishment of the entity in that country; and

(b)          consists of a royalty paid by a resident, not being an outgoing incurred in carrying on business in a country outside Australia at or through a permanent establishment of the payer in that country.

Liability and obligation to withhold

16.          Any royalties paid by Company X to Company Y's Australian bank account, that are income derived by Company Y as owner of rights under the cooperation agreements with AEPs, will not give rise to a liability to withholding tax for Company Y under section 128B as the payment is to a resident of Australia. Accordingly, Company X will not have an obligation to withhold from such payments under section

17.          12-280 of the TAA 1953.[4]

18.          If Company X paid royalties to Foreign Co, and the royalties were income derived by Foreign Co, then Foreign Co would have a liability to withholding tax under section 128B. In this case, Company X would have an obligation to withhold under section 12-280 of the TAA 1953.

19.          If Company X paid royalties to Company Y, but Company X was aware, or should have known based on information available to it, that Foreign Co owned the rights under the cooperation agreements, and Company Y was receiving the payments on behalf of Foreign Co, then as the royalties would be income derived by Foreign Co, then Foreign Co would have a liability to withholding tax under section 128B. Company X would accordingly have an obligation to withhold under section 12-280 of the TAA 1953.

Payments to Company Y

20.          You advised that at the time that Company X entered into the Agreement, Company Y had entered into all cooperation agreements with the AEPs. Further cooperation agreements were entered into by Company Y with additional AEPs after that time and copies provided to Company X. Cooperation agreements were subsequently varied to replace Company Y with Foreign Co as the agent under each of the cooperation agreements. However, you have stated that you were not advised of this change and continued making payments of commissions under clause X(B)(a) of the Agreement to Company Y's Australian bank account.

21.          Company X would not have an obligation to withhold under section 12-280 of the TAA 1953 in relation to royalty payments made to Company Y during the period in which it was the agent under cooperation agreements with the AEPs, as Company Y would not have a liability to withholding tax under section 128B, as it is a resident of Australia.

22.          After the time that the cooperation agreements were varied to replace Company Y with Foreign Co, Foreign Co would have a liability to withholding tax under section 128B, as it is not a resident of Australia.

23.          Company X would only have an obligation to withhold under section 12-280 of the TAA 1953 for royalty payments made to Company Y's Australian bank account if it was aware, based on information in its possession, that Company Y was receiving the payments on behalf of Foreign Co which beneficially derived the royalty income as owner of rights under cooperation agreements. However, you have stated Company X was not aware, based on records available to you, of the change to the cooperation agreements. Accordingly, Company X would not have an obligation to withhold under section 12-280 of the TAA 1953 in this circumstance. However, Company Y would have a withholding obligation under section 12-285 of the TAA 1953, as it was receiving the payment on behalf of Foreign Co, a foreign resident.

Payments by the 4 AEPs to an overseas bank account.

24.          You advised that 4 AEPs paid the amount due under the cooperation agreements to the franchisor agent's (Foreign Co's) overseas bank account and that the payments would subsequently be settled between Company X and the franchisor agent either via an exchange of payments or a setoff.

25.          It is your view that the AEPs would have an obligation to withhold in relation to these payments. Whether payments by the AEPs give rise to royalty withholding tax or obligations to withhold is outside the scope of this ruling, which only applies to liabilities or obligations of Company X. Further, obligations of the AEPs have no bearing to considering whether commission payments by Company X under the Agreement result in Company X having an obligation to withhold. The implications for Company X in relation to these payments to the overseas bank account are considered below.

Constructive payment

26.          Once payments were received by the 'franchisor agent' (Foreign Co) via its overseas bank account, the payments would be paid to Company X via an exchange of payments or set off. You advised that Company X only ever paid 20% commission under clause X(B)(x) of the Agreement and no payments were made under clause X(B)(y) of the Agreement. Accordingly, it is understood that 80% of the payments would be paid to Company X and 20% would be retained by Foreign Co as its commission.

27.          Although Company X has not made any 'actual' payments under the above arrangement, for income tax purposes, it would be taken to have constructively derived 100% of the amount paid by the 4 AEPs to the franchisor agent's overseas bank account in relation to Company X's services provided to these AEPs (under subsection 6-5(4) of the ITAA 1997) and to have constructively paid 20% as commission to Foreign Co (under subsection 128A(2) and section 11-5 of the TAA 1953). Each of these constructive payments will constitute a payment of a royalty by Company X at the time it receives net payment of 80% of each service fee, as that is the time it has constructively paid the 20% commission.

Withholding liability and obligation

28.          While you have stated that Company X had not been advised by Party A that Foreign Co had replaced Company Y in cooperation agreements with the AEPs, Company X was aware that the 4 AEPs were making payments to the franchisor agent's overseas bank account. Accordingly, Company X, prima facie, had an obligation to withhold under section 12-280 of the TAA 1953 given that, based on records in its possession, the recipient of the payments (and therefore Company X's constructive payments of the 20% commission) had an address outside Australia or payments were made to a place outside Australia.

29.          Pursuant to section 12-300 of the TAA 1953, in order for a resident entity to have an obligation to withhold under section 12-280 of the TAA 1953, there first must be an entity (a non-resident or foreign permanent establishment) that is liable for withholding tax under section 128B in relation to the payments. Information available to Company X that would have indicated there was, or very likely was, such an entity, include the following:

(a)          the Agreement includes Foreign Co, a non-resident of Australia, an entity within Party A

(b)          Clause X of the Agreement, in relation to Party A, states that it is a level one education agent in a foreign jurisdiction

(c)           the Agreement includes scope for students to be recruited overseas, indicating along with the above fact, that Company Y and/or Foreign Co (or other recipient of the payments from the 4 AEPs) had overseas operations

(d)          under the cooperation agreements (which Company X was a party to), payments made by the AEPs could only be paid to an agreed nominated bank account

(e)          using the cooperation agreement provided as an example, clause XX of the Agreement regarding invoicing relevantly states:

(i) The Agent must provide the AEP with a completed Representative Payment Details form containing their contact and bank account details, their GST registration status and, where relevant, their ABN.

(ii) the AEP will not make any payment to the Agent under this Agreement until a Representative Payment Details Form has been provided to the AEP.

(iii) The Agent must provide an updated Representative Payment Details Form to the AEP within three days of a change to any of the information in the form. The AEP will not be held responsible for payments made to incorrect bank accounts where the Agent has not updated their payment details with the AEP.

(iv) Invoices for commission payable to the Agent under this Agreement will be issued by xxxx and not by the Agent.

(v) the AEP will pay the amount due under an invoice into the Agent's nominated bank account no later than 60 days after the relevant census date.

(f)            the commissions were paid by the AEPs to an overseas bank account, i.e., an offshore location

(g)          the Agreement leaves open the possibility that either entity within Party A could have entered into a cooperation agreement with AEPs in Australia, i.e., was not limited to Company Y.

30.          Given the parties to the Agreement, it would have been reasonable for Company X to conclude that Foreign Co, was the actual and intended recipient of the payments from the 4 AEPs, and accordingly, that recipient (Foreign Co) had entered into cooperation agreements with the applicable AEPs. Foreign Co would therefore derive the 20% commission income constructively paid by Company X and would have a liability to withholding tax under section 128B.

31.          Accordingly, Company X would have an obligation to withhold under section 12-280 of the TAA 1953 in relation to its constructive payment of the 20% commission to Foreign Co that were paid to the overseas bank account by the 4 AEPs.

32.          Even if Company X was not sure if it had a withholding obligation, the onus was on Company X to make enquiries, given the above information in its possession, to exclude the possibility that it had an obligation to withhold. The obligation to withhold is not voluntary, and penalties apply for failing to withhold.[5] Under section 16-30 of the TAA 1953, the penalty is the amount of the withholding tax not withheld.

Question 3

Regarding the payments referred to in question 2 that are royalties, what is the rate of withholding from these payments?

Summary

The rate of withholding from these payments is 30%.

Detailed reasoning

33.          In relation to the 20% commissions constructively paid by Company X to Foreign Co, a royalty withholding tax rate of 30% would apply. This is based on information available to Company X, being the location of the recipient's overseas bank account, that Foreign Co was registered in a foreign jurisdiction and lack of information otherwise evidencing that the recipient (which it would be reasonable to conclude was Foreign Co) resided in a country with which Australia has a double tax agreement.

Question 4

Whether agent and principal are liable together to account for and make disclosures necessary to closely associated third parties to determine the respective party's correct amount of Australian tax payable?

Summary

The Commissioner is not able to rule on this question, as it is not a tax question in relation to Company X.

Detailed reasoning

34.          You advised that Company X is not in an agent and principal relationship in relation to the Agreement. Further, notwithstanding characterisations referred to in the cooperation agreements, based on the information provided, the relationship between the AEPs and Company X, or AEPs and Company Y/Foreign Co, is one of service provider and customer, not agent and principal. Payments for services are not royalties[6] and according to the cooperation agreement provided, there is no payment by the AEPs for use of any rights owned by Company X, Company Y or Foreign Co. Therefore, there is no agent and principal relationship that relates to the Agreement for the Commissioner to rule on.

[1] IT 2660, paragraph 10.

[2] IT 2660, paragraph 11.

[3] IT 2660, paragraph 25.

[4] This is based on the assumption that Company X is not deriving the commission income in carrying on a business outside at or through a permanent establishment in a country outside Australia.

[5] Section 16-25 of the TAA 1953

[6] IT 2660 paragraphs 7 and 25

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