TASK TECHNOLOGY PTY LTD V FC of T

Judges:
Dowsett J
Gordon J
Jagot J

Court:
Full Federal Court of Australia, Melbourne

MEDIA NEUTRAL CITATION: [2014] FCAFC 113

Judgment date: 5 September 2014

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Dowsett, Gordon and Jagot JJ

INTRODUCTION

1. This appeal concerns Art 12(7) of the Convention between Australia and Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (21 May 1980)
[1981] ATS 14 (entered into force 29 April 1981) (the Canadian DTA ) and, in particular, whether payments made in the 2007 to 2011 income years by Task Technology Pty Ltd ( Task ) to CaseWare International Inc ( CWI ), a resident of Canada, pursuant to a CaseWare dated 1 July 1997 (the Distribution Agreement ), were payments of the kind specified in Art 12(7).

2. It was common ground that if payments made by Task to CWI under the Distribution Agreement were royalties, they were subject to withholding tax under the applicable taxing statutes. The question at trial was whether the payments fell within an exclusion provided by Art 12(7) of the Canadian DTA, namely whether they were "payments or credits made as consideration for the supply of, or the right to use, source code in a computer software program, provided that the right to use the source code is limited to such use as is necessary to enable effective operation of the program by the user". Task submitted that the payments were not royalties as a result of the operation of this provision.

3. The primary judge held that the payments made by Task were not payments of the kind specified in Art 12(7). Task appealed and the respondent filed a notice of contention. We would dismiss the appeal. The payments made by Task were not payments of the kind specified in Art 12(7) but we reach that conclusion for different reasons to those of the primary judge.

LEGISLATION

4. Under s 12-280(a) of Sch 1 to the Taxation Administration Act 1953 (Cth) (the TAA ), an entity must withhold an amount from a royalty it pays to an entity if the recipient has an address outside Australia.

5.

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Section 12-300 relevantly provides that Subdiv 12F of Sch 1 to the TAA 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).

6. Section 128B of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act ) deals with withholding tax liability. Section 128B(2B) deals with royalties and relevantly provides that the section applies where income of a non-resident consists of a royalty that is paid to that non-resident by a person to whom the section applies. A "royalty" is defined in s 6 of the 1936 Act.

7. There was no dispute that the payments made by Task to CWI under the Distribution Agreement and the subject of this appeal fall within s 128B(2B) if the payments were not royalties in consequence of the operation of Art 12(7) of the Canadian DTA. Section 128B(5A) provides that:

A person who derives income to which this section applies that consists of a royalty is liable to pay income tax upon that income at the rate declared by the Parliament in respect of income to which this subsection applies.

Absent other provisions, the rate declared was 30%.

8. Section 128C entitled "Payment of withholding tax" then provides that the withholding tax is due and payable by the person liable to pay the tax (ie Task) at the expiration of 21 days after the end of the month in which the income to which the tax relates was derived by the person (ie CWI).

9. The next relevant statute is the International Tax Agreements Act 1953 (Cth) (the Int TAA ). The Int TAA overrides the 1936 Act to the extent of any inconsistency: s 4(2) of the Int TAA. Section 6AB of the Int TAA provides that after the entry into force of the Protocol Amending the Convention Between Australia and Canada for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (23 January 2002)
[2002] ATS 26 (entered into force on 18 December 2002) ( Canadian Protocol ), the provisions of that protocol, to the extent that they affect Australian tax, have and are to be taken to have had the force of law according to their tenor.

10. The Canadian Protocol, was during the relevant periods, set out in Sch 3A to the Int TAA. It modified the then existing Canadian DTA (as was set out in Sch 3). Both the Canadian Protocol and the Canadian DTA formed part of the Int TAA during the whole of the relevant period. Article 12 of the Canadian DTA (as modified by the Canadian Protocol) relevantly provided:

ARTICLE 12

Royalties

• (1) Royalties arising in one of the Contracting States, being royalties to which a resident of the other Contracting State is beneficially entitled, may be taxed in that other State.
• (2) Such royalties may be taxed in the Contracting State in which they arise, and according to the law of that State, but the tax so charged shall not exceed 10 per cent of the gross amount of the royalties.
• (3) The term "royalties" as used 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:
  • (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; or
  • …
  • (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 right as is mentioned in subparagraph (a) …
• …
• (7) Without prejudice to whether or not such payments would be dealt with as royalties under this Article in the absence of this paragraph, the term "royalties" as used in this Article shall not include payments or credits made as consideration for the supply

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  of, or the right to use, source code in a computer software program, provided that the right to use the source code is limited to such use as is necessary to enable effective operation of the program by the user .

(Emphasis added.)

11. A number of matters should be noted. The Canadian DTA (as modified by the Canadian Protocol) overrode the 1936 Act by limiting the withholding tax to a rate of 10% (Art 12(2)) and in its definition of a "royalties" (Art 12(3)). In this appeal, Task accepted that the payments it made to CWI were caught by Art 12(3)(a) but contended that they became excluded by reason of Art 12(7). Task submitted that the payments it made to CWI under the Distribution Agreement were payments or credits made as consideration for the supply of, or the right to use, source code in a computer software program and the right to use the source code was limited to such use as was necessary to enable effective operation of the program by the user. The focus of the appeal was necessarily on the words of Art 12(7) and, in particular, the application of that provision to the terms of the Distribution Agreement.

12. The principles of construction of an international treaty or convention are well settled:
Applicant A v Minister for Immigration and Ethnic Affairs (1997) 190 CLR 225 at 230-1 (Brennan J) and at 254-6 (McHugh J). A holistic approach is to be taken to the interpretation of the Canadian DTA, including Art 12(7): Applicant A at 231 and 254. The written text is the starting point. It has primacy in the interpretation process. However, the context, object and purpose of Art 12(7) must also be considered: Applicant A at 255-6 and Art 31 of the Vienna Convention on the Law of Treaties (open for signing 23 May 1969)
[1974] ATS 2 (entry into force for Australia and generally 27 January 1980).

13. The purpose of Art 12(7) was identified in the Explanatory Memorandum that accompanied the International Tax Agreements Amendment Bill (No 2) 2002 (Cth) at [1.35]:

Canadian tax treaty practice in relation to computer software, in accordance with its Observation to the Commentary to Article 12 of the OECD Model, is to treat as royalties, payments under contracts that require the source code in the computer software to be kept confidential. However, new paragraph 7 provides that such payments will not be treated as royalties where the right to use the source code is limited to such use as is necessary to enable the user to operate the software program. In these cases, Article 7 of the Convention will apply.

Article 12(7) was inserted into the Canadian DTA to create an exception to the Canadian practice.

14. The balance of these reasons will consider the facts and then turn to consider the proper construction of Art 12(7) and its application to those facts.

FACTS

15. First, what was granted by CWI to Task? By cl 2.2 of the Distribution Agreement, CWI granted to Task (defined as the Distributor ) the exclusive right (for Australia, New Zealand and New Guinea) to:

• 2.2.1 market End User Licences and Application Template Licences;
• 2.2.2 make Copies of Licensed Software and CaseWare Documentation;
• 2.2.3 supply Copies of Licensed Software to End Users pursuant to End User Licences and Application Template Licences;
• 2.2.4 supply Copies of CaseWare Documentation;
• 2.2.5 supply Professional Services specified in Section 2.5.1 to End Users pursuant to Professional Services Agreements;
• 2.2.6 develop Application Templates for use by End Users;
• 2.2.7 supply Application Templates developed by Distributor to End Users pursuant to Application Template Licences.

(Emphasis added.)

16. For the purposes of this appeal, the Court was told that sub-paragraphs 2.2.4 and 2.2.5 were not relevant and that although the term of the Distribution Agreement had expired, the parties had continued to conduct themselves in accordance with its terms as amended orally from time to time. There was no suggestion that the parties at some stage agreed to pay for

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something other than what is set out in the Distribution Agreement.

17. A number of the terms referred to in cl 2.2 were defined in an Appendix to the Agreement including:

…

Application Template means content and mathematical instructions used in conjunction with Licensed Software which increase the ease and efficiency of Use of Licensed Software and/or assist the User of Licensed Software to adapt use of Licensed Software to the User's particular needs and all enhancements, modifications, adaptations, translations thereof and derivations therefrom whether in tangible form or not.

Application Template License means a software licensing agreement permitting installation and use of an Application Template and Documentation by a licensee in the Territory and providing for protection of CWI's Intellectual Property Rights.

CaseWare Documentation means User Documentation related to Licensed Software.

…

Documentation means textual and / or graphic material, perceivable directly by humans and / or with the aid of a device or a machine, relating to a Computer Program.

…

End User means an individual, corporation, partnership or other business entity resident in the Territory to whom Licensed Software or an Application Template developed by Distributor has been supplied under an End User License or an Application Template License.

End User License means a software licensing agreement permitting installation and Use of Licensed Software and Documentation by a licensee in the Territory providing for protection of CWI's Intellectual Property Rights.

…

Intellectual Property Rights means any and all rights to exclude or control existing from time to time in a specified jurisdiction under patent law, copyright law, moral rights law, trade-secret law, semiconductor chip protection law, trademark law, unfair competition law, or other similar rights.

…

Licensed Software means all or any portion of the Computer Programs generally described as CaseWare, CaseView, CaseSpell, CaseReport and Practice Administration and Application Templates developed by CWI, and all Computer Programs that supplement, correct or enhance other Licensed Programs.

…

User Documentation means Documentation that describes the function and use of a Computer Program in sufficient detail to permit use of the Computer Program.

18. What was granted to Task was the right to market and distribute the CWI software to end users pursuant to End User Licences and to make copies of the software for distribution. In addition, it was granted the right to develop and supply templates for use with the CWI software pursuant to "Application Template Licences". The CWI software enables customers to import financial data from other computer programs not produced by CWI in machine readable formats to interface with the CWI software. In general terms, the CWI software maps the data by giving entries a unique mapping number that allows for its identification by the software for its later use in auditing working papers and financial reports. The software causes information captured in particular templates to be automatically output into various financial reports.

19. Stopping there, a careful reader of cl 2.2 will notice that there is no reference to source code. Indeed, the only references to source code in the Distribution Agreement are in cl 8 which is entitled "Protection of Confidential Information" and in the Annexure which contains definitions. Clause 8 contained four sub-clauses. Relevantly, cl 8.1 and 8.2 provided:

• 8.1 DEFINITION
  • 8.1.1 As used in this License, "Confidential Information" means all information which has not been made

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    generally known with the consent of CWI (whether or not tangibly embodied in a document, computer storage device, or other physical object) concerning Licensed Software or Application Templates developed by CWI or the business, affairs or property of CWI or any Affiliated Company including :
    • 8.1.1.1 any and all information relating to concepts, ideas, models, know-how, presentation design elements and algorithms now or hereafter incorporated in Licensed Software or Application Templates developed by CWI or on which either of them is based; and
    • 8.1.1.2 Design Documentation, Source Code, Executable Code, standards and specifications now or hereafter incorporated in or relating to Licensed Software;
    • …
• 8.2 CONFIDENTIAL INFORMATION OBLIGATIONS
  • …
  • 8.2.3 Distributor shall not reverse engineer, reverse compile or disassemble Licensed Programs without the prior specific written consent of CWI which consent may be arbitrarily refused.
  • …

(Emphasis in bold added.)

20. Again, terms were defined in an Appendix to the Agreement and, in addition to the terms set out at [17] above, also relevantly included the following:

Computer Program means a set of statements or instructions, to be used directly or indirectly in a computer in order to bring about a certain result.

…

Design Documentation means Documentation describing the data flows, data structures, and control logic of a Computer Program.

…

Executable Code means a series of one or more instructions executable after suitable processing by a computer or other programmable machine, without compilation or assembly.

…

Licensed Program means a Computer Program comprising part of Licensed Software.

…

Source Code means a series of instructions or statements in an English-like high-level computer language which are readable by appropriately trained humans such as FORTRAN, C, C++, PASCAL, or LISP, or in a relatively low-level language such as the assembly language for a particular processor.

…

21. Again, a careful reader of cl 8 will notice that the definition of Confidential Information concerns, amongst other things, all information not … generally made known with the consent of CWI concerning Licensed Software or Application Templates developed by CWI. That, by definition, included Source Code: see cl 8.1.1.2.

22. Royalties were payable by Task to CWI in relation to the rights it was granted under cl 2. The obligations to pay royalties were set out in cl 3 of the Distribution Agreement. The evidence of Mr Solly Lew (a director and Chairman of Task) was that:

[T]he fees paid by Task to CWI have changed from time to time. But there was no written agreement as to those changes; they were merely agreed orally between Mr Wainman [from CWI] and me. Clause 3.2.1 of the contract provides that the fees to be paid are calculated on the number of copies of the software made and supplied by [Task] to its customers. For the period in issue in these proceedings, the fees actually paid by Task included an amount equal to 50% of the revenue from the CWI software licences of the CWI software sold by Task to its customers in Australia.

In addition, fees paid by Task to CWI has included further amounts equal to 25% of the revenue received by Task from customers for the right to use application templates created by it, and 25% of the revenue received from customers for

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provision by [Task] of user support, training and other ancillary services.

23. The relevant payments made by Task to CWI were as follows:

Income Year ended 30 June	Amount of payment
2007	$566,361
2008	$763,033
2009	$807,464
2010	$767,028
2011	$772,539

24. The Commissioner of Taxation issued a notice under s 16-30 of Sch 1 to the TAA to Task to pay an administrative penalty of $352,822 for failing to withhold 10% from the payments detailed in [23] as required by Div 12 of Sch 1 to the TAA.

ANALYSIS

25. First, the text of Art 12(7) of the Canadian DTA. For that article to apply, it was necessary for Task to satisfy two limbs.

26. First, the payments Task made to CWI under the Distribution Agreement had to be made as consideration for (a) the supply of source code in a computer software program or (b) the right to use source code in a computer software program: Art 12(7).

27. Second, if the payments Task made to CWI were as consideration for one of those elements, then (and only then) did the proviso in Art 12(7) become relevant. The proviso was that if there was a supply, or a right to use, source code, the use of the source code had to be limited to such use as is necessary to enable effective operation of the program by the user: Art 12(7).

28. The primary judge decided that the payments Task made to CWI under the Distribution Agreement did not satisfy the proviso and therefore Art 12(7) did not apply. In our opinion, Task fails on the first limb and the application of the proviso does not arise.

First Limb

29. As the Commissioner submitted, Art 12(7) required Task to identify the supply to it of the source code in the relevant program (or the right it had to use the source code in the relevant program) and which of the payments it made to CWI were in consideration for that supply (or that right).

30. The only vehicle which provided Task with any rights was the Distribution Agreement: see [15]ff above. By cl 2 of the Distribution Agreement, Task is granted the right in a defined territory to:

• 2.2.1 market End User Licences and Application Template Licences;
• 2.2.2 make Copies of Licensed Software and CaseWare Documentation;
• 2.2.3 supply Copies of Licensed Software to End Users pursuant to End User Licences and Application Template Licences;
• …
• 2.2.6 develop Application Templates for use by End Users;
• 2.2.7 supply Application Templates developed by Distributor to End Users pursuant to Application Template Licences.

(Emphasis added.)

That clause defines the licensed rights granted to Task and the extent of them.

31. Clause 2 of the agreement identifies two relevant rights - the supply to Task of the Licensed Software for it to copy (cl 2.2.2) and supply (cl 2.2.3) to End Users and the right to develop Application Templates for use by End Users (cl 2.2.6) and to supply those Application Templates to End Users under licence (cl 2.2.7). The phrases Licensed Software and Application Templates are defined terms: see [17 above. Licensed Software is defined to mean all or any portion of the Computer Programs generally described as CaseWare, CaseView, CaseSpell, CaseReport and Application Templates developed by CWI and all Computer Programs that supplement, correct or enhance other Licensed Programs.

32. As the Distribution Agreement makes clear, it distinguishes between a Computer Program, the Executable Code, the Licensed Program and the Source Code. Each is defined separately in the agreement: see [20] above. Not only are the terms and phrases distinct, the operation of them is distinct. The Licensed Software (incorporating Computer Programs as that phrase is defined) is installed on and run on a computer. Source Code is not. Source Code is defined to mean "a series of instructions or

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statements in an English-like high level computer language which are readable by appropriately trained humans such as FORTRAN, C, C++, PASCAL, or LISP, or in a relatively low-level language such as the assembly language for a particular processor" (emphasis added). The series of instructions which comprise the Source Code is not the same as the Computer Program or the Executable Code which the computer reads to execute the computer program: see [20] above.

33. There is nothing in the express terms of cl 2.2 which supplies to Task the particular information which is the Source Code or the right to use the Source Code. Task was not granted a supply of the source code in the relevant program or given the right to use the source code in the relevant program. Put another way, given the specificity with which the rights were granted by CWI to Task in the Distribution Agreement, there could only be a right to use source code if that right had been created by way of a grant of that right by CWI to Task. Here, there was no such grant and therefore no right to use source code existed for the purpose of Art 12(7). As we have said, the only rights concerning the relevant software program (defined as Licensed Software) were those granted under cl 2.2. The anodyne assertions by Dwight Wainman, the joint founder and former president and chief executive officer of CWI, that CWI's products include "CaseWare Working Papers", that Task is the Australian distributor for CaseWare Working Papers, and the CaseWare Working Papers software is a computer program consisting of source code are immaterial to the rights granted under the Distribution Agreement, which must be determined by reference to the terms of that agreement.

34. That analysis provides a complete answer to Task's submissions. Without more, the supply of a computer software program does not constitute the supply of source code in that program for the purposes of Art 12(7). The contention of Task that a right to use a computer software program constitutes a right to use source code in that program for the purpose of Art 12(7) also fails. Under the terms of the Distribution Agreement, that is not what occurred. Further, Task's submissions about what might constitute "source code" whether by reference to
Computer Edge Pty Ltd v Apple Computer, Inc (1986) 161 CLR 171 or otherwise are irrelevant. The matter was and remains governed by the Distribution Agreement.

35. When might there be a supply of, or the grant of a right to use source code? Paragraph 14.3 of the OECD (2012), "Commentary on Article 12: Concerning the taxation of royalties", in Model Tax Convention on Income and on Capital 2010 (Full Version), OECD Publishing, provided one example and described that example in the following terms:

Another type of transaction involving the transfer of computer software is the more unusual case where a software house or computer programmer agrees to supply information about the ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques. In these cases, the payments may be characterised as royalties to the extent that they represent consideration for the use of, or the right to use, secret formulas or for information concerning industrial, commercial or scientific experience which cannot be separately copyrighted. This contrasts with the ordinary case in which a program copy is acquired for operation by the end user.

(Emphasis added.)

We are in the ordinary case, not the unusual case.

36. There is a further reason why Task's submissions fail on the first limb. Not only must there be a supply to Task of the source code in the program (or the grant of a right to use source code in the program) (and there was not), Task must demonstrate which of the payments in [22]-[23] above (if any) were made by it to CWI as consideration for the supply or the right to use the source code. As we have seen, the payments Task was required to make to CWI under cl 3 of the Distribution Agreement were as consideration for the rights granted by CWI to Task under cl 2.2. Those rights were extensive. The Distribution Agreement did not provide for any payment to be made by Task to CWI for the supply of source code in the program, or the right to use source code in the program. Put another way,

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Task did not demonstrate any connection between the payments in [22]-[23] above and the alleged supply of source code in the program, or the right to use source code in the program so that a payment could have been said to have been made as consideration for one or both of those rights. On the contrary, the Distribution Agreement expressly stated that the payments were made as consideration of other rights - those listed in cl 2.1-2.3, 2.6 and 2.7 of the Distribution Agreement.

Second Limb

37. Given the views expressed above, it is unnecessary to consider the application of the proviso or what has been described as the second limb of Art 12(7). Task's failure on the first limb means that the proviso cannot be engaged.

ORDERS

38. For those reasons, the appeal is dismissed with costs.