Edited version of private ruling

Authorisation Number: 1011756068988

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Ruling

Subject: Royalty withholding tax on Licence Fees

Question 1

Are the payments made to Entity A by Entity B for the licence to use, maintain and support, copy, adapt, sub-licence to Entity B suppliers and to customers and transfer amongst affiliated companies of all software forming part of the system considered to be 'royalties' to which section 128B of the Income Tax Assessment Act 1936 (ITAA 1936) applies?

Answer

No

Question 2

If the answer to Question 1 is confirmed in the affirmative, are the payments of ongoing support and maintenance fees (covering support, upgrades and new releases) royalties to which section 128B of the ITAA 1936 applies?

Answer

No

This ruling applies for the following periods:

Substituted Accounting Periods 31 December 2009 to 31 December 2015

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Background

Entity A is a company incorporated in country X and is a non-resident of Australia for income tax purposes. Entity A does not carry on a business at or through a permanent establishment situated in Australia.

The principal activities of Entity A are the building of networks that enable its customers to make business changes to improve efficiency, reliability and customer service. Whilst Entity A's expertise and services described above are provided remotely, Entity C, a wholly owned subsidiary of Entity A provides support and assistance in Australia. This work comprises of troubleshooting and fault finding services and configuration of the software onto the licensee's networks.

Relevant agreements

Entity A and Entity B are not associated entities.

Entity A and Entity B, an Australian resident company, have entered into an agreement for the supply of Entity A hardware, software and related support services. Under the agreement, Entity A is to provide a bundle of information technology and other services and product for the design, development, supply, support and maintenance of a system required by Entity B.

Entity A's management in Country X is responsible for negotiating and concluding the agreement and additional Statements of Works (SOWs) with Entity B.

Employees of Entity C perform a facilitative and supporting role in the contract negotiations and have no authority to conclude on relevant contractual terms. Actual terms of the contract and relevant contractual undertakings are decided and concluded by employees of Entity A in Country X.

Licence Fees

The clause relating to licence fees in the Agreement defines licence to mean a 'royalty free, irrevocable world-wide, perpetual and non-exclusive licence'.

(a) Software usage

As consideration for the right to use the abovementioned software, Entity B agrees to pay the 'supply sum', as detailed in the relevant clause of the Agreement. This sum incorporates the licence fee chargeable, as well as all other charges in conjunction with the provision of the deliverables under the Agreement, including inter alia, direct and indirect costs associated with the deliverables .

(b) Support Services

Under the Agreement and separate Statement of Work (SOW), Entity A is also to provide Entity B with a range of support services in relation to the system. These support services include (but are not limited to):

· support, assistance, identification, management, workarounds, resolution and fixes of problems with the supported system;

· provision of release and updates including product revisions, identified by version and release numbers; enhancements and fixes, accompanying regular technical support bulletins; pre-installation testing on the contractors systems and data ; and release notes; including but not limited to details of what, why and how changed;

· assistance and supporting relation to the update or release installation;

· supported system implementation documentation and updating of documentation;

· testing support services.

Whilst the initial installation of software onto Entity B's networks will be conducted remotely from Country X via electronic delivery, the abovementioned ancillary support services may be provided by both Entity C and Entity A remotely. Initial queries will be initially handled by Entity C and escalated to Entity A in Country X for support/resolution where necessary.

(c) Nature of Software Licence

The manner in which Entity B is to deal with the licensed software is set out in the relevant clause of the Agreement.

Entity B's permitted uses include:

in relation to the system, including all software forming part of the system, Entity A grants Entity B a licence to use, maintain, support, copy, adapt, sub-licence (to Entity B suppliers and customers) and transfer amongst affiliated companies;

in relation to existing documentation, a licence to use, copy, modify, sub-licence (to Entity B suppliers and customers) and transfer amongst affiliated companies.

The clause relating to third party software in the Agreement states that where Entity A provides Entity B with any deliverable that incorporates software owned by a third party (Third Party Software), Entity A must provide Entity B with a licence to:

· copy the Third Party Software into machine readable form to the extent permitted under the Copyright Act 1968 (Cth);

· use the Third Party Software on any Entity B hardware platform/operating system combination;

· use, reproduce, revise, adapt and modify the documentation supplied by Entity A with the Third Party Software;

· maintain and support the Third Party Software through level 1 and level 2 help-desk and troubleshooting;

· adapt interfaces in the Third Party Software to allow integration with Entity B systems;

· sub-licence (to Entity B suppliers and to customers);

· transfer amongst affiliated companies.

You have stated that in addition to the arrangement as stated in the Software Licence Agreement and Escrow Agreement, the following commercial arrangements apply:

Entity A will deliver the software electronically to Entity B.

The software will be licensed and used as an enterprise software application, which is installed on Entity B's servers. End users (that is, Entity B employees) will access the software through a web interface.

Entity B does not have access to the underlying source code of the software as evidenced by the existence of an escrow arrangement whereby the source code is held by an escrow agent.

Entity B is permitted to modify the software only for the purposes of making the software operate within Entity B's existing infrastructure. Entity B cannot otherwise modify or reproduce the software, except upon the occurrence of certain defined events that trigger the release of the source code and technical data from escrow.

Entity B is permitted to make back-up copies of the software, adapt for the purpose of enabling the operation of the software program on Entity B's services systems and download to affiliates' sites (consistent with the workings of an enterprise licence) but otherwise is prohibited from copying, manufacturing or distributing the software.

Other third party software may be bundled/incorporated with Entity A deliverables, to allow Entity B to copy the licensed software to machine readable form and the software for use on Entity B's hardware platform.

Escrow Provisions - release of source code:

Entity A is required to deposit the source code for the licensed software into escrow on the terms and conditions contained in a separate agreement between Entity A, Entity B and the Escrow Agent.

The effect of the Escrow Agreement is to hold in its custody the source code and supporting material for the licensed software on behalf of Entity A and Entity B, which would be released only on the happening of specific defined events. Only under these limited prescribed events (as set out in the specific clause of the Agreement and as set out below) would Entity B be entitled to receive access to the relevant source code:

· Entity A fails to obtain acceptance of deliverables from Entity B (as defined at the relevant clause) as a result of an act, default or omission of Entity A or its personnel;

· Entity A fails to comply with any material requirements in the Agreement or any contract and fails to remedy that breach within 14 days, or such longer period as Entity B may at its discretion allow, after receiving written notice from Entity B to remedy the breach;

· Entity A is or will be unable to pay debts as they fall due;

· Entity A tries to enter into a composition or arrangement with its creditors;

· Entity A makes a general assignment of the benefits of its creditors;

· Entity A has an administrator appointed or a receiver appointed for Entity A or its property;

· Entity A ceases its business or goes into liquidation or is wound up otherwise than for the purpose of reconstruction, or a meeting is called for the purpose of considering the appointment of a liquidator;

· an execution is levied against Entity A in any amount in excess of $100,000;

· Entity A is issued with a statutory demand in excess of $100,000 from any person and Entity A fails to satisfy the statutory demand within the time period specified in the statutory demand; or

· Entity A files or any other person files against Entity A under Country X's Bankruptcy Code for reorganisation or liquidation or any other law for debtors' relief, or Entity A takes any steps to seek moratorium on collection of any debts or appoint any trustee over any assets or any other step under the relevant parts of Country X's Bankruptcy Code.

Copies of the following documents have been provided with your Ruling Application:

· Agreement undated.

· Statement of Work - support, maintenance and software licence.

Those documents and your response to our letter of the recent year form part of the facts for the purpose of this ruling.

Relevant legislative provisions

Income Taxation Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1936 Subsection 6(1)

International Tax Agreements Act 1953

Question 1

Summary

The payments made to Entity A by Entity B for the licence to use, maintain and support, copy, adapt, sub-licence to Entity B suppliers and to customers and transfer amongst affiliated companies of all software forming part of the system are not considered to be 'royalties' to which section 128B of the ITAA 1936 applies. It is considered that the payment relates to the right to use the software provided by Entity A rather than the right to use the copyright subsisting within the software. Furthermore, Entity B does not have access to the source code which would allow them to modify the software.

Detailed reasoning

The term royalty is defined in section 995-1 of the Income Taxation Assessment Act 1997 (ITAA 1997) to have the meaning given by subsection 6(1) of the ITAA 1936.

Subsection 6(1) of the ITAA 1936 defines 'royalty' or 'royalties' to include:

…..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, trademark, or other like property or right;

……………

(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 property or right as is mentioned in paragraph (a), ……..or any such knowledge or information as is mentioned in paragraph (c)……'

Under the Copyright Act 1968, a number of rights, including rights to reproduce (other than the making of a back-up copy), modify or adapt a computer program, are exclusive rights of the copyright owner. The copyright owner may, however, authorise another person to do what would otherwise be an infringement of copyright.

Payments for the right to do acts comprised in the copyright are considered to come within paragraph (a) of the definition of 'royalty', being amounts paid as consideration for the use of, or the right to use, copyright in the computer program. The term 'copyright' is not defined in the ITAA 1936 and, for the purposes of the definition of 'royalty' in subsection 6(1) of the ITAA 1936, is taken to have the same meaning as it has under the Copyright Act 1968.

In determining whether or not a payment is for the use of copyright, it is important to distinguish between a payment for the right to use the copyright in a program and the right to use the program itself. A payment for the right to use the program itself only allows the licensee to operate or run the program on a computer. On the other hand, a payment for the right to use the copyright in a program allows the licensee to modify, adapt or copy, or otherwise do what would ordinarily be the exclusive right of the copyright owner. However, payments solely for the right to import and/or distribute the software, without any licence to use the copyright are not royalties (paragraph 20 of TR 93/12).

TR 93/12, states at paragraph 3 that a payment is considered to be a royalty for the purposes of the ITAA 1936 where the payment is:

(a) consideration for the granting of a license to reproduce or modify the computer program in a manner that would, without such license, constitute an infringement of copyright (paragraph (a) of the definition of royalty). Examples include payments for the right to manufacture copies of program from a master-copy for distribution, and payments for the right to modify or adapt a program.

(b) consideration for the supply of know-how (paragraph (c) of the definition of royalty). Payments for the supply of the source code or algorithms of a program are, prima facie, considered to come within this paragraph.'

A right to produce, reproduce or exploit a work or other subject matter in which copyright subsists will be a payment for the use of the copyright, whether or not the right is actually used by the person paying the royalty (Taxation Ruling IT 2660).

Payments for the granting of a license which allows only simple use of the software, that is, allows the end-user to run the software on a single computer or a computer network but does not otherwise permit any use of the copyright in the program is not generally a royalty (sub-paragraph 4(b) of TR 93/12).

A copy of a software program, embodied on disk, diskette, magnetic tape or other carrying media, is frequently acquired under a licensing arrangement, the most common of which is known as a 'shrink-wrap' licence. Under these arrangements the end-user is granted a licence to use the software, that is, to run the program and to make a back-up copy of the program. A licence is granted to use the software either on a single computer, or on a specified number of the licensee's computers or network servers. The licence may also specify that the software may only be used on the licensee's computers at certain locations (Site Licence) or may limit the number of simultaneous users. The licence also purports to limit the end-user's powers to deal with the software, for example, it cannot be transferred or hired without the permission of the licensor. Under such licence agreements, neither copyright in the program nor property in the tangible carrying media is transferred to the end-user; the software and all copies made of it remain the property of the software manufacturer or developer (paragraph 26 of TR 93/12).

Paragraph 27 of TR 93/12 states that payments for any licence for simple use of computer software (that is, where the end-user acquires only the right to run the program, whether on a single computer only or on the licensee's computer network, and does not acquire any rights to use the copyright in the program) are not royalties for purposes of income tax law. It is arguable that some part of the amount paid for the acquisition of computer software under a licensing arrangement is attributable to an express or implied licence to use the copyright in the program. For example, it may be that the act of loading a program onto the hard disk of a computer would, without permission from the copyright owner, be an infringement of copyright (see Sheppard J in Damson and Ors v. Autodesk Inc and Amor (1990) 96 ALR 57 at p. 88). Although the amount attributable to such express or implied licence would strictly be a royalty, being an amount paid 'for the use of, or the right to use, any copyright' (paragraph (a) of the definition of royalty in subsection 6(1) of the ITAA 1936), it is accepted that the amount, if quantifiable, is likely to be minimal. For this reason, it has been decided that no apportionment of the licence fee paid in respect of the software is necessary to take account of this amount.

It is also accepted that, in the case of packaged software, payments for the acquisition of software under a licensing arrangement does not ordinarily involve the supply of technical knowledge or information for purposes of paragraph (c) of the definition of royalties. Where the purchaser or licensee obtains nothing more than a set of coded computer instructions, without the underlying source code, it cannot be said that knowledge or information about the program in the relevant sense of know-how has been transferred (paragraph 28 of TR 93/12).

Paragraph 29 of TR 93/12 states that payments for a licence for simple use only of computer software are not royalties, irrespective of whether the software is acquired by a distributor for sub-licensing to end-users or by end-users directly.

In the tax treaty between Australia and Country X which is contained in the International Tax Agreements Act 1953 ('the Country X Agreement') royalties is defined as:

...payments or credits of any kind to the extent to which they are consideration for the use of or the right to use:

· copyright, patent, design or model, plan, secret formula, trademark or other like property or right;

· the supply of scientific, technical, industrial or commercial knowledge or information owned by any person;

· the supply of any assistance of an ancillary and subsidiary nature furnished as a means of enabling the application or enjoyment of knowledge or information referred to in sub-paragraph above or of any other property to which the Article applies;

· a total or partial forbearance in respect of the use or supply of any property or right described in this paragraph.

There is no discrepancy between the definition of the word 'royalty' in the royalty Article of Country X's Agreement and the definition in subsection 6(1) of the ITAA 1936:.

Country X's Agreement is based on the OECD Model Convention. The relevant paragraph of the Article on royalties of the OECD Model Convention's Commentaries ('OECD Commentary') states that where consideration is for the granting of rights to use the program in a manner that would, without the license, constitute an infringement of copyright, then under such arrangements, the payments would be for the right to use the copyright in the program. Examples include licenses to: 'reproduce and distribute to the public software incorporating the copyrighted program, or to modify and publicly display the program'.

The relevant royalty paragraphs of the OECD Commentary on Country X's Agreement describe the transactions where the payments would not constitute royalties:

In other types of transactions, the rights acquired in relation to the copyright are limited to those necessary to enable the user to operate the program, for example, where the transferee is granted limited rights to reproduce the program ... Regardless of whether this right is granted under law or under a license agreement with the copyright holder, copying the program onto the computer 's hard drive or random access memory or making an archival copy is an essential step in utilising the program. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the program by the user, should be disregarded in analysing the character of the transaction or tax purposes... .

The ease of reproducing computer programs has resulted in distribution arrangements in which the transferee obtains rights to make multiple copies of the program for operation only within its own business. Such arrangements are commonly referred to as 'site licences', 'enterprise licences' or 'network licences'. Although these arrangements permit the making of multiple copies of the program, such rights are generally limited to those necessary for the purpose of enabling the operation of the program on the licensee's computers or network, and reproduction for any other purpose is not permitted under the license.....

The OECD Commentary above follows closely the ATO's views expressed in TR 93/12.

Generally, payments by the end-user, or by the distributor, for the simple use of software are not royalties even if the end-user also obtains the right to download the software on the end-user's own computer network or to make a back-up copy. However, payments for the right to make copies from a master-copy or payments for the right to modify the software or payments to obtain the source code are royalties.

In your case, Entity A, a non-resident company, with no permanent establishment in Australia, has entered into a software licensing arrangement with an Australian resident company Entity B

Under the arrangement Entity A is to provide software and other services for the system..

The initial installation of the software onto Entity B's networks is conducted remotely from Country X via electronic delivery. Entity B is granted perpetual, non-exclusive, irrevocable, royalty-free, worldwide licence to use the copies of the software.

The relevant clause of the Agreement between Entity A and Entity B confers the right to copy, adapt, sub-licence and transfer all software in the system, however, you have stated that in addition to the arrangement as stated in the Agreement and SOW, the following commercial arrangements apply:

· Entity A will deliver the software electronically to Entity B.

· The software will be licensed and used as an enterprise software application, which is installed on Entity B's servers. End users (that is, Entity B's employees) will access the software through a web interface.

· Entity B does not have access to the underlying source code of the software as evidenced by the existence of an escrow arrangement whereby the source code is held by an escrow agent.

· Entity B is permitted to modify the software only for the purposes of making the software operate within Entity B's existing infrastructure. Entity B cannot otherwise modify or reproduce the software, except upon the occurrence of certain defined events that trigger the release of the source code and technical data from escrow.

· Entity B is permitted to make back-up copies of the software, adapt for the purpose of enabling the operation of the software program on Entity B's services systems and download to affiliates' sites (consistent with the workings of an enterprise licence) but otherwise is prohibited from copying, manufacturing or distributing the software.

Other third party software may be bundled/incorporated with Entity A deliverables, to allow Entity B to copy the licensed software to machine readable form and the software for use on Entity B's hardware platform.

Whilst the permitted uses in the relevant clause of the Agreement may appear to provide for broader application than the ability to enjoy 'simple use' of the software; it is accepted that any adaptation or copying of the licensed software will be for the purposes of making the software operate within Entity B's existing network infrastructure/business. Further, the ability of Entity B to copy the software is restricted to duplication for the purposes of usage by Entity B's affiliates. The Agreement merely grants Entity B the right to install or reproduce the data in order to run multiple copies of the program on Entity B's internal networks. The specified permitted uses namely copy, adapt or transfer are therefore essential steps or processes to enable effective operation and usage of the licensed software for Entity B's internal business use.

The payment is therefore not considered to be a royalty in terms of subsection 6(1) of the ITAA 1936.

Furthermore the escrow provisions in the Agreement do not provide for Entity B to have access to the source code except on the happening of certain events as outlined in the relevant clause of the Agreement. Entity A is required to deposit the source code for the licensed software into escrow on the terms and conditions contained in a separate agreement between Entity A, Entity B and the Escrow Agent.

The effect of the Escrow Agreement is to hold in its custody the source code and supporting material for the licensed software on behalf of Entity A and Entity B, which would be released only on the happening of specific defined events.

Entity B's ability to adapt or modify the licensed software other than for operational purposes under the 'simple use' concept is not possible unless certain events transpire as neither the Agreement nor the Escrow Agreement contemplates the transfer of 'know-how'.

Conclusion

The payments made to Entity A by Entity B for the licence to use, maintain and support, copy, adapt, sub-licence to Entity B, suppliers and to customers and the transfer amongst affiliated companies of all software forming part of the system are not considered to be 'royalties' to which section 128B of the ITAA 1936 applies.

Question 2

Summary

As the provision for software under the Agreement has not been regarded as the provision of rights involving copyright nor the transfer of know how, the provision of the software upgrades are afforded similar status. The ongoing maintenance is considered to be the provision of services rather than a royalty.

Detailed reasoning

Generally, payments for services will not constitute a payment of a royalty. However, payments for services that are ancillary to or part and parcel of, enabling relevant technology, information, know-how, copyright, machinery or equipment to be transferred or used may constitute royalties.

Paragraphs 43 to 46 of TR 93/12 considers contracts for the supply of software where they also provide for ongoing assistance/services and whether payments for such assistance are royalties within the meaning of subsection 6(1) of the ITAA 1936.

Contracts for the supply of software sometimes also provide for certain on-going assistance, such as bug-fixing, training, maintenance or hot-line services. Where this occurs, it is necessary to consider whether payments for such assistance are royalties by reason of paragraph (d) of the definition of royalties in subsection 6(1) of the ITAA 1936 (paragraph 43 TR 93/12).

Paragraph (d) of the definition includes as royalties payments for the supply of assistance which is ancillary and subsidiary to, and furnished as a means of enabling the application or enjoyment of, any property, right or know-how covered by paragraphs (a) to (c) of the definition. Thus, payments for assistance relating to software are royalties within the meaning of the definition in subsection 6(1) where the assistance is subsidiary and ancillary to the right to use copyright or the supply of know-how (paragraph 44 TR 93/12).

In the case of contracts for the acquisition of packaged software, where there will generally be no transfer of know-how or a right to use copyright, any assistance provided by the software house or distributor will not come within the definition (paragraph 45 TR 93/12).

However, in those cases where there is a transfer of know-how or a right to use copyright in the software, it will be necessary to determine whether any payments for ancillary services are royalties. It should be noted that only those payments for assistance which relates to the supply of know-how or the right to use the copyright will be royalties. Payments for assistance which relates to the use of the software rather than the transfer of know-how or the use of the copyright will not fall within the definition in paragraph (d) (paragraph 46 TR 93/12).

The OECD Commentary on the relevant Article provides examples of payments which should be regarded as consideration for the provision of services. These include:

· payments for pure technical assistance,

· payments for advice provided electronically, for electronic communications with technicians or for accessing, through computer networks, a trouble-shooting database such as a database that provides users of software with non-confidential information in response to frequently asked questions or common problems that arise frequently.

In your case, the annual maintenance and upgrade protection fees are designed to provide the customers with helpdesk support, implementation and technical assistance. Helpdesk support services are generally not regarded as involving the provision of pre-existing knowledge or know-how but tailored specifically to the person making the enquiry. It is therefore accepted that the ongoing maintenance is considered to be the provision of services rather than a royalty.

As the provision for software under the Agreement has not been regarded as the provision of rights involving copyright nor the transfer of know how, the provision of the software upgrades are afforded similar status.

Conclusion

The payments of ongoing support and maintenance fees (covering support, upgrades and new releases) are not considered to be royalties to which section 128B of the Income Tax Assessment Act 1936 applies.