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Ruling

Subject: PAYG non-resident royalty withholding

Question 1

Is Payer required to withhold an amount under section 12-280 of Schedule 1 of the Taxation Administration Act 1953 (the TAA 1953) in respect of rights fees which were paid by Subsidiary to the Payees and have not actually been personally remitted by Payer?

Answer 1

Yes. Payer is required to withhold an amount under section 12-280 of Schedule 1 of the TAA 1953 in respect of rights fees which were paid by Subsidiary to the Payees even though they have not actually been personally remitted by Payer.

However, in relation to amounts payable to Payee 1, Payer is not required to withhold an amount under section 12-280 of Schedule 1 of the TAA 1953. Amounts payable to Payee 1 are dealt with separately in Question 3.

Question 2

Is Payer required to withhold an amount under section 12-280 of Schedule 1 of the TAA 1953 in respect of rights fees which were payable to the Payees in relation to rights which was used in Country Z being licence fees which were actually paid by Subsidiary and have not actually been personally remitted by Payer?

Answer 2

Yes. Payer is required to withhold an amount under section 12-280 of Schedule 1 of the TAA 1953 in respect of rights fees which were payable to the Payees in relation to rights which was used in Country Z being licence fees which were actually paid by Subsidiary even though they have not actually been personally remitted by Payer.

However, in relation to amounts payable to Payee 1, Payer is not required to withhold an amount under section 12-280 of Schedule 1 of the TAA 1953. Amounts payable to Payee 1 are dealt with separately in Question 3.

Question 3

Is Payer required to withhold an amount under section 12-280 of Schedule 1 of the TAA 1953 in respect of rights fees which were payable by Payer to a Country X-based Payee, (Payee 1), having regard to the definition of royalties in the Country X Treaty?

Answer 3

No. Payer is not required to withhold an amount in respect of rights fees which were payable by Payer to Payee 1 in light of the Country X Treaty.

Question 4

At what point will Payer be regarded as having 'paid' the rights fees for the purpose of the Pay As You Go (PAYG) withholding provisions, having regard to subsection 11-5(1) of Schedule 1 of the TAA 1953, if Payer has not yet personally remitted any amount to the overseas Payees, but, the amount was in fact paid directly to the overseas Payees by Subsidiary?

Answer 4

For the purposes of Schedule 1 of the TAA 1953, Payer will be regarded as having paid an amount to an Payee at the point in time when Subsidiary pays the amount which was payable under the rights agreement, or, at the point in time that Payer records an accounting entry for the amount which was payable under the rights agreement, whichever occurs first.

This ruling applies for the following periods:

Year ended 31 March 2007

Year ended 31 March 2008

Year ended 31 March 2009

Year ended 31 March 2010

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.

Structure & background

Payer is a resident of Australia for Australian tax purposes and is not a resident of any other country for the purposes of any other country's tax laws.

Subsidiary is a resident of Country Z for Country Z tax purposes and is not a resident of Australia for Australian tax purposes.

Australian Subsidiary is a resident of Australia for Australian tax purposes.

Payer, Subsidiary and Australian Subsidiary are collectively referred to as the Group.

Payer is the Australian holding company of the Group and trades to the limited extent of being the named contracting party under various rights agreements.

Australian Subsidiary is the wholly owned Australian subsidiary of Payer and is the main trading entity in Australia. All contracts with customers in Australia are entered into by Australian Subsidiary.

Subsidiary is the wholly owned Country Z subsidiary of Payer and is the trading entity in Country Z. All contracts with customers in Country Z are entered into by Subsidiary.

The Group provides services to customers in Australia and Country Z.

Various Payees provide the rights which are made available to customers of the Group. Rights fees are paid to the Payees in exchange for the right to include certain rights.

The rights fees that are payable under the various rights agreements with the Payees are recharged by Payer to both Australian Subsidiary and Subsidiary so as to allocate the rights fees between those two subsidiaries.

The Country X-based Payee, Payee 1, is a resident of Country X for the purposes of the Country X Treaty.

Payee 1 is one of the Payees but special considerations apply in the case of the arrangements with Payee 1 (as discussed below).

Payer does not have a permanent establishment in Country Z.

The Payees are non-residents and have supplied an overseas postal address or overseas payment location to the entity paying the rights fees.

Rights agreements

There are a number of agreements which allow the Group to use the rights which is provided by the various Payees.

For instance, the D Licence Agreement grants a right to Payer to use certain rights. Payment is calculated according to the number of users.

Payer is the named party to the Licence Agreement - Subsidiary is not a named party. The two signatures which appear under the signature block for Payer are Mr A the COO, and Mr B the head of finance. There is nothing on the face of the signature block to indicate that those individuals are not the COO and head of finance of Payer. However, in fact they are employees of Subsidiary.

Negotiating and signing the rights agreements

Subsidiary was responsible for administering, including all invoicing, payments, and the relationship management of the rights contracts between the Group and the Payees (except the Payee 1 Agreement).

Due to the fact that predominately the personnel who specialise in the sourcing of rights, negotiation with and management of the Payees, are based in Country Z, the administration of this area of the business has historically been performed from Country Z for both Australia and Country Z.

Each contract with an overseas Payee (except Payee 1) is signed by A, who is the COO of Subsidiary.

A was delegated the authority verbally by the Payer to sign the rights contracts with the Payees but he is and at all times held himself to be the COO of Subsidiary.

Where a second signatory was required it has been provided by B who is an Senior Executive of the Subsidiary.

The Payees (except Payee 1) directly bill Subsidiary, issuing the invoice in the name of Subsidiary and Subsidiary directly makes payments to those Payees.

The personnel with expertise in managing and handling the rights agreement with Payee 1 are based in Australia and historically those responsibilities have been administered from Australia.

Agency agreement

There is no written agency agreement nor any express verbal agency agreement under which Payer has been made an agent of Subsidiary for the purpose of entering into rights agreements as an agent for and on behalf of Subsidiary with the Payees.

Intra-group rights arrangement with Subsidiary

The Services Agreement was entered into between Payer and Subsidiary. In terms of the Services Agreement, Payer must provide to Subsidiary rights. In consideration for that rights, Subsidiary must make payments either to Payer or to third parties as Payer directs.

The Services Agreement provides that all variations to the Services Agreement must be signed. There is no document which evidences a signed variation to the Services Agreement.

The administrative practice that has been followed for many years is that Subsidiary pays all licences fees to Payees (with the exception of Payee 1). The licences fees are dissected between Australia and Country Z on the basis of customer numbers.

Once a year, Payer issues an invoice to Subsidiary for the rights fees payable under the Services Agreement.

Subsidiary charges Payer for the rights fees which Subsidiary has remitted to the Payees. Subsidiary does not raise an invoice to Payer in respect of those amounts.

There is a set-off of the amounts payable between the two related companies. Any shortfall or surplus is settled between the companies.

Arrangement with Australian Subsidiary

Payer entered into a verbal rights agreement with Australian Subsidiary under which Payer provided rights.

Subsidiary did not enter into a rights agreement with Australian Subsidiary under which Subsidiary provided rights to Australian Subsidiary.

Relevant legislative provisions

Income Tax Assessment Act 1936, subsection 6(1)

Income Tax Assessment Act 1936, section 128B

International Tax Agreements Act 1953, section 4

International Tax Agreements Act 1953, section 17A

Taxation Administration Act 1953, section 11-5

Taxation Administration Act 1953, Schedule 1, section 12-280

Taxation Administration Act 1953, Schedule 1, section 12-300

Article 10(3) of the Country X treaty:

Article 12(3) of the Country Y treaty

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

Summary

Payer is required to withhold an amount under section 12-280 of Schedule 1 of the TAA 1953 in respect of rights fees which were paid by Subsidiary to the Payees even though they have not actually been personally remitted by Payer.

Question 2

Summary

Payer is required to withhold an amount under section 12-280 in respect of rights fees which were payable to the Payees in relation to rights which was used in Country Z being licence fees which were actually paid by Subsidiary even though they have not actually been personally remitted by Payer.

Question 3

Summary

Payer is not required to withhold an amount in respect of rights fees which were payable by Payer to Payee 1 in light of the Country X Treaty.

Question 4

Summary

Payer will be regarded as having paid an amount to an Payee at the point in time when Subsidiary pays the amount which was payable under the rights agreement, or, at the point in time that Payer records an accounting entry for the amount which was payable under the rights agreement, whichever occurs first.

Detailed reasoning Questions 1 to 4

Agency

Before dealing with the withholding tax issues, it is necessary to determine whether Payer entered into the rights agreements as an agent for Subsidiary.

Objectively, Payer is the contracting party to the rights agreements with the Payees - not Subsidiary. There is no written variation of the rights agreements to indicate that there has been a change in the parties to the agreements.

There is no express written agency agreement or express verbal agency agreement between Payer and Subsidiary. Employees of Subsidiary signed the rights agreements with the Payees (except the Payee 1 Agreement) on behalf of Payer after Payer authorised them to execute the contracts.

The applicant has submitted that an agency agreement can be inferred from the circumstances of this case. For instance, invoices were issued by the Payees in the name of Subsidiary. Subsidiary paid the licence fees to the Payees.

The actions of the parties can readily be understood on the basis that the Payees will communicate with whichever employees in the corporate group they have a close relationship with. An inference of agency does not arise merely because invoices are issued to a different company in a corporate group or negotiations of contracts are conducted with employees of a different company in the corporate group or that payments are made by a different company in the corporate group.

It is not uncommon for payments to be made by one company in a corporate group on behalf of another company in the group. It is not uncommon for a subsidiary company to set off amounts that it owes to the parent company against amounts that the parent company owes to it. The set-off arrangement under which Subsidiary has made licence fee payments which were correctly payable by Payer to the Payees and set off against those payments the amounts that Subsidiary owes to Payer in terms of the Services Agreement is consistent with the view that Payer is entering the rights agreements as a principal (not as agent). It is not uncommon for an employee of a different company in the corporate group to be authorised to sign on behalf of another company.

If Payer entered into the rights agreements as an agent for Subsidiary, Subsidiary would have acquired the right to use the rights by virtue of the fact that Subsidiary was the principal under the rights agreements. Payer would not have any right to the rights - Subsidiary would have the rights to the rights. Payer could not charge Subsidiary for the rights if Subsidiary was the principal. In terms of the Services Agreement, Subsidiary must pay Payer for the rights provided by Payer to Subsidiary. The Services Agreement between Payer and Subsidiary is entirely inconsistent with Payer being an agent. If Subsidiary was the principal under the various agreements with the Payees (other than Payee 1), Payer would not have entered into the Services Agreement under which Payer purports to provide rights to Subsidiary because Subsidiary, as the principal, already has the rights to the rights.

It is considered that, in the present circumstances, the party who entered into the rights agreements with the Payees was Payer and it is considered that Payer did not enter into the agreements as an agent for Subsidiary.

Withholding tax

General

Royalty withholding tax must be collected under the Pay As You Go (PAYG) withholding provisions in section 12-280 of Schedule 1 of the Taxation Administration Act 1953 (the TAA 1953) by Australian residents who pay royalties to non-residents.

The PAYG withholding provisions apply irrespective of whether the royalties are Australian sourced income.

However, PAYG withholding does not need to be paid if withholding tax is not payable under section 128B of the Income Tax Assessment Act 1936 (the ITAA 1936): see section 12-300 of Schedule 1 of the TAA 1953.

Moreover, withholding tax under section 128B of the ITAA 1936 is only payable if the payment constitutes a 'royalty' in terms of subsection 6(1) of the ITAA 1936.

Also, the relevant treaty (if any) will restrict the operation of section 128B: see sections 4 and 17A of the International Tax Agreements Act 1953 (the ITAA 1953) and Interpretative Decision ATO ID 2006/282.

Payer is an Australian resident which has paid rights fees to the Payees who are non-residents and who have provided an Australian postal address or payment location.

Royalty

The definition of a 'royalty' in terms of subsection 6(1) of the ITAA 1936 includes:

(a) the use of, or the right to use, any copyright...

The definition of a 'royalty' in terms of subsection 6(1) also includes a 'royalty' within the ordinary meaning of that word. A 'royalty' within the ordinary meaning of that term will contain the following elements (see, for example, Taxation Ruling IT 2660):

(a) A payment is made in return for the right to exercise a beneficial privilege or right, such as, the right to use a copyright.

(b) The payment is made to the person who owns the right to confer that beneficial privilege or right or to a person who has been licensed or sub-licensed to deal with the right.

(c) The consideration payable is determined on the basis of the amount of use made of the right acquired.

(d) The consideration payable 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 of the amount of use made of the right acquired.

D Licence Agreement and similar agreements - In consideration for

The various Payees will provide rights under the rights agreements. The rights would be entitled to copyright protection either as a literary work, a dramatic work, an artistic work or a musical work. The Payees would have either obtained a licence, or, they would be the owner of the copyright in those works. In either event, the Group requires a licence from the copyright owner to provide the rights to its customers. A copyright owner has the exclusive rights to communicate the work. Payer would be infringing the copyright owner's rights if Payer communicated the material without a licence. Hence, the various rights agreements are in exchange for the rights that are conferred upon the copyright owner under copyright law. It is considered that the various rights agreements, either expressly or by necessary implication, grant a rights to Payer to communicate the rights in Australia and Country Z for a fee. The essence of the present arrangement involves the offshore Payee rights Payer to communicate the material.

The licence fees are roughly calculated according to the number of customers that the Group has in Australia and Country Z. Hence, the licence fees are paid essentially for the copyright and are paid on a per user basis.

D Licence Agreement and similar agreements - Ordinary concepts

As stated above, the term 'royalty' in subsection 6(1) includes royalties within the ordinary meaning of that word. In the case of the D Licence Agreement and similar agreements, the rights fee is being predominantly paid for the right to communicate the rights, as discussed above. The right to communicate is a right which is protected by copyright. The rights fees are basically paid on a per user basis. Hence, the rights fees are paid in respect of a monopolistic right (copyright) to the copyright owner or the copyright rights on a per user basis and are payable on a regular basis. In that situation, the rights fees would be regarded as royalty payments within the ordinary meaning of the word 'royalties'.

D Licence Agreement and similar agreements - Copyright

Also, the licence fees fall within the definition of the term 'royalty' in paragraph (a) of the definition because they are predominantly in consideration for copyright - they are paid for a right protected by copyright law (as explained above).

D Licence Agreement and similar agreements - Royalties

The licence fees in the present case are royalties either in terms of the ordinary meaning of the word, or, paragraph (a) or paragraph (db) of the definition of the term 'royalty'. Accordingly, the licence fees will fall within the definition of 'royalties' in terms of subsection 6(1) unless the rights fees are derived by residents of a country with which Australia has a comprehensive tax treaty (in which case it will be necessary to consider what impact, if any, the treaty has on the outcome).

All agreements - Overall

Although there are minor differences in the various rights agreements with the Payees, it is considered that all the agreements involve a payment for a royalty within the ordinary meaning of the word or within paragraph (a) of the definition (unless a treaty changes this outcome).

Payee 1 - Country X treaty

Payee 1 is a resident of Country X and is entitled to the benefit of the Country X treaty.

The overall effect of sections 4 and 17A of the ITAA 1953 and section 12-300 of Schedule 1 of the TAA 1953 is that PAYG withholding tax does not need to be deducted and remitted by the Australian payer in respect of a payment that does not fall within the definition of 'royalty' in the Country X treaty: See also Interpretative Decision ATO ID 2006/282.

Under the Country X treaty, the fees will be excluded from the definition of the term 'royalty' for the purposes of the Country X treaty. Royalties which are excluded from the operation of Article 10 of the Country X treaty will be excluded from the withholding tax provisions of section 128B of the ITAA 1936: ATO ID 2006/282. PAYG withholding tax on royalties does not need to be deducted if the payment is not subject to the withholding tax provisions of section 128B of the ITAA 1936: section 12-300 of Schedule 1 of the TAA 1953.

Accordingly, there is no obligation on Payer to deduct PAYG withholding tax under section 12-280 of Schedule 1 of the TAA 1953 from the payment of the rights fees to Payee 1.

Payee 1 - ABN Withholding

For the purposes of this ruling it is not necessary to decide whether PAYG withholding should have been deducted under section 12-190 of Schedule 1 of the TAA 1953 (the No ABN withholding tax) if Payee 1 did not quote its Australian Business Number. There are a number of exemptions from the No ABN withholding tax, for instance, where the supply was not made in furtherance of an enterprise carried on in Australia by Payee 1, where the payment was not made in furtherance of an enterprise carried on in Australia by the Group, or, where Payee 1 is not assessable on the income: see section 12-1, subparagraph 12-190(1)(a) and subparagraph 12-190(4)(a) of Schedule 1 of the TAA 1953.

Payee 1 - Tax obligations

It is noted that even though the PAYG withholding provisions do not apply to the rights fees paid to Payee 1, this does not mean that Payee 1 is exempt from Australian income tax. Payee 1 will need to consider its own Australian tax obligations. For the purposes of this ruling which has been issued to Payer, it is not necessary to decide whether Payee 1 has any Australian tax obligations. If Payee 1 has an Australian income tax liability instead of an Australian royalty withholding tax liability, any PAYG withholding which has been remitted in respect of Payee 1 may need to be applied against Payee 1's income tax liability.

Country Y Treaty

It appears that some of the Payees may be residents of Country Y and might have the benefit of the Double Tax Agreement between Australia and Country Y (the Country Y treaty).

As stated above, the rights fees are predominantly paid in consideration for the right to use copyright. They would be 'royalties' for the purposes of the Country Y treaty and they would be 'royalties' in terms of subsection 6(1) of the ITAA 1936.

Therefore, the Country Y treaty would not alter the conclusion that the rights payments would be subject to PAYG withholding.

Paid

PAYG withholding must be deducted from amounts which are paid or constructively paid in terms of section 11-5 of Schedule 1 of the TAA 1953.

It is considered that a payment by a paying agent who is authorised by the person who is legally required to make the payment is equivalent to a payment by the person who has authorised the payment. Under an arrangement between Payer and Subsidiary, the practice has developed that Subsidiary has been allowed by Payer to carry out the tasks of calculating the amounts of the rights fees and paying the rights fees to the various Payees (other than Payee 1). Under an understanding with Payer, Subsidiary annually sets off the amount of the rights fees which it paid to the overseas providers against the fees that are payable by it to Payer under the Services Agreement. In those circumstances, it is considered that a payment by Subsidiary to the Payees should be regarded as a payment made by Payer to the Payees. Payer should be regarded as having made payments to the Payees at the time that Subsidiary made each payment as Payer's paying agent.

A set-off is generally regarded as being tantamount to payment: see for example, Whim Creek Consolidated N.L. v. FC of T (1977) 31 FLR 146 (1977) 8 ATR 154 (1977); 77 ATC 4503; 17 ALR 421. Because it has been concluded, above, that a payment by Subsidiary to the Payees is tantamount to a payment by Payer, itself, it is not necessary to decide whether the set off should be regarded as a payment by Payer to the Payees.

Section 11-5 of Schedule 1 of the TAA 1953 provides:

11-5(1) In working out whether an entity has paid an amount to another entity, and when the payment is made, the amount is taken to have been paid to the other entity when the first entity applies or deals with the amount in any way on the other's behalf or as the other directs.

11-5(2) An amount is taken to be payable by an entity to another entity if the first entity is required to apply or deal with it in any way on the other's behalf or as the other directs.

Taxation Determination TD 93/146 explains that section 11-5 expresses the same idea as the former subsection 221YK(3) of the ITAA 1936 which deems interest to have been paid or payable when it is 'reinvested, accumulated, capitalised, carried to any reserve, sinking fund or insurance fund however designated, or otherwise dealt with on behalf of the other person or as the other person directs'.

It appears from the example in TD 93/146 that interest will be treated as having been constructively paid at the time when the interest is capitalised and credited to a non-resident's loan account.

If Payer recorded an entry in its accounts for the amount of the rights fee after the amount became payable, but, before the rights fee was paid by Subsidiary to the Payees, the accounting entry would be regarded as a constituting a constructive payment at the time when the credit entry was recorded by Payer.

Hence, if an accounting entry was made after the amount became payable, the date of payment, or constructive payment, would be the earlier of the date when Subsidiary made the payment, or, the date of the accounting entry.

Summary

Accordingly, PAYG withholding tax should be deducted in respect of rights fees paid to the Payees except in respect of rights fees paid to Payee 1.

The PAYG withholding tax should be deducted at the time that the royalty payments are made by Subsidiary to the Payees. If there is a constructive payment before the date of payment, such as, a credit entry being made in the accounts of Payer in respect of the royalties which are payable, the withholding tax should be deducted at the time of the earlier constructive payment.

PAYG withholding tax does not need to be deducted in respect of rights fees paid to Payee 1.