Edited version of administratively binding advice

Authorisation Number: 1012550730968

Subject: Administratively binding advice - Royalty payments from intellectual property

Question

Are distributions made from the payment of royalties from intellectual property to employees of the organisation considered to be ordinary times earnings (OTE) for the purposes of subsection 6(1) of the Superannuation Guarantee (Administration) Act 1992 (SGAA)?

Advice

No, Please refer to 'Reasons for decision'.

The arrangement commences on:

After 1 July 2013 

Relevant facts and circumstances

Your organisation pays a form of royalties from intellectual property to its employees.
There are rules which regulate how these royalties are calculated and paid.

A share of the profit is paid to those employees who contributed in developing the items that are commercialised.

The royalties are commercialised in the name of the organisation rather than the employees.

Relevant legislative provisions

Superannuation Guarantee (Administration) Act 1992 subsection 6(1)

Superannuation Guarantee (Administration) Act 1992 section 11

Reasons for decision

From 1 July 2008, all employers must use OTE as the earnings base to calculate the minimum super guarantee contributions required for your employees.

From 1 July 2008, employers may still be required to use notional earnings bases specified in legislation or industrial agreements as the basis of their superannuation support in cases where these are above an employee's OTE, but SGAA obligations will only be assessed against OTE.

The phrase 'ordinary time earnings' is defined in subsection 6(1) of the SGAA as follows:

ordinary time earnings, in relation to an employee, means:

(a) the total of:

(i) earnings in respect of ordinary hours of work other than earnings consisting of a lump sum payment of any of the following kinds made to the employee on the termination of his or her employment:

(A) a payment in lieu of unused sick leave;
(B) an unused annual leave payment, or unused long service leave payment, within the meaning of the Income Tax Assessment Act 1997; and …

(ii) earnings consisting of over-award payments, shift-loading or commission; or

(b) if the total ascertained in accordance with paragraph (a) would be greater than the maximum contribution base for the quarter - the maximum contribution base.

In broad terms (and subject to some exceptions), OTE of an employee means earnings in respect of ordinary hours of work. Payments for work performed outside the ordinary hours of work, such as overtime payments, are not OTE.

OTE is usually the amount an employee earns for their ordinary hours of work. It includes commissions, shift-loadings and some allowances, but does not include overtime payments. Superannuation Guarantee Ruling SGR 2009/2 Superannuation guarantee: meaning of the terms 'ordinary time earnings' and 'salary or wages' (SGR 2009/2) provides further guidance on what constitutes OTE.

Salary or Wages

Section 11 of the SGAA defines salary or wages and includes commissions, directors fees, payments made to employees subject to the former Prescribed Payment System where the person works wholly or principally for their labour, allowances, ordinary time earnings, bonuses, payments to Government office holders, artists and sportspersons.

Ordinary Time Earnings and Salary or Wages

Section 6 of the SGAA defines OTE, it includes; earnings in respect of ordinary hours of work other than earnings consisting of a lump sum payment made to the employee on the termination of his or her employment, earnings consisting of over-award payments, shift-loading and commissions.

The difference between salary or wages and OTE is covered by SGR 2009/2, paragraph 7:

7. An amount can only be part of an employee's OTE if it is 'salary or wages' of the employee. But an employee's salary or wages may include amounts that are not OTE.

Therefore where earnings do not satisfy the definition of salary or wages it will also fail to satisfy the definition of OTE.

Meaning of Royalty

In Stanton v. F.C. of T. (1955) 92 CLR 630; 11 ATD 1 the Full Court of the High Court of Australia described the essence of a royalty.

'... 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'.

Paragraph 11 of Income Tax Ruling 2660 (IT 2660) states how subsection 6(1) of the Income Tax Assessment Act 1936 extends the meaning of royalty:

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.

Paragraph 12 of IT 2660 states:

The definition includes as royalties amounts paid or credited 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;

(b) the use of, or the right to use, any industrial, commercial or scientific equipment;

(c) the supply of scientific, technical, industrial or commercial knowledge or information (e.g. know-how payments);

(d) the supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b), or any such knowledge or information as is mentioned in paragraph (c);

(e) the use of, or the right to use, motion picture films, films or video tapes for use in connection with television, or tapes for use in connection with radio broadcasting; or

(f) a total or partial forbearance in respect of the use of, or the granting of the right to use property of any of the kinds referred to in paragraphs (a), (b) or (e), or the supply of knowledge, information or assistance of any of the kinds referred to in paragraphs (c) or (d).'

Royalty payments are not included in the definition of salary and wages and therefore cannot be included in the definition of OTE. They are amounts paid or credited for: 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.

IT 2660 provides guidelines for distinguishing between royalty payments and payments for services rendered. Paragraphs 28 and 29 state:

28. Three important elements emerge which can be used as a basis for distinguishing between a contract for the supply of know-how and one involving the rendering of services. These are that under a contract for the supply of know-how :

(a) a "product" (i.e. knowledge, information, technique, formula, skills, process, plan etc.) which has already been created or developed or is already in existence is transferred;

(b) the product which is the subject of the contract is transferred for use by the buyer (i.e. it is supplied); and

(c) except in the case of a disposition where the seller divests himself completely of any further interest in the product, the property in the product remains with the seller. All that is obtained by the buyer is the right to use the product. Subject to the terms of the contract, the seller retains the right to use the product himself and to transfer it to others.

29. By contrast, in a contract involving the performance of services:

(a) the contractor undertakes to perform services which will result in the creation, development or the bringing into existence of a product (which may or may not be know-how);

(b) in the course of developing a product, the contractor would apply existing knowledge, skill and expertise - there is not a transfer (i.e. supply) of know-how from the contractor to the buyer as such but a use by the contractor of his knowledge for his own purposes; and

(c) the product created as a result of the services belongs to the buyer for him to use without having to obtain any further rights in respect of the product. However, in the course of rendering services the contractor would, in most cases, also produce as a by-product a work (e.g. plan, design, specification, report, etc., - which could contain knowledge, etc. not otherwise known to the buyer and which may or may not be protected by patents, etc..) in which copyright would subsist. Unless specifically agreed otherwise, the contractor is the owner of such copyright and the buyer or any other person is, by law, precluded from using the property in which the copyright subsists for any purpose other than the purpose for which it was originally designed without first obtaining the approval of the contractor. This would not alter the nature of the contract which would remain one for the performance of services.

Application to your circumstances:

In this case the items are developed and then later commercialised.

As per paragraph 28 of IT 2660 the share of profit which is passed on to the contributing employees is considered a royalty as it is sourced from the organisation commercially exploiting items which have already been created. As per paragraph 29 of IT 2660 it is not payments for services rendered by the organisation or its employees as it is not payments for the creation, development or bringing into existence of a product.

As the payments are royalty payments they are not salary or wages and are therefore not OTE.