Edited version of your written advice

Authorisation Number: 1051338716938

Date of advice: 9 March 2018

Ruling

Subject: Payments made under a Software Licence Agreement

Question 1

Are Licence Fees paid by Company A to Company B pursuant to the Software Licence Agreement ‘royalties’ as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

If the answer to Question 1 is ‘yes’, are Licence Fees paid by Company A to Company B pursuant to the Software Licence Agreement ‘royalties’ as defined in Article 12 of the Tax Treaty?

Answer

Yes.

Question 3

Does section 12-280 of Schedule 1 to the Taxation Administration Act 1953 (TAA) require Company A to withhold an amount from Licence Fees paid by it to Company B pursuant to the Software Licence Agreement?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Company A is an Australian resident company that makes Licence Fee payments to Company B, a non-resident, for certain rights associated with Software under a Software Licence Agreement.

Company A has the right to use the software as well as the exclusive right to incorporate the Software into their own products and services in the course of their business within Australia. Company A also has the right to grant sub-licences if consented to by Company B. One or more of these sub-licenses are currently in existence. However, Company A does not have any right in relation to any part of the source code (including being able to view, access, or modify that source code).

Company A must pay a Licence Fee for the use of the Software being a certain percentage of the total revenue of Company A.

The Software Licence Agreement lists Company B’s address as outside Australia.

Relevant legislative provisions

Copyright Act 1968 subsection 10(1)

Copyright Act 1968 subsection 13(2)

Copyright Act 1968 section 21

Copyright Act 1968 section 29

Copyright Act 1968 section 30A

Copyright Act 1968 section 31

Copyright Act 1968 section 32

Copyright (International Protection) Regulations 1969

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 128B

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

Income Tax Assessment Act 1936 subsection 128B(5A)

Income Tax Assessment Act 1997 subsection 995-1(1)

Taxation Administration Act 1953 section 3AA

Taxation Administration Act 1953 section 12-280 of Schedule 1

Taxation Administration Act 1953 section 12-300 of Schedule 1

Tax Treaty

Reasons for decision

Question 1

All references in this question are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise noted.

Summary

Licence Fees paid by Company A to Company B pursuant to the Software Licence Agreement are, in whole or in part, ‘royalties’ as defined in subsection 6(1).

Detailed reasoning

The definition of ‘royalties’ in subsection 6(1), to the extent that it is relevant, states:

royalty or royalties includes 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, trade mark, or other like property or right;

…

(f) a total or partial forbearance in respect of:

(i) the use of, or the granting of the right to use, any such property or right as is mentioned in paragraph (a) …

The Commissioner has provided advice on the definition of ‘royalties’ in subsection 6(1) through a number of public rulings. In particular, Taxation Ruling IT 2660 Income Tax: Definition of Royalties makes a number of general comments about the definition of ‘royalties’:

11. Subsection 6(1) expands the meaning of royalty to include certain amounts which may not be royalties within the ordinary meaning of that term …

14. It is important to note that the definition encompasses a payment for the use of, or the right to use, a right or property, or for the supply of knowledge or information or assistance, even though the right, property or knowledge etc., is not used physically by the person making the payment or is not supplied directly by the person to whom the payment is made. For example, payment by a film distributor to a non-resident for the distributor's right to exploit a film by allowing cinema owners to exhibit it will be a royalty. Similarly, a payment by an Australian parent company to a United States' corporation for know-how will be a royalty as defined whether the know-how and any connected rights were to be used by the Australian parent company or by its manufacturing subsidiary, and whether the know-how was to be supplied directly by the United States' corporation itself, or by a local or foreign company associated with that corporation.

15. The form of a payment and the way in which it is computed will not be conclusive in determining whether or not the payment is a royalty under the definition. Nor will the description given to a payment in any agreement between the parties be conclusive. If, having regard to the substance of the contract, a payment falls within the scope of the definition, it will be a royalty whether it is paid in a lump sum or periodically. Unlike the ordinary meaning of royalty, it is not necessary for the payment to be calculated by reference to the degree of use of the property, right or know-how …

In the circumstances, it is necessary to consider whether the Licence Fee payments will fall within paragraphs (a) and (f) of the definition of ‘royalties’.

Paragraph (a)

In relation to paragraph (a) of the definition of ‘royalties’, IT 2660 states:

16. … a payment for the 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.

As such, there are three questions that must be considered in order to determine whether Licence Fees paid by Company A are ‘royalties’ as defined in subsection 6(1):

1. Does any relevant ‘copyright’ exist for the purposes of subsection 6(1)?

2. Is Company A granted ‘the right to use any copyright’ by the Software Licence Agreement?

3. Are Licence Fees paid ‘as consideration for’ the right to use copyright?

Does any relevant ‘copyright’ exist for the purposes of subsection 6(1)?

The word ‘copyright’ in subsection 6(1) means ‘copyright’ as defined in the Copyright Act 1968. This is based on the general rule of statutory interpretation that a word that has a technical legal meaning, when it is used in a statute, should be understood in its legal sense unless a contrary intention appears (Central Bayside General Practice Association Ltd v Commissioner of State Revenue (Vic) (2006) 228 CLR 168 at 178, footnote 28; [2006] HCA 43 at [18]).

In this regard, subsection 31(1) of the Copyright Act 1968, to the extent that it is relevant, states:

For the purposes of this Act, unless the contrary intention appears, copyright, in relation to a work, is the exclusive right:

(a) in the case of a literary, dramatic or musical work, to do all or any of the following acts:

(i) to reproduce the work in a material form;

(ii) to publish the work;

(iii) to perform the work in public;

(iv) to communicate the work to the public;

(vi) to make an adaptation of the work;

(vii) to do, in relation to a work that is an adaptation of the first‑mentioned work, any of the acts specified in relation to the first‑mentioned work in subparagraphs (i) to (iv), inclusive; and

…

(d) in the case of a computer program, to enter into a commercial rental arrangement in respect of the program. …

Pursuant to subsection 10(1) of the Copyright Act 1968:

● a ‘work’ is defined to include a ‘literary work’;

● a ‘literary work’ is defined to include a ‘computer program or compilation of computer programs’;

● a ‘computer program’ is defined to mean ‘a set of statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result’.

The Software in the Software Licence Agreement will constitute, in whole or in part, one or more ‘computer programs’ for the purposes of the Copyright Act 1968 (as the Software includes statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result). Therefore, the Software will be one or more ‘literary work’ for the purposes of the Copyright Act 1968.

However, copyright will not ‘subsist in’ a work unless that work has a connection to either Australia (section 32 of the Copyright Act 1968) or other relevant country covered by the Copyright (International Protection) Regulations 1969. Relevantly, Company B’s jurisdiction is covered by those regulations.

It is also important to note that, in the circumstances, the Commissioner is satisfied that Company B either owns the copyright in relation to the Software or is a licensee of the copyright in the Software.

Consequently, ‘copyright’ exists for the purposes of the definition of ‘royalties’ in subsection 6(1).

Is Company A granted ‘the right to use any copyright’ by the Software Licence Agreement?

The rights to use the Software extend, through the Software Licence Agreement, to incorporating the Software into Company A’s products and services. The Software Licence Agreement also allows Company A to sublicense the Software to third parties subject to approval by Company B.

The Commissioner considers that the Software Licence Agreement involves Company B granting Company A some or all of the following express or implied rights for the purposes of the Copyright Act 1968 in relation to the relevant literary work(s) constituted by the Software:

● The right to make an adaptation of the literary work(s).

● The right to reproduce the literary work(s), or an adaptation thereof, in a material form.

● The right to communicate the literary work(s), or an adaptation thereof, to the public.

Note: The italicised terms are defined, or partly defined, in various provisions of the Copyright Act 1968:

● adaptation – subsection 10(1) of the Copyright Act 1968

● reproduction – section 21 of the Copyright Act 1968 deems various acts to constitute a reproduction, although the term primarily has a common law meaning – see Computer Edge Pty Ltd v Apple Computer Inc. (1986) 161 CLR 171 at 186 per Gibbs CJ

● material form – subsection 10(1) of the Copyright Act 1968

● communicate – subsection 10(1) of the Copyright Act 1968

● to the public – subsection 10(1) of the Copyright Act 1968

These rights are the exclusive rights of Company B pursuant to subsection 31(1) of the Copyright Act 1968.

Furthermore, the exclusive right to do certain acts under subsection 31(1) of the Copyright Act 1968 includes the exclusive right to authorize another person to do those acts (subsection 13(2) of the Copyright Act 1968). In this case, the Software Licence Agreement grants Company A the right to authorize its customers to do certain acts under subsection 31(1) of the Copyright Act 1968 (particularly ‘reproduction’ of the Software, or products including the software, in order to be used on the customer’s computers through sublicences).

Consequently, Company A is granted the right to use copyright by the Software Licence Agreement.

Are Licence Fees paid ‘as consideration for’ the right to use copyright?

The Licence Fee payments under the Software Licence Agreement are described by the relevant clause as ‘for the use of the Software’. Payments for the simple use of software are generally not royalties under subsection 6(1) (paragraphs 4 and 27 of Taxation Ruling TR 93/12 Income tax: computer software).

However, in the context of the broader Software Licence Agreement, the Licence Fee payments are consideration for all the rights granted rather than merely the right for the simple use of the Software. In addition, the rights to use the copyright associated with the Software are, in the circumstances, far more valuable than Company A’s simple right to use the software as an end-user.

The Licence Fee payments pursuant to the Software Licence Agreement are therefore paid as consideration for the express or implied right to use the copyright associated with the Software. Consequently, each Licence Fee payment meets the definition of ‘royalty’ in subsection 6(1).

Paragraph (f)

In addition, the Commissioner considers that an ‘exclusive’ right to use copyright in Australia constitutes a total or partial forbearance in respect of Company B’s own use of copyright, and its ability to grant other entities the right to use the copyright in Australia (Heap v Hartley (1889) 42 Ch D 461 at 470; O'Keefe, O'Keefe, O'Keefe and McKenna v Williams (1910) 11 CLR 171 at 211; Murray (Inspector of Taxes) v Imperial Chemical Industries Ltd [1967] Ch 1038 at 1051). This total or partial forbearance falls within paragraph (f) of the definition of ‘royalties’ in subsection 6(1). To the extent that any consideration is attributable to the forbearance, that consideration would meet the definition of ‘royalties’ in subsection 6(1).

Conclusion

The Licence Fees paid by Company A to Company B pursuant to the Software Licence Agreement are ‘royalties’ as defined in subsection 6(1).

Question 2

All references in this question are to the Tax Treaty unless otherwise noted.

Summary

The Licence Fees paid by Company A to Company B pursuant to the Software Licence Agreement are ‘royalties’ as defined in Article 12 of the relevant Tax Treaty.

Detailed reasoning

The definition of ‘royalties’ in Article 12, to the extent that it is relevant, states:

The term "royalties" 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, trademark or other like property or right;

…

(e) total or partial forbearance in respect of the use or supply of any property or right referred to in this paragraph.

For the purposes of this case, the definition is materially similar to the definition of ‘royalties’ in subsection 6(1) of the ITAA 1936 that was considered in Question 1.

The relevant terms of Article 12 (‘copyright’, ‘as consideration for’ and ‘forbearance’) are not defined in the Tax Treaty. However, Article 3 of the Tax Treaty relevantly states:

As regards the application of this Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the laws of that State for the purposes of the taxes to which this Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.

Furthermore, the Commentary on Article 12 of the 2014 version of the OECD Model Tax Convention provides some material relevant to the interpretation of Article 12. Most relevantly, paragraph 13.1 states:

13.1 Payments made for the acquisition of partial rights in the copyright (without the transferor fully alienating the copyright rights) will represent a royalty where the consideration is for granting of rights to use the program in a manner that would, without such license, constitute an infringement of copyright. Examples of such arrangements include licenses to reproduce and distribute to the public software incorporating the copyrighted program, or to modify and publicly display the program. In these circumstances, the payments are for the right to use the copyright in the program (i.e. to exploit the rights that would otherwise be the sole prerogative of the copyright holder). …

Consequently, for the reasons given in Question 1, the Licence Fee payments are ‘royalties’ for the purposes of the definition in Article 12.

Question 3

All references in this question are to Schedule 1 to the Taxation Administration Act 1953 (TAA) unless otherwise noted.

Summary

Section 12-280 requires Company A to withhold amounts from Licence Fees paid by it to Company B pursuant to the Software Licence Agreement.

Detailed reasoning

Sections 12-280 and 12-300 relevantly state:

Subdivision 12‑F—Dividend, interest and royalty payments

…

Royalties

12‑280 Royalty payment to overseas person

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

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

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

….

12‑300 Limits on amount withheld under this Subdivision

This Subdivision does not require an entity:

(a) to withhold an amount from a *dividend, from interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936) or from a *royalty if no *withholding tax is payable in respect of the dividend, interest or royalty …

As established in Questions 1 and 2, Licence Fee payments are ‘royalties’ for the purposes of subsection 6(1) of the ITAA 1936 and Article 12 of the Tax Treaty (and therefore also for the purposes of Schedule 1 to the TAA pursuant to section 3AA of the TAA and subsection 995-1(1) of the Income Tax Assessment Act 1997). The recipient in this case, Company B, also has an address outside Australia according to the Software Licence Agreement (being a record in the payer’s possession about the transaction to which the royalty relates).

For the purposes of section 12-300, the term ‘withholding tax’ is defined in subsection 995-1(1) of the ITAA 1997 to include income tax payable under section 128B of the ITAA 1936. The relevant parts of section 128B of the ITAA 1936 are reproduced below:

128B Liability to withholding tax

(1A) In this section, a reference to a person to whom this section applies is a reference to the Commonwealth, a State, an authority of the Commonwealth or of a State or a person who is, or persons at least 1 of whom is, a resident.

…

(2B) Subject to subsection (3), this section also applies to income that:

(a) is derived by a non-resident:

(i) during the 1993-94 year of income of the non-resident; or

(ii) during a later year of income of the non-resident; and

(b) consists of a royalty that:

(i) is paid to the non-resident by a person to whom this section applies and is not an outgoing wholly incurred by that person in carrying on business in a foreign country at or through a permanent establishment of that person in that country; or

(ii) is paid to the non-resident by a person who, or by persons each of whom, is not a resident and is, or is in part, an outgoing incurred by that person or those persons in carrying on business in Australia at or through a permanent establishment of that person or those persons in Australia.

…

(5A) 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.

The Commissioner considers that subsection 128B(2B) of the ITAA 1936 applies to the Licence Fee payments and, as such, subsection 128B(5A) of the ITAA 1936 creates a liability to pay income tax (i.e. withholding tax) in respect of those royalties.

Consequently, paragraph (a) of section 12-300 does not apply in the circumstances.

Conclusion

Company A must withhold amounts from Licence Fees it pays to Company B pursuant to section 12-280.