Edited version of private advice

Authorisation Number: 1051775741424

Date of advice: 9 November 2020

Ruling

Subject: Issue of subscription shares and the assignment of copy right

Question 1

Will the issue of subscription shares by Aus Co to Foreign Co, as consideration for transfer of the Transferred IP by Foreign Co, constitute a royalty under:

(a)  Australian domestic tax law; or

(b)  Article 12(3) of the relevant Agreement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, and Protocol (the Agreement)

Answer

No

Question 2

Will Aus Co have an obligation to withhold tax in respect of the issue of the subscription shares under section 12-280 of Schedule 1 to the Taxation Administration Act 1953 (TAA)?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Relevant facts and circumstances

All legislative references in this Ruling are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

Aus Co is an Australian resident company. It was established solely as a joint venture vehicle, with Foreign Co and another unrelated entity each to hold 50% of the issued shares of Aus Co.

Foreign Co entered into the incorporated joint venture to develop and commercialise certain technologies.

Foreign Co is a resident of XXX for the purposes of Article 4(1) of the Agreement.

Foreign Co does not carry on a business at or through a permanent establishment in Australia.

Under the IP Transfer Agreement between Foreign Co and Aus Co, the Transferred IP is assigned in its entirety by Foreign Co to Aus Co.

'Transferred IP' means the copyright in the relevant technologies.

Pursuant to the Framework Agreement, Aus Co issues ordinary shares to Foreign Co as consideration for the assignment of Transferred IP (subscription shares).

The Framework Agreement and Shareholder Agreement provide for the termination of the arrangement and the winding up of Aus Co in certain circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 128A(1AA)

Income Tax Assessment Act 1936 section 128B

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

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

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

Income Tax Assessment Act 1936 Division 11A

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-20

Taxation Administration Act 1953 section 12-280 of Schedule 1

Taxation Administration Act 1953 section 12-300 of Schedule 1

International Tax Agreements Act 1953 subsection 4(2)

International Tax Agreements Act 1953 subsection 17A(1)

International Tax Agreements Act 1953 subsection 17A(4)

International Tax Agreements Act 1953 subsection 17A(5)

relevant Agreement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, and Protocol (the Agreement)

Reasons for Decision

Question 1

Summary

The issue of subscription shares by Aus Co to Foreign Co as consideration for transfer of the Transferred IP by Foreign Co, does not constitute a royalty under subsection 6(1) of the ITAA 1936 or under Article 12(3) of the Agreement.

Detailed reasoning

Legislative context

A person is liable under subsection 128B(5A) of the ITAA 1936 to pay withholding tax if they derive 'income' that consists of a royalty and the requirements of subsections 128B(2B) or (2C) of the ITAA 1936 are satisfied in relation to that income.

Subsection 128A(1AA) of the ITAA 1936 provides that for the purposes of Division 11A of Part III of the ITAA 1936 and the Act imposing withholding tax the term 'income' includes a royalty. It is therefore critical to establish whether a particular payment is a 'royalty' for withholding tax purposes.

Royalties in the ordinary meaning of the word are assessable under section 6-5 if they constitute ordinary income and are included in assessable income under section 15-20 otherwise. Payments which are not royalties within the ordinary meaning of the word, but which fall within the extended statutory definition in section 6(1) of the ITAA 1936, are assessable under section 6-5 provided they are ordinary income.

As section 15-20 applies to an amount that falls within the ordinary meaning of the word 'royalty', it is first necessary to determine the ordinary meaning of the term.

'Royalty'- ordinary meaning

The Shorter Oxford English Dictionary contains the following meanings of 'royalty' which are relevant for income tax purposes:

1)    a payment made to the landowner by the lessee of a mine in return for the privilege of working it;

2)    a sum paid to the proprietor of a patented invention for the use of it;

3)    a payment made to an author, editor, or composer for each copy of a book, piece of music, etc, sold by the publisher, or for the representation of a play.

Woellner, Vella, Burns and Barkoczy in Australian Taxation Law, CCH Australia 1997 at pp. 459 - 460 identified a common law royalty as having the following features:

1)    it is a payment made in return for the right to exercise a beneficial privilege or right, e.g. to remove minerals or natural resources such as timber, to use a copyright or to produce a play: McCauley v FC of T (1944) 69 CLR 235(McCauley); FC of T v Sherrit Gordon Mines Ltd 77 ATC 4365(Sherrit Gordon Mines);

2)    the payment is made to the person who owns the right to confer that beneficial privilege or right: Barrett v FC of T (1968) 118 CLR 666, Sherrit Gordon Mines;

3)    the consideration payable is determined on the basis of the amount of use made of the right acquired, e.g. a payment of X cents per performance, per cubic yard taken or per item manufactured or sold: McCauley, Stanton v FC of T (1955) 92 CLR 630(Stanton), Sherrit Gordon Mines; and

4)    the consideration will usually be paid as and when the right acquired is exercised: McCauley, Stanton. However, a lump sum payment will be a royalty where it is a pre-estimate or an after-the-event recognition of the amount of use made of the right acquired: IR Commrs v Longmans Green & Co Ltd (1932) 17 TC 272.

On the other hand, an amount unrelated to any estimate of likely amount of use and which is simply an amount paid to acquire the right to exercise a privilege will not usually be a common law royalty, even if paid by instalments: Stanton, Earle v FC of T 86 ATC 4441.

The Commissioner has adopted these features as the key characteristics of a common law royalty in Taxation Ruling IT 2660 Income tax: definition of royalties (IT 2660), and states in paragraph 10 that, a common law royalty will normally have all of the following features:

(a)  It is a payment made in return for the right to exercise a beneficial privilege or right (e.g. to remove minerals or natural resources such as timber, to use a copyright, or to produce a play) - McCauley v. F.C. of T. (1944) 69 CLR 235; 7 ATD 427; F.C. of T. v. Sherritt Gordon Mines Ltd (1977) 137 CLR 612; 77 ATC 4365; 7 ATR 726. Amongst other things, copyright can cover music, literary and artistic works, various forms of mechanical, electronic and biological knowledge, equipment and processes. Where, for example, the copyright is licensed to someone to manufacture and sell records, compact discs, books, prints of art works, motor vehicle engines, packaged computer software etc., for an amount based on the number of units produced or sold, the amount paid would be a royalty.

(b)  The payment is made to the person who owns the right to confer that beneficial privilege or right - Barrett v. F.C. of T. (1968) 118 CLR 666; Sherritt Gordon Mines Ltd; Case H9 76 ATC 39; 20 CTBR(NS) Case 64. However, the payment would still be a royalty if paid to another person or otherwise applied or dealt with at the direction of the owner. Moreover, payments for the use of the right that are made to a person who has been licensed or sub-licensed to deal with the right will also be regarded as royalty payments.

(c)   The consideration payable is determined on the basis of the amount of use made of the right acquired - McCauley; Stanton; Sherritt Gordon Mines; Case H9.

(d)  The consideration payable will usually be paid as and when the right acquired is exercised - McCauley; Stanton; Case H9. However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired - I.R. Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272; Mills v. Jones (1929) 14 TC 769; Constantinesco v. R (1927) 11 TC 730.

'Royalty' - domestic tax law definition

For the purposes of section 128B of the ITAA 1936, the term 'royalty' is defined by subsection 6(1) of the ITAA 1936 as follows:

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;

(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;

(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);

(da) the reception of, or the right to receive, visual images or sounds, or both, transmitted to the public by:

              i.        satellite; or

             ii.        cable, optic fibre or similar technology;

(db) the use in connection with television broadcasting or radio broadcasting, or the right to use in connection with television broadcasting or radio broadcasting, visual images or sounds, or both, transmitted by:

              i.        satellite; or

             ii.        cable, optic fibre or similar technology;

(dc) the use of, or the right to use, some or all of the part of the spectrum (within the meaning of the Radiocommunications Act 1992) specified in a spectrum licence issued under that Act;

(e)  the use of, or the right to use:

              i.        motion picture films;

             ii.        films or video tapes for use in connexion with television; or

            iii.        tapes for use in connexion with radio broadcasting; or

(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) or any such equipment as is mentioned in paragraph (b);

             ii.        the supply of any such knowledge or information as is mentioned in paragraph (c) or of any such assistance as is mentioned in paragraph (d);

iia. the reception of, or the granting of the right to receive, any such visual images or sounds as are mentioned in paragraph (da);

iib. the use of, or the granting of the right to use, any such visual images or sounds as are mentioned in paragraph (db);

iic. the use of, or the granting of the right to use, some or all of such part of the spectrum specified in a spectrum licence as is mentioned in paragraph (dc); or

            iii.        the use of, or the granting of the right to use, any such property as is mentioned in paragraph (e).

This definition is inclusive, in that it extends the meaning of 'royalty' to the amounts mentioned without excluding amounts that would be considered to be royalties within the ordinary or common law meaning of that term.

Further, the Commissioner's views on the definition of "royalty" and "royalties" in subsection 6(1) of ITAA 1936 are stated in IT 2660.

Assignment of copyright vs outright sale of the copyright

In Taxation Ruling TR 2008/7 Income tax: royalty withholding tax and the assignment of copyright (TR 2008/7) the Commissioner considers whether an amount paid or credited as consideration for the assignment of copyright is subject to royalty withholding tax under section 128B of the ITAA 1936.

The Commissioner accepts at paragraph 14 of TR 2008/7 that an assignment of copyright amounts to an outright sale if:

•         it is for the full remaining life of the copyright; and

•         it extends geographically over an entire country or several entire countries; and

•         it is not limited as to the class of acts that the copyright assignee has the exclusive right to do; and

•         the amount and the timing of the payment or payments for the assignment are not dependent on the extent of exploitation of the copyright by the assignee.

The Commissioner states at paragraph 16 of TR 2008/7 that, the expression 'payment for the use of, or the right to use' a copyright captures all payments made in consideration for an assignment of copyright unless the assignment is, having regard to the following factors, more comparable to an outright sale of the copyright than to the grant of a right to use the copyright:

•         the duration of the assignment as compared with the actual or estimated legal life of the copyright;

•         the geographical extent of the assignment;

•         any limitation on the assignment as to the class of acts that the copyright assignee has the exclusive right to do;

•         whether the amount and the timing of the payments are dependent upon or determined by the exploitation of the copyright by the assignee.

Further, for the assignment to be considered an outright sale, TR 2008/7 at paragraph 90 provides that, 'substantially all of the rights must be transferred but that it is not necessary that every legal right be transferred, if in taking an overall view of the transaction the limitations on the scope of the assignment are not so significant in practical terms to detract from the nature of the assignment as an outright sale.'

Application of TR 2008/7 to the assignment of the Transferred IP

The duration of the assignment

The duration of the assignment of Transferred IP is not limited by the IP Transfer Agreement. However, it is noted that the IP Transfer Agreement is subject to the terms of the Framework Agreement and Shareholders Agreement, which allow for the arrangement to be terminated and for Aus Co to be wound-up, thereby ending the assignment of the Transferred IP.

Therefore, this factor is neutral and not indicative of either an outright sale or the opposite conclusion.

The geographical extent of the assignment

The assignment of the Transferred IP has no geographical limit and extends to exploitation of the technologies on a global basis.

Therefore, this factor is consistent with the concept of an outright sale.

Any limitation on the assignment as to the class of acts that the copyright assignee has the exclusive right to do

The IP Transfer Agreement provides Aus Co the ability to use and commercialise the Transferred IP as it wishes, including making modifications and alterations. Importantly, Aus Co is free to deal with the Transferred IP by way of further assigning or licencing it to third parties.

Given the assignment covers a whole class of possible exploitation of the copyright it is consistent with the concept of an outright sale.

Whether the amount and the timing of the payments are dependent upon or determined by the exploitation of the confidential information and copyright by the assignee

The consideration for the assignment of the Transferred IP paid by Aus Co to Foreign Co is a lump sum payment comprising the subscription shares. The value of the subscription shares was negotiated on an arm's length, commercial basis and represents the parties' agreed value of the Transferred IP. Importantly, the value of the shares is not dependent, or based on the actual use or exploitation of the Transferred IP.

This points positively towards a conclusion that the transaction is for the ownership of the Transferred IP and the equivalent of an outright sale.

Based on the above, it is considered that the issue of subscription shares in consideration for the assignment of the copyright in the technologies, the 'Transferred IP' amounts to an outright sale for Australian tax purposes as per the Commissioners views in TR 2008/7. Therefore, it is not considered a royalty within the ordinary meaning of 'royalty', or the term 'royalty' as defined by subsection 6(1) of the ITAA 1936.

'Royalty' - Article 12(3) of the Agreement

The Australian domestic royalty withholding tax provisions contained in section 128B of the ITAA

1936 are modified by the International Tax Agreements Act 1953 (Agreements Act). Relevantly:

•         subsection 17A(1) limits the amount of domestic withholding tax on 'royalties' to 10 percent as set out in Article 12(2) of the Agreement,

•         subsections 17A(4) and (5) limit the scope of the domestic definition of 'royalties' to the scope of the definition of 'royalties' in Article 12(3) of the Agreement, and

•         subsection 4(2) gives primacy to the definition of 'royalties' in Article 12(3) of the Agreement in the event of inconsistency or conflict.

Therefore, the definition of 'royalties' in Article 12(3) of the Agreement is the definition that applies for the purpose of determining the extent to which the Agreement limits the operation of section 128B of the ITAA 1936.

Article 12(3) of the Agreement relevantly provides as follows:

The term "royalties" in this Article means payments, whether periodical or not, and however described or computed, to the extent to which they are paid as consideration for 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 industrial, commercial or scientific equipment, or for the supply of scientific, technical, industrial or commercial knowledge or information, or for the supply of any assistance of an ancillary and subsidiary nature furnished as a means of enabling the application or enjoyment of such knowledge or information or any other property or right to which this Article applies, and includes any payments to the extent to which they are paid as consideration for 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.

As outlined above, the issue of subscription shares as consideration for the assignment of the Transferred IP by Foreign Co to Aus Co is more appropriately characterised as an outright sale of copyright rather than a payment for the use of, or the right to use copyright. Accordingly, it is not considered a 'royalty' for the purposes of Article 12(3) of the Agreement.

Question 2

Summary

Aus Co will not have an obligation to withhold tax in respect of the issue of the subscription shares under section 12-280 of Schedule 1 to the TAA

Detailed reasoning

Section 12-280 of Schedule 1 to the TAA imposes a withholding obligation in respect of royalty payments. It states:

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).

However, no withholding is required from a royalty payment where no withholding tax is payable pursuant to Division 11A of the ITAA 1936 (section 12-300 of Schedule 1 to the TAA). Relevantly, a payment is subject to royalty withholding tax under section 128B(2B) of the ITAA 1936, where it consists of a 'royalty' that is paid by a resident to a non-resident, except where it is wholly incurred by the payer in carrying on business outside Australia at or through a permanent establishment in that country.

As outlined in Question 1 above, the issue of subscription shares by Aus Co as consideration for the assignment of the Transferred IP does not constitute a 'royalty' under the domestic tax law definition or under the Agreement. Consequently, the issue of the subscription shares is not subject to a royalty withholding tax liability under section 128B(2B) of the ITAA 1936.

Therefore, Aus Co has no obligation to withhold under section 12-280 of Schedule 1 of the TAA in respect of the issue of the subscription shares pursuant to section 12-300 of Schedule 1 of the TAA.