Edited version of private advice

Authorisation Number: 1052175968679

Date of advice: 13 October 2023

Ruling

Subject: Income tax

Question 1

Will the payments made by Company A under the Agreement be subject to royalty withholding tax under subsection 128B(2C) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Will the Funding Payments made by Company A under the Agreement be immediately deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Subject: Withholdings from payments

Question 1

Will the Payments made by Company A under the Agreement be subject to the no-ABN withholding tax provisions under section 12-190 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953)?

Answer

No.

This ruling applies for the following periods:

Year 1 Income Tax Year

Year 2 Income Tax Year

Year 3 Income Tax Year

Year 4 Income Tax Year

Year 5 Income Tax Year

The scheme commenced on:

Year 1 Income Tax Year

Relevant facts and circumstances

Company A is an Australian company.

Company A has entered into a contract (Agreement) with several non-Australian entities to perform testing of the application of a specific technology for a new purpose, in the industry Company A is involved in.

Per the conditions of the Agreement, Company A will make several payments at various milestones of the testing. In return, Company A will receive a series of reports while the testing is being undertaken, and a final report when the testing has been completed.

The Agreement confers on Company A certain limited rights to use the information in the reports for marketing, reporting and decision making purposes. Company A has no right to implement, resell or develop further any intellectual property in the technology that is being tested.

Reasons for decision

Subject: Income tax

Question 1

Subsection 128B(2C) of the ITAA 1936 provides the following:

128B(2C)

Subject to subsection (3), where income:

(a)

is derived, or derived in part, by a person (the recipient) to whom this section applies in carrying on business in a country outside Australia at or through a permanent establishment of the person in that country; and

(b)

consists of a royalty that:

(i) is paid to the recipient by another person (the payer) to whom this section applies and is not an outgoing wholly incurred by the payer in carrying on business in a country outside Australia at or through a permanent establishment of the payer in that country; or

(ii) is paid to the recipient by one or more persons (the non-resident payers), each of whom is not a resident, and is, or is in part, an outgoing incurred by the non-resident payers in carrying on business in Australia at or through a permanent establishment of the non-resident payers in Australia;

this section also applies to that income or to the part of that income mentioned in paragraph (a).

For completeness, subsection (3) provides several circumstances that will prevent the application of 128B(2C), none of which apply to Company A when applied to the present scheme.

Royalties

The ordinary meaning of the term 'royalty' has been considered by Australian judiciaries on many occasions. In Stanton v. FC of T (1955) CLR 630, the High Court of Australia described the essence of a royalty and stated that:

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.

The definition of 'Royalty' is extended 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);

(f) a total or partial forbearance in respect of [the above]

The Commissioner's view of what constitutes a royalty is given in Taxation Ruling IT 2660. Paragraph 10 of IT 2660 advises that in the Commissioner's view there are four key characteristics of a common law royalty:

•         it is a payment made in return for the right to exercise a beneficial privilege or right, for example to remove minerals or natural resources such as timber (McCauley v. FC of T (1944) 69 CLR 235)

•         the payment is made to the person who owns the right to confer that beneficial privilege or right (Barrett v. FC of T (1968) 11 CLR 666)

•         the consideration payable is determined on the basis of the amount of use made of the right required (McCauley, Stanton), and

•         the consideration 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 or an after the event recognition of the amount of use made of the right acquired (IR Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272).

Paragraph 25 of IT 2660 gives the Commissioner's view that payments for services rendered and work done are not royalties, 'unless the services are ancillary to, or part and parcel of, enabling relevant technology, information, know-how, copyright, machinery or equipment to be transferred or used.'.

Payments for 'know-how'.

Royalties can be present in the form of 'the supply of scientific, technical, industrial or commercial knowledge or information', otherwise known as 'know-how'. A basis for determining whether a payment is for 'know how' or for provision of services is provided in paragraphs 25 to 34 inclusive of IT 2660.

Paragraph 33 of IT 2660 states:

the first question to be answered is: is the contract one for the supply, for use by the 'buyer', of a 'product' which is already in existence (or substantially in existence), or is it one which requires the contractor to apply special skills and knowledge for his own purposes in order to bring the 'product' into existence for the buyer? In the first case the contract is for the supply of know-how and will give rise to a royalty. In the second it will be a contract for services rendered.

Factors such as the level of cost and planning involved in bringing a 'product' to a buyer are used to determine whether the product is one that is already in existence.

Application to the Agreement

On basis of applying the relevant facts to the above, no part of the payments made under the Agreement are for royalties.

Question 2

Detailed reasoning

Section 8-1 of the ITAA 1997 provides that:

(1) You can deductfrom your assessable income any loss or outgoing to the extent that:

(a) it is incurredin gaining or producing your assessable income; or

(b) it is necessarily incurredin carrying on a business for the purpose of gaining or producing your assessable income.

(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature;

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

It has long been held through decisions in Australian case law that for a sufficient nexus to exist between a loss or outgoing and a purpose that satisfies either limb of subsection 8-1(1) of the ITAA 1997, the loss or outgoing must

a)    be "incidental and relevant" to the income producing activities (Ronpibon Tin NL v FC of T (1949) 8 ATD 431(1949) 78 CLR 47

b)    have the "essential character" of an income producing expense (Lunney v FC of T; Hayley v FC of T (1958) 11 ATD 404 (1958) 100 CLR 478

c)    have a "perceived connection" with the gaining or producing of income (FC of T v Hatchett 71 ATC 4184).

In Taxation Ruling 95/33, Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings (TR 95/33) at paragraph 37, the Commissioner (observing comments made in Magna Alloys & Research Pty Ltd v. FC of T (80 ATC 4558; 11 ATR 294) concluded that it was the subjective purpose or motive behind the outgoing that was of critical importance as to whether an outgoing was necessarily incurred in carrying on a relevant business, rather than whether the outgoing resulted in achieving a quantifiable return of income or profit.

The Commissioner concludes that the outgoings are relevant to the income producing activities of Company A.

Of the four negative limbs, only the first limb is relevant to the present case.

Outgoings of capital, or of a capital nature

There is no legal definition of what is 'capital, or of a capital nature' however the principles to determine this have been established through Australian case law.

The distinction between capital and revenue expenditure was considered by Dixon J in Associated Newspapers Ltd v FCT; Sun Newspapers Ltd v FCT (1938) 61 CLR 337. In that case, Dixon J said that there were 3 matters to be considered:

•         the character of the advantage sought;

•         the manner in which it is to be used, relied upon or enjoyed; and

•         •the means adopted to obtain it.

Character and Manner of the Funding Payments

In Hallstroms Pty Ltd v FCT (1946) 72 CLR 634at 648, Dixon J makes the observation that it is the advantage that is sought from making the payment that determines the character of the payment:

What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.

In GP International Pipecoaters Pty Ltd v Commissioner of Taxation (Cth) [1990] HCA 25, it was noted that the character of expenditure is 'ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure.'

On application of the relevant facts to the above, the outgoing by Company A is not capital in nature.

Subject: Withholdings from payments

Question 1

Section 12-190 of Schedule 1 to the TAA 1953, regarding pay as you go withholdings, provides that:

(1) An entity (the payer) must withhold an amount from a payment it makes to another entity if:

(a) the payment is for a supply that the other entity has made, or proposes to make, to the payer in the course or furtherance of an enterprise carried on in Australia by the other entity; and

(b) none of the exceptions in this section applies.

None of the payments made by Company A are 'in the course or furtherance of an enterprise carried on in Australia', and therefore Section 12-190 has no application.