Edited version of private advice

Authorisation Number: 1052278628283

Date of advice: 16 August 2024

Ruling

Subject: Income tax - royalties

Question

Are the payments received by you from specified entities assessable under section 15-20 of the Income Tax Assessment Act 1997 (ITAA 1997) as a royalty?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

In the relevant calendar years you developed software (Intellectual Property).

You registered the trademark for the Intellectual Property on a specified date.

You registered a business name relating to the Intellectual Property on a specified date.

On a specified date you assigned all of the right, title and interest in, and to the intellectual property, software, copyrights, know-how and trademark to an Assignee by way of Deed of Assignment.

Consideration from the Assignee to you was in the form of:

•         A licensing agreement to a third party

•         A Royalty Deed between the parties

•         A contract for further employment with the Assignee.

On the same day, you and the Assignee agreed to terms for a Royalty Deed.

The Royalty Deed provided that the Assignee was to commercialise the know-how and software.

The Royalty Deed provided that know-how revenue shall be disbursed by the Assignee in an agreed upon manner.

This Royalty Deed was then amended by way of a Deed Recording Variation.

The Variation Deed amended the disbursement clause to reflect commercialisation revenue to be disbursed by the Assignee in an agreed upon manner.

Additionally, you agreed to a separate Royalty Deed between yourself and a related entity on a specified date, however this deed was later terminated by a Royalty Termination Deed on a specified date.

In a specified year, the Assignee then entered into an IP Assignment Agreement with a related entity, transferring all of the right, title and interest in, and to the intellectual property, software, copyrights, know-how and trademark to said related entity.

This transfer triggered two lump sum payments to you under the terms of the original Deed of Assignment, Royalty Deed and Varied Royalty Deed.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1997 section6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 15-20

Reasons for decision

Issue 1

Question 1

Detailed reasoning

Ordinary Income

Section 6-5 of the ITAA 1997 states that assessable income includes income according to ordinary concepts. Jordan CJ in Scott v Commissioner of Taxation (1935) 35 SR (NSW) at page 219 outlines that

'Income is not a term of art and what forms of receipts are comprehended within it and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind'.

Statutory Income

Under section 6-10 of the ITAA 1997 an amount that is not ordinary income may be assessable under another statutory provision. This is referred to as statutory income.

Subsection 15-20(1) of the ITAA 1997 provides that your assessable income includes an amount that you receive as or by way of royalty within the ordinary meaning of royalty if the amount is not assessable as ordinary income under section 6-5.

Statutory Definition of Royalty

Section 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) defines a royalty 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, 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;

(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).

Taxation Ruling TR 2024/D1 Income tax: royalties - character of payments in respect of software and intellectual property (TR 2024/D1)

TR 2024/D1 considers when an amount paid under a software arrangement is considered a royalty for the purposes of section 6(1) of the ITAA 1936.

Paragraph 11 provides the following:

the domestic tax law definition of royalty is inclusive and covers amounts that would fall within the ordinary meaning of a royalty consistent with Australian case law. As a consequence, the domestic tax law meaning of royalties is broader than the standard tax treaty definition (which is exhaustive). It follows that where an amount is a royalty under a standard tax treaty definition, it will also be a royalty under the domestic tax law definition and royalty withholding tax will apply at the rate provided for in that tax treaty.

Paragraph 12 then outlines that the character of payments in relation to a software arrangement for or that results in, the use of, or right to use, software in Australia, depends upon all the facts and circumstances of the particular case, including the terms of any agreement between the parties and the conduct of the parties in relation to the software arrangement.

Relevantly, paragraph 13 discusses that an amount may be a royalty even if it is not paid periodically and howsoever the payment is described or computed. For example, payments made under an agreement need not be described as being for, or being calculated with reference to, the use of, or right to use, specified IP rights.

Paragraphs 14 outlines a non-exhaustive list of payments that are categorised as royalties:

(a)         the grant of a right to use IP, regardless of whether that right is exercised (paragraph (a) of the standard tax treaty definition) - for example, the grant of the right to reproduce a computer program, regardless of whether or not that right is exercised;

(b)         the use of an IP right (paragraph (a) of the standard tax treaty definition) -for example, the use of a copyright right consists of doing an act in respect of a copyright work that is the exclusive right of the copyright holder, such as authorising the communication of a computer program;

(c)         the supply of know-how in relation to an IP right referred to in subparagraphs 14(a) and (b) of this Ruling (paragraph (b) of the standard tax treaty definition);

(d)         the supply of assistance furnished as a means of enabling the application or enjoyment of the supply (paragraph (c) of the standard tax treaty definition);

(e)         the sale by a distributor of hardware with embedded software, where the distributor is granted or uses rights in the IP of the software.

This is contrasted against paragraph 15 that lists payments that are not characterised as royalties:

(a)         consideration that is wholly for the grant of a right to distribute copies of a computer program, without the use of, or right to use, the copyright or another IP right;

(b)         consideration for the transfer of all rights relating to the copyright in software;

(c)         payments from a distributor that are consideration wholly for the acquisition of hardware with embedded software, provided that the distributor does not use, and is not granted the right to use, any copyright or another IP right in the embedded software;

(d)         payments from a distributor that are consideration wholly for the acquisition of physical carrying media on which software is stored, provided that the distributor does not use, and is not granted the right to use, any copyright or another IP right in the embedded software;

(e)         consideration for the provision of services that are unrelated to any IP right referred to in paragraph (a) of the standard tax treaty definition or any knowledge or information mentioned in paragraph (b) of the standard tax treaty definition.

Paragraphs 16-18 then provided that the enquiry under the standard tax treaty definition and the domestic tax law definition of royalty is often expressed as whether or not the payment is paid 'as consideration for' certain things. In this context, 'consideration' is what moves the payment and is something of value given in exchange for it. 'Consideration' does not have its technical meaning in contract law.

Where a payment is consideration for several things, only some of which fall within the standard tax treaty definition, the payment is a royalty to the extent that it is 'for' the things that are within that definition. That is, the payment must be a royalty to at least some extent, even if it is also for other things that are not within the definition of a royalty.

If an undissected amount is paid as consideration for matters all of which are sufficiently connected with the things mentioned in the definition of royalty, the whole amount of the payment will be taken to be a royalty in the first instance. However, it does not necessarily follow that because an amount is paid as consideration for several things that it is paid only in part for each of them. For example, this will be the case where any IP rights granted are inseparable, from a practical and business point of view, from any other things for which the consideration is paid.

Taxation Ruling TR 2008/7 Income tax: royalty withholding tax and the assignment of copyright (TR 2008/7)

TR 2008/7 further considers the concept and definition of what payments are considered to be a royalty.

Paragraph 12 discusses the fact that 'all amounts paid as consideration for an assignment of copyright are royalties under the standard tax treaty definition of that term unless the assignment is properly characterised as an outright sale of the copyright'.

Paragraph 13 then states that 'this is a question of determining, in light of the definition of 'royalties', and having regard to all relevant facts and circumstances, whether the payment is to be regarded as a payment for the sale of property consisting of the copyright or as a payment for the use of, or the right to use, that property. It is necessary to carefully construe the terms of the agreement between the parties and characterise the consideration by reference to the substance of the arrangement'.

Paragraph 15 then states that 'the Commissioner's view is that it is not accepted that any payment made in consideration for an assignment of copyright automatically falls outside the standard tax treaty definition of 'royalties' merely because, as a matter of copyright law, the transaction is an assignment of the owner's interest in the copyright, rather than, say, a grant of a licence in respect of that copyright. If the other indications are that the payment can more accurately be described as for the use or the right to use the copyright then the payment is a royalty'.

Paragraph 16 then relevantly outlines that 'the Commissioner's view is 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.'

Taxation Ruling IT 2660: Income tax: definition of royalties (IT 2660)

IT 2660 expands on the ordinary meaning of a royalty and discusses the interpretation of the concept by their respective Honour's in the following cases:

In Stanton v. F.C. of T. (1955) 92 CLR 630, the Full Court of the High Court of Australia described the essence of a royalty. The Court said at page 641 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".

Later, at page 642 the Court stated:

"In the case of monopolies and the like the essential idea seems to be payment for each thing produced or sold or each performance or exhibition in pursuance of the licence. In the same way in the case of things taken from the land the essential notion seems to be that the payment is made in respect of the taking of something which otherwise might be considered to belong to the owner of the land in virtue of his ownership. In other words it is inherent in the conception expressed by the word that the payments should be made in respect of the particular exercise of the right to take the substance and therefore should be calculated either in respect of the quantity or value taken on the occasions upon which the right is exercised."

The key characteristics of a common law royalty (i.e. a royalty within the ordinary meaning of the term) are detailed in the following cases:

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; F.C. of T. v. Sherritt Gordon Mines Ltd (1977) 137 CLR 612.

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.

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.

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.

Application to your circumstances

Royalties are specifically included in assessable income under section 15-20 if they are not assessable as ordinary income under section 6-5.

The follow up assignment of IP was a direct result of the commercialisation and exploitation of the IP as agreed upon in the Original Assignment Deed and Variation Deed between you and the Assignee.

Under schedule 1 in the Variation Deed the definition of commercialisation revenue includes lump sum amounts and proceeds of sale of shares in a company into which the IP is assigned. You were then disbursed an amount accordingly when this assignment took place.

The disbursement in question best aligns with the example in TR 2008/7 at paragraph 16 "whether the amount and the timing of the payments are dependent upon or determined by the exploitation of the copyright by the assignee." The disbursement was contingent on exploitation and commercialisation, which involved a further sale of IP.

Further, within the various contracts, details in relation to percentage entitlements are detailed, which suggests to the Commissioner, that the payment received on a specified date, would be an entitlement to various back-dated amounts of royalty for specific rights of use of aspects of the IP.

It is considered that the payments you received are royalties and therefore assessable under section 15-20 of the ITAA 1997. They are not considered to be capital in nature as they are not instalments of a set capital sum.

Consideration as to whether the amount was capital was undertaken. Though, due to the construction of the related deeds the only payment that could be considered to be capital would be the $XX assignment fee under a specified clause of the Original Assignment Deed.

Consequently, the amounts are assessable on revenue account and will be included in assessable income under section 15-20 of the ITAA 1997 in the income year that they are received.