In releasing draft Taxation Ruling 2021/D4, the Commissioner has changed his long-standing views in respect of receipts relating to computer software, affecting software distributors, creators and licensees. Businesses must now be aware of an expanded set of situations where receipts for licences and distribution of software can attract royalties.
What's changed for the taxation of software royalties
TR 2021/D4 has replaced the Commissioner's existing guidance in TR 93/12, which has now been withdrawn. In recognition of the fact that software is constantly evolving and is now more likely to be digitally downloaded rather than distributed through disks or other physical media, TR 2021/D4 seeks to update the Commissioner's guidance on computer software. However, the draft ruling has also expanded the circumstances in which a payment for licensing and distribution of software may constitute a royalty.
Under the section 6(1) of the Income Tax Assessment Act 1936, a payment in relation to software will constitute a royalty where it is:
- consideration for the grant of a right to do something in relation to software that is the exclusive right of the owner of the copyright in the software;
- consideration for the supply of know-how in relation to software; or
- consideration for the supply of assistance furnished as a means of enabling the application or enjoyment of the supply.
Pointedly, the Commissioner notes at the outset that the character of a receipt from the licensing and distribution of software depends on all the facts and circumstances of a particular case.
To this end, TR 2021/D4 provides eight examples to illustrate how the definition of "royalty" should apply in practice. The biggest change from the existing guidance in TR 93/12 relates to licences for the simple end-use of software.
TR 93/12 considered that a payment for the granting of a licence which allows only simple use of the software was not a royalty. TR 2021/D4 still states that grants of licences for only the simple use of software will not give rise to a royalty. However, payments for licences which involve a right to sub-licence the software to an end-user, even for the simple use for which the software was intended, will be regarded as a royalty. The Commissioner's basis for this position is that the payment is for the right to do something in relation to software that is the exclusive right of the copyright owner – that is, the distributor is paying for the right to stand in the shoes of the copyright owner and exploit the copyright in the software.
Examples of how the new rules on software royalties work in practice
TR 2021/D4 gives a range of examples as to which circumstances attract or do not attract royalties. For instance, licences to reproduce, modify or adapt the software as well as to do anything which is "the exclusive right of the copyright holder" will attract a royalty. Similarly, "payments for the supply of source code relating to software", as well as payments for the owner of custom operating system software to provide additional assistance to a computer programmer, so that the programmer can understand the software for the purposes of the programmer's ongoing tasks, will constitute a royalty.
In contrast, a payment made by a distributor that is granted the right to market and distribute packaged software (but not to sub-licence the use of the software to end-users or to otherwise use the copyright in the software) will not be regarded as a royalty.
Interestingly, TR 2021/D4 emphasises the notion of copyright as found in section 31(1) of the Copyright Act 1968 (Cth) which includes – as an exclusive right of the copyright owner – "communicat[ing] a copyright work to the public". This can be done, in the Commissioner's view, by "the making of a copyright work available online irrespective of whether it is electronically transmitted". Specifically, "[a] communication may occur in the relevant sense when software is made accessible to or is used by an end-user via cloud-based technology such as software-as-a-service, that is, without being downloaded on the end-user's computer or device". It is therefore important to appreciate how the Commissioner's guidance now widely expands the circumstances where an "exclusive right of the copyright holder" can be granted, such as merely making the work accessible online.
As stated in the draft ruling, whether a payment in respect of software should be characterised as a royalty is inherently fact-specific. Further, cross-border arrangements will still need to consider the application of any double tax agreement, the provisions of which will prevail over Australia's domestic law in the determination of withholding tax implications.
Businesses should review TR 2021/D4 carefully and consider how it would apply to their agreements concerning software development, modification and distribution, particularly where intermediaries are used to distribute software to the public.
Public comment welcome
Members of the public are invited to comment on TR 2021/D4 by 23 July 2021.