ATO ID 2007/188: Failure to withhold from a royalty payment to a non-resident and the effect on the payment's deductibility
Date of decision: 1 October 2007
Business line: Public Groups and International

Issue
Does the payment of an administrative penalty amount imposed under section 16-30 of Schedule 1 to the Taxation Administration Act 1953 (TAA), for failure to withhold from a royalty paid to a non-resident, constitute a payment of withholding tax for the purposes of subsection 26-25(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The payment of an administrative penalty amount imposed under section 16-30 of Schedule 1 to the TAA, for failure to withhold from a royalty paid to a non-resident, constitutes a payment of withholding tax for the purposes of subsection 26-25(3) of the ITAA 1997.

Facts
An Australian resident entity (the payer) made a royalty payment to an overseas person who is a non-resident. An overseas person, for the purposes of section 12-280 of Subdivision 12-F of Schedule 1 to the TAA, is the recipient of the royalty who, from the payer's records has an address outside of Australia. The royalty income was not exempt from withholding tax under Division 11A of the Income Tax Assessment Act 1936 (ITAA 1936). The payer was required to withhold an amount from the payment under Subdivision 12-F in Schedule 1 to the TAA but failed to do so. Consequently, the payer was liable to pay the Commissioner an administrative penalty under section 16-30 of the TAA, equal to the amount it should have withheld. The payer paid the penalty and no remission was sought or granted.

Reasons for decision
Summary: Subsection 128B(5A) of the ITAA 1936 imposes a withholding tax liability on a non-resident who derives royalty income which is paid by a person who is a resident (subparagraph 128B(2B)(b)(i) of the ITAA 1936) or by a non-resident who incurs the royalty in carrying on business in Australia at or through a permanent establishment in Australia (subparagraph 128B(2B)(b)(ii) of the ITAA 1936). As subparagraph 128B(2B)(b)(i) of the ITAA 1936 applies in this case, the payer should have withheld an amount from the royalty payment to an overseas person as required by section 12-280 of Subdivision 12-F of Schedule 1 to the TAA. As a result, the payer was liable to pay and paid the Commissioner an administrative penalty equal to that amount in accordance with section 16-30 in Schedule 1 to the TAA. An administrative penalty paid under section 16-30 of Schedule 1 to the TAA for not withholding from a royalty payment is not income tax payable under section 128B of the ITAA 1936. However, paragraph 18-35(1)(a) of Schedule 1 to the TAA states that where an entity fails to withhold an amount in relation to the royalty payment and pays an equal amount of penalty imposed under section 16-30 of the TAA or the general interest charge (GIC) in relation to that penalty to the Commissioner, the person liable to pay the withholding tax on the royalty payment, being the non-resident, is entitled to a credit equal to the amount of the penalty or GIC paid. Where the penalty is paid in full the effect, is ordinarily, to extinguish the liability for the withholding tax on that royalty. In that sense the withholding tax payable on the royalty may be said to be paid. But, subsection 26-25(1) of the ITAA 1997 provides that an entity that fails to withhold an amount from a royalty as required by Subdivision 12-F of the TAA is precluded from claiming a deduction for the royalty. However, subsection 26-25(3) of the ITAA 1997 provides that if, apart from subsection 26-25(1) of the ITAA 1997, the entity can deduct the royalty for an income year, it will be deductible for that year if the withholding tax payable for the royalty is paid. Accordingly, the relevant amount of withholding tax is regarded as having been paid for the purposes of subsection 26-25(3) of the ITAA 1997 when the Australian entity pays the administrative penalty equal to the amount it should have withheld and that amount is subsequently credited to the non-resident's account in accordance with paragraph 18-35(1)(a) of the TAA. Hence, as the payer paid an administrative penalty equal to the withholding tax it should have withheld from the royalty payment, the withholding tax is taken to be paid for the purposes of subsection 26-25(3) of the ITAA of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1936 section 128B subparagraph 128B(2B)(b)(i) subparagraph 128B(2B)(b)(ii) subsection 128B(5A)
Subject references: International tax Non-resident royalty withholding tax Withholding tax credits Withholding taxes Failure to withhold