International Business Machines Corporation v Commissioner of Taxation
Document type: Decision Impact Statement
Venue: Federal Court of Australia (NSD 661 of 2009)
Judgment date: 12 April 2011
Date published: 22 June 2011

Summary of decision:
Outlines the ATO response to the decision of the Federal Court which concerned the extent to which payments made under a software licensing agreement were royalties.

Overview of facts:
The applicants were two non-resident corporations that received payments from IBM Australia Limited (a group subsidiary) under a Software License Agreement (SLA). | There was no dispute that at least some amount of withholding tax was due and payable in respect of the payments. The applicants accepted that the part of the payment attributable to intellectual property (IP) licences were royalties and therefore subject to withholding tax. The dispute arose over the contention, on the part of the Applicants, that the payments under the SLA were also in respect of rights not related to IP with the consequence that only a portion of the fees paid were royalties. | Issues decided by the court or tribunal | The issue decided by the court was whether the fees payable under the SLA were (as contended by the Commissioner) wholly royalties, or (as contended by the applicants) royalties only in part as per the definition of 'royalty' in Article 12(4) of the US / Australia Double Tax Agreement. | Under the Double Tax Agreement, royalty is defined to mean 'payments ... to the extent to which they are consideration for the use of or the right to use any (a) copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right ...'. | The court held that the entirety of the fees payable under the SLA were royalties and gave rise to a liability to non-resident withholding tax. | The Court noted that the construction of the SLA is fundamental to the characterisation of the payments (para 11) and that to the extent that intellectual property licences were the subject matter of the SLA and the payments were for those licences they could properly be characterised as royalties (para 18). | The court rejected the taxpayers' construction of the agreement (which had been to the effect that it was primarily a distribution rather than software licensing agreement such that the fees paid under the agreement were primarily paid for a right to distribute). The Court held that the fees payable under the SLA had the character of payments for rights to use IP. This was so even if those rights are not exercised and regardless of the basis used to quantify the fees to be paid (para 44). | The Court observed that there was no ambiguity in the construction of the SLA (para 54). Moreover the Court noted that even if the terms of the SLA had been ambiguous, the extrinsic evidence that had been tendered by the taxpayers would not have supported the taxpayers' construction of the agreement (paras 61, 62). | The Court also agreed with the Commissioner's contention that the expression 'for the use of or the right to use' in the definition of 'royalty' means that the definition applies to payments both for the use of IP, that is, the exercise of the right granted, and also for the grant of the right to use the IP (para 14).

Issues decided:
The issue decided by the court was whether the fees payable under the SLA were (as contended by the Commissioner) wholly royalties, or (as contended by the applicants) royalties only in part as per the definition of 'royalty' in Article 12(4) of the US / Australia Double Tax Agreement. Under the Double Tax Agreement, royalty is defined to mean 'payments ... to the extent to which they are consideration for the use of or the right to use any (a) copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right ...'. The court held that the entirety of the fees payable under the SLA were royalties and gave rise to a liability to non-resident withholding tax. The Court noted that the construction of the SLA is fundamental to the characterisation of the payments (para 11) and that to the extent that intellectual property licences were the subject matter of the SLA and the payments were for those licences they could properly be characterised as royalties (para 18). The court rejected the taxpayers' construction of the agreement (which had been to the effect that it was primarily a distribution rather than software licensing agreement such that the fees paid under the agreement were primarily paid for a right to distribute). The Court held that the fees payable under the SLA had the character of payments for rights to use IP. This was so even if those rights are not exercised and regardless of the basis used to quantify the fees to be paid (para 44). The Court observed that there was no ambiguity in the construction of the SLA (para 54). Moreover the Court noted that even if the terms of the SLA had been ambiguous, the extrinsic evidence that had been tendered by the taxpayers would not have supported the taxpayers' construction of the agreement (paras 61, 62). The Court also agreed with the Commissioner's contention that the expression 'for the use of or the right to use' in the definition of 'royalty' means that the definition applies to payments both for the use of IP, that is, the exercise of the right granted, and also for the grant of the right to use the IP (para 14).

ATO view of decision:
The decision is largely case specific in that the decision turned on how the SLA entered into by the parties was to be properly construed. The decision does however provide a useful example of how a court goes about the task of construing an agreement which on its face relates to the licensing of software.

Administrative treatment:
Implications for ATO precedential documents (Public Rulings & Determinations etc) | Nil

Legislative references: International Tax Agreements Act 1953 Article 12(4) of Schedule 2 (US/Australia DTA) Income Tax Assessment Act 1936 128B(5A) 128C
Subject references: Construction of contract Copyright Intellectual property Royalties Royalty Withholding Tax Software licence agreement