Private ruling: Liability to Pay As You Go withholding in respect of royalties
Published: July 2013
Ruling period: Year ending 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015
Date scheme commenced: 1 July 2008

Ruling: Q1: Is the Payer required to deduct royalty withholding tax under section 12-280 and section 12-300 of Schedule 1 of the Taxation Administration Act 1953 (TAA 1953) in respect of royalty payments made to the Government of Country X, the Government of Country Y and the Government of Country Z on the basis that the doctrine of sovereign immunity applies? | A1: No. the Payer is not required to deduct royalty withholding tax under section 12-280 and section 12-300 of Schedule 1 of the TAA 1953 in respect of royalty payments made to the Government of Country X, to the Government of Country Y nor to the Government of Country Z.

Relevant facts and circumstances: The Payer is a resident of Australia for taxation purposes. The Payer has entered into agreements with foreign governments which will result in the payment of royalties to those governments. The royalty payments were not outgoings incurred by the Payer in carrying on a business at or through permanent establishments overseas.

Relevant legislative provisions: Income Tax Assessment Act 1936 , Section 128B. | Income Tax Assessment Act 1997, Section 995-1 | Taxation Administration Act 1953, Schedule 1 Part 2-5 | International Tax Agreements Act , Subsection 17A(5)

Reasons for decision: Summary: The Payer is not required to withhold any amount from the royalties paid to the foreign governments in light of the operation of the doctrine of sovereign immunity. | Detailed Reasoning - Detailed reasoning: Under subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997), a 'royalty' has the meaning given by subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and includes, ' the use of, or the right to use, any copyright, patent…trademark, or other like property or right.' Taxation Ruling IT 2660 states that a common law royalty (i.e. a royalty within the ordinary meaning of the term) will normally have all of the following features: (a) it is a payment made in return for the right to exercise a beneficial privilege or right… (b) the payment is made to the person who owns the right to confer that beneficial privilege or right… (c) the consideration payable is determined on the basis of the amount of use made of the right acquired…[and] (d) the consideration payable will usually be paid as and when the right acquired is exercised… In determining liability to tax on Australian sourced income, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (Agreements Act). Australia does not have a tax treaty with either Country X or Country Y therefore the provisions of the Agreements Act would not apply to payments made to the Governments of those countries. Australia does have a tax treaty with Country Z (Country Z treaty), therefore the Agreements Act would apply to payments made to the Government of Country Z. Subsection 4(1) of the Agreements Act provides that ITAA 1936 and ITAA 1997 must be read as one with the Agreements Act. Subsection 17A(5) of the Agreements Act provides that royalty withholding tax will not be payable if the relevant treaty does not treat the amount as a royalty. Article X of the Country Z treaty provides that royalties arising in Australia, derived by a Country Z resident who is beneficially entitled to that income, may be taxed in Australia at a rate not exceeding XX per cent of the gross amount of the royalties. Article X of the Country Z treaty defines a royalty to include 'the use of, or the right to use, any copyright, patent…trademark, or other like property or right.' It is considered that the payments made by the Payer constitute 'royalties' within the meaning of both subsection 6(1) of the ITAA 1936 and Article X of the Country Z treaty. Withholding tax will be imposed on a non-resident under subsection 128B(2B) of ITAA 1936 if the following conditions are satisfied: (a) the payments must be income; (b) the payments must be derived by a non-resident after the 1994 tax year; (c) the income must be a royalty; (d) the payment is made to the non-resident by a person; and (e) the payment is not an outgoing wholly incurred by the person who makes the payment in carrying on a business in a foreign country at or through a permanent establishment in that country. The payments made by the Payer to the foreign governments satisfy the above conditions. Section 128B(5A) of ITAA 1936 states that a person who derives royalty income is liable to pay withholding tax upon that income. Therefore, the non-resident recipients of the payments made by the Payer under the agreements would be liable to withholding tax, unless otherwise exempt. Section 12-280 of Schedule 1 to the Taxation Administration Act 1953 (the TAA 1953) imposes the obligation on the payer to withhold an amount from royalties paid to an overseas person. However, according to section 12-300 of Schedule 1 to the TAA 1953, the payer is not required to withhold an amount from a royalty if no withholding tax is payable under section 128B of the ITAA 1936 in respect of the royalty by the payee. Therefore, where the royalties paid by the Payer under the present agreements do not give rise to a withholding tax liability under section 128B of ITAA 1936, the Payer is not required to deduct withholding tax from the royalties paid. Sovereign Immunity Certain income derived from within Australia by foreign governments is exempt from Australian tax under the international law doctrine of sovereign immunity. In accordance with that doctrine, Australia accepts that any income derived by a foreign government from the performance of governmental functions within Australia is exempt from Australian tax. An activity undertaken by a foreign government will generally be accepted as being in the performance of governmental functions provided that it is a function of government, and the agency is owned and controlled by the government and does not engage in ordinary commercial activities. Interpretative Decision ATOID 2002/45: Withholding Tax: Sovereign Immunity states that for the principle of sovereign immunity to apply to interest or dividends, it is necessary to establish the following: • that the person making the investment (and therefore deriving the income) is a foreign government or an agency of a foreign government; • that the moneys being invested are and will remain government moneys; and • that the income is being derived from a non-commercial activity. If these three conditions are satisfied, then the dividend and interest income will not be subject to Australian income or withholding taxes. In the present case, the income which is derived by the foreign governments is royalty income. In relation to royalty income, the above conditions can be restated as follows: (a) that the person granting the right (and therefore deriving the income) is a foreign government or an agency of a foreign government; (b) that the rights remain government property; and (c) that the income is being derived from a non-commercial activity. In the present case, all the above conditions are satisfied. As the above three conditions are satisfied, it is considered that, in light of the doctrine of sovereign immunity, the foreign governments would be exempt from withholding tax in relation to royalties received. Accordingly, the Payer will not be required to withhold an amount under the Pay As You Go withholding provisions in terms of section 12-280 of Schedule 1 of the TAA 1953 from the royalty payments made to the foreign governments because of the operation of section 12-300 of Schedule 1 of the TAA 1953.