Private ruling: Royalty withholding
Date of advice: 18 February 2016
Published: April 2016

Ruling: Q1: Is Company X required to withhold under section 12-280 of the Taxation Administration Act 1953 (TAA 1953) from payments made to Company Y under Agreement Z? | A1: No.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. Company Y is a resident of Country Y. Company Y is a wholesale distributor of books in both paper and electronic versions. Company Y provides various distribution services on behalf of publishers, including sale of books to retail book sellers. Company X is an Australian resident. Company Y enters into Agreement Z with Company X for sale of electronically transmitted content. Under Agreement Z Company Y grants and assigns to Company X a limited, non-exclusive, non-transferable and worldwide right and license to market, distribute and transmit electronically the content received from Company Y, to certain customers. Agreement Z provides that, except for the limited license granted therein to Company X, the publishers dealing with Company Y are, the sole owners of copyright in all electronically transmitted content. All rights, title and interest in any modifications by Company X to the transmitted content, permitted under the Agreement, shall be solely owned by the publishers concerned. Agreement Z quotes the price payable by Company X for the content received from Company Y. Company X will download the transmitted content for onward transmission to a customer. Company X incurs a liability owing to Company Y, i.e., the price payable under Agreement Z for the content received from Company Y, soon as Company X makes a sale by transmitting that content to a customer. The payments under Agreement Z are not incurred by Company X in carrying on a business through an overseas PE. Company X monitors the transmitted content sold to customers for copyright infringement or other unauthorised use by customers. If breach of copyright or unauthorised use of the content by customers is detected, Company X will promptly inform Company Y of such occurrences. Assumptions Company Y does not carry on business through a permanent establishment in Australia.

Relevant legislative provisions: Section 12-280 of Schedule 1 to the Taxation Administration Act 1953 | Section 12-300 of Schedule 1 to the Taxation Administration Act 1953 | Section 6(1) of the Income Tax Assessment Act 1936 | Subsection 128B(2B) of the Income Tax Assessment Act 1936 | Subsection 128B(5A) of the Income Tax Assessment Act 1936 | Subsection 3(9), International Tax Agreements Act 1953 | Royalty Article of the Country Y Convention | Section 31 of the Copyright Act 1968

Reasons for decision: Summary: The payment by Company X to Company Y cannot be characterised as consideration for the assignment of copyright in the electronically transmitted content or a payment for the right to exploit the copyright subsequent to acquisition of the transmitted content. Accordingly, the payment does not constitute a royalty in the hands of Company Y for the purposes of the Royalty Article of the tax treaty between Australia and Country Y, the Country Y Convention. Accordingly, Company Y is not liable to royalty withholding tax, pursuant to subsection 128B(5A) of the ITAA 1936, in respect of payments received from Company X under Agreement Z. Consequently, pursuant to section 12-300 of Schedule 1 to the TAA, Company X is not required to withhold from payments it makes to Company Y under Agreement Z. | Detailed Reasoning - PAYG Withholding: Section 12-280 of Schedule 1 to the Taxation Administration Act 1953 (TAA) provides that a resident entity that pays an amount that is a royalty must withhold an amount from the payment if the recipient has an address outside Australia according to the payer's records or if the payer is authorised to pay the royalty outside Australia. However, pursuant to section 12-300 of Schedule 1 to the TAA, no withholding is required if withholding tax is not payable in respect of a payment of royalty. | Detailed Reasoning - Royalty withholding tax: A person is liable under subsection 128B(5A) of the Income Tax Assessment Act 1936 (ITAA 1936) to pay withholding tax if they derive 'income' that consists of a royalty, and the requirements of subsections 128B(2B) or (2C) of the ITAA 1936 are satisfied in relation to that income. Subsection 128B(2B) applies to income that consists of a royalty derived by a non-resident that is, among others, paid by a resident and is not an outgoing wholly incurred by the payer in carrying on a business through a permanent establishment in a foreign country. The term 'royalties' for the purposes of subsection 128B(5A) and section 12-300 of the ITAA 1936 is defined in section 6(1) of the ITAA 1936. The definition of "royalty" or "royalties" in subsection 6(1) of the ITAA 1936 lists certain types of payments that are to be treated as royalties for purposes of the Income Tax Assessment Act. The definition is inclusive. The term "royalty" is also defined in Australia's double tax agreements broadly in similar terms to the subsection 6(1) definition, except that the list of payments which are defined as royalties is intended to be exhaustive. Where there is a conflict between the definitions of royalties for the purposes of Australia's domestic tax law and that in a particular double tax agreement, the definition in the relevant double tax agreement will override subsection 6(1) of the ITAA 1936 (subsection 3(9) of the International Tax Agreements Act 1953 ). Company Y is a Country Y resident for income tax purposes. It is therefore necessary to consider the definition of the term 'royalty' under the Country Y Convention. | Detailed Reasoning - Definition of 'royalty': The term 'royalty' is defined in the Royalty Article of the Country Y Convention in identical terms to the definition of that term under subsection 6(1) of the ITAA 1936. | Detailed Reasoning - Paragraph (a) of the Royalty Article defines 'royalty' to mean:: 'payments or credits of any kind to the extent to which they are consideration for the use of or the right to use any: (i) copyright, patent, design or model, plan secret formula or process, trademark or other like property or right; (ii) motion picture firms; or (iii) films or audio or video tapes or disks, or any other means of image or sound reproduction or transmission for use in connection with television, radio or other broadcasting'. | Detailed Reasoning - Paragraph (b) defines 'royalty' to mean:: 'payments or credits of any kind to the extent to which they are consideration for: (i) the supply of scientific, technical, industrial or commercial knowledge or information owned by any person; (ii) supply of any assistance of an ancillary and subsidiary nature furnished as a means of enabling the application or enjoyment of knowledge or information referred to in sub-paragraph (b)(i) or of any other property or right to which this Article applies; or (iii) a total or partial forbearance in respect of the use or supply of any property or right described in this paragraph'. Since the definition of royalties applies to 'payments for' any of the various items listed in that definition, it is necessary to carefully construe the terms of the agreement between the parties concerned and characterise the consideration by reference to the substance of the agreement. | Detailed Reasoning - Copyright: Intellectual property rights such as 'copyright' are a form of personal property, being in the nature of exclusive rights to use or prohibit others from using the underlying invention or work. Section 31 of the Copyright Act 1968 (the Copyright Act) defines copyright as the exclusive right in the case of a literary, dramatic, artistic or musical work, to do among others, the following acts: (i) to reproduce the work in a material form; (ii) to publish the work; (iii) to cause the work to be transmitted to subscribers to a diffusion service; or (vi) to make an adaptation of the work Assignment of copyright Taxation Ruling TR 2008/7 (TR 2008/7) entitled ' Income Tax: royalty withholding tax and the assignment of copyright' considers whether a payment for assignment of copyright is subject to royalty withholding tax under section 128B of the ITAA 1936. Paragraphs 82 and 83 of TR 2008/7 point out that under intellectual property law an assignment of copyright is different to grant of a licence over copyright. To the extent of an assignment, all of the owners' property rights are transferred to the assignee, including the right to take legal action against any third party who infringes the copyright. By contrast, when a copyright holder grants a licence, even an exclusive licence, the licensor retains a right to sue third parties for infringements. In contrast, to the extent that copyright is assigned the assignor is no longer the owner of the copyright and therefore cannot continue to exploit it. Outright sale of copyright Further, in light of the definition of 'royalties', TR 2008/7, at paragraphs 12 and 14, distinguishes between a payment for the sale of property consisting of the copyright and a payment for the use of, or the right to use, the copyright in that property. Consideration for an outright sale of property consisting of copyright is generally not a royalty. | Detailed Reasoning - Substance of the arrangement in Agreement Z: In the present circumstances, under Agreement Z, Company X is assigned a limited, non-exclusive, non-transferable right and license to market and distribute electronically, and sell transmitted content to end users. As stated in paragraphs 82 and 83 of TR 2008/7, the grant of a non-exclusive licence to deal with property, such as Digital Content in the present circumstances, does not amount to an assignment of copyright in that property. The issue to be determined is therefore, whether, in light of the definition of the term 'royalties' in the Country Y Convention, and having regard to the terms of Agreement Z, whether the payment by Company X is to be regarded as a payment merely for the acquisition of electronically transmitted content, or includes a payment for the use of, or the right to use, the copyright in the transmitted content. | Detailed Reasoning - Payments for download of digital content: The characterisation of payments made for transactions which permit electronic download of digital content in the nature of images, sounds or text is addressed in the OECD Model Convention on Income and Capital ('OECD Commentary'). The OECD Commentary Taxation Ruling TR 2001/13, Income tax: Interpreting Australia's Double Tax Agreements serves as a guide in interpreting Australia's double tax agreements (DTAs). TR 2001/13 provides at paragraphs 104 that, the OECD commentaries, provides important guidance on interpretation and application of the OECD Model and as a matter of practice will often need to be considered in the interpretation of DTAs. In particular, paragraph 108 provides that the Commissioner considers it appropriate, as a matter of practice, to consider, at least, the most recently adopted/published OECD as well as others which may have been available at the time of negotiation of the treaty under consideration. Often, if a DTA provision is to be fully understood, the changes that have occurred to the relevant OECD Commentaries over time will need to be examined and considered. In the present circumstances, the OECD (2015) 'Commentary on Article 12: Concerning the Taxation of Royalties', in Model Tax Convention on Income and on Capital 2014 (Full Version) , ('the Commentary') is relied upon for guidance in interpreting the application of Article 12 of the Country Y Convention to payments made by Company X to Company Y under Agreement Z. Paragraphs 17.1 to 17.4 of the Commentary which deal with payments involving transfers of Digital Products are summarised as follows: Digital products 'Transactions which permit the customer (which may be an enterprise) to electronically download digital products (such as images, sounds or text) for that customer's own use can give rise to use of copyright by the customer under the relevant legislation of some countries. This occurs where the contract grants the customer a right to make one or more copies of the digital content. However, if the payment by the customer in these transactions is essentially for the acquisition of data transmitted in the form of a digital signal, the determining factor for the purposes of the definition of royalties, such copying is merely the means by which the digital signal is captured and stored rather than use of copyright. Therefore the payments do not constitute royalties. By contrast, transactions where payment is made for the granting of the right to use a copyright in a digital product that is electronically downloaded for that purpose will give rise to royalties. This would be the case, for example, of a book publisher who would pay to acquire the right to reproduce a copyrighted picture that it would electronically down load for the purposes of including it on the cover of a book that it is producing. In this transaction, the essential consideration for the payment is the acquisition of rights to use the copyright in the digital product, i.e. the right to reproduce and distribute the picture, and not merely for the acquisition of the digital content'. | Detailed Reasoning - Are payments by Company X to Company Y under Agreement Z, 'royalties'?: On behalf of publishers, Company Y provides electronically transmitted content to Company X. Company X acquires the content for resale by transmission to its customers. This requires Company X to download the content for electronic transmission to the customers. Under Agreement Z, the publishers that deal with Company Y are the sole copyright holders that maintain all rights to the copyright in the transmitted content acquired by Company X. Further, pursuant to Agreement Z, all rights, title and interest in any modifications by Company X to the transmitted content, permitted under the Agreement, shall be solely owned by the publishers concerned. On the sale of the content by transmission to customers, Company X makes a corresponding payment to Company Y being the purchase price of the content under Agreement Z. Due to the limited, non-exclusive, license granted under the Agreement to distribute the transmitted content, Company X is unable to sue its customers for unauthorised downloading or copyright infringement other than to monitor such occurrences and promptly notify Company Y if such an act occurs. In light of the above, it is considered that a payment representing the purchase price by Company X to Company Y is essentially for the acquisition of the transmitted content. As the payment by Company X to Company Y cannot be characterised as consideration for the assignment of copyright in the transmitted content or a payment for the right to exploit the copyright subsequent to acquisition of the content from Company Y, the payment does not constitute a royalty in the hands of Company Y for the purposes of the Royalty Article of the Country Y Convention. Accordingly, Company Y is not liable to royalty withholding tax, pursuant to subsection 128B(5A) of the ITAA 1936, in respect of payments received from Company X under Agreement Z. Consequently, pursuant to section 12-300 of Schedule 1 to the TAA, Company X is not required withhold from payments it makes to Company X under the Agreement Z.