Private ruling: Royalties
Published: November 2013
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 2012

Ruling: Questions and Answers | 1. Is the base licence fee for the licence to use, maintain, support, copy, adapt, sub-licence to customers and transfer amongst affiliated companies of all software forming part of the Core Modules considered to be 'royalties' to which section 128B of the Income Tax Assessment Act 1936 (ITAA 1936) applies? | No | 2. Is the base licence fee for the licence right for parameterisation and the Reference Parameterisation considered to be 'royalties' to which section 128B of the ITAA 1936 applies? | Yes | 3. Is the support and maintenance fee considered to be 'royalties' to which section 128B of the ITAA 1936 applies? | No

Relevant facts and circumstances: X is a company that is a tax resident of Australia. Y is a company that is a tax resident of Z and is a nonresident of Australia. Y does not carry out any business through a permanent establishment in Australia. Y is an unrelated third party of X. Y is the legal owner of certain software intellectual property. Y has entered into a Licence and Support Agreement (the Agreement) with X and members of the X group of entities to licence certain software to X so as to allow X and its group entities to use the software. The software being licenced, will consist of Core Modules. The Agreement contains the following clauses: With respect to the Core Modules the Agreement provides: · all intellectual property rights will remain with Y. · Y will issue X with a perpetual, worldwide, irrevocable, non-exclusive, royalty free licence to exercise usage rights to the software in connection with Xs business purpose. Core Modules consist of: · the Base Product: various software modules developed by Y (inclusive of certain "Open Source Software" and "Third Party Software" disclosed in the Agreement. · Reference Parameterisation: data setting/scripting provided by Y to X as an example of the Parameterisation that is able to be set in relation to the development of the software solution. Is not part of the underlying software solution itself that constitute the Base Product, · Core Module Documentation: various guides prepared by Y to facilitate the implementation of the Core Modules, · Core Module Customisation: subsequent customised additions made to the Core Modules, · Use Case Documentation: documentation describing business processes pertaining to the software, and · Optional Software Modules. In relation to Parameterisation the Agreement provides: · all intellectual property rights created (whether by Y or X) will be retained by Y. · Y will issue X with a perpetual, worldwide, irrevocable, non-exclusive royalty free licence to: o exercise usage rights; and o modify, adapt, reproduce, develop, support and maintain the Parameterisation. The licence also allows suppliers and customers of X to use the software. Customers are not permitted to install or operate their own instance of the software. The source code for the Core Modules will be held by a separate arm's length Escrow Provider. In certain circumstances, it is possible that the source code may be released by the Escrow Provider to X. The licence being provided by Y to X is an enterprise licence whereby there will be no limitations on the number of instances and location as to where the software is installed across X and its related entities. Under the terms of the Agreement, Y will also be responsible for providing ongoing maintenance and support services to X in relation to the operation of the Core Module software (excluding Parameterisation). The minimum maintenance and support service period will be Z years but may be extended by X in further Z year blocks thereafter. Y will be provided with a service and maintenance fee for the provision of the support and maintenance services. Y will receive the following base licence fees from X: 1. A base licence fee of $ for the licence of Core Module software. 2. A base licence fee of $ for the licence of the Reference Parameterisation and Parameterisation. 3. Base support fees (totaling $ over a Z year period) for ongoing support and maintenance of the software.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 128B | Income Tax Assessment Act 1936 Subsection 6(1) | Income Taxation Assessment Act 1997 Section 995-1 | International Tax Agreements Act 1953 Schedule 15-Art 12

Reasons for decision: Summary: The base licence fee for the licence to use, maintain and support, copy, adapt, sub-licence to X customers and transfer amongst affiliated companies is not considered to be 'royalties' to which section 128B of the ITAA 1936 applies. The base licence fee for the licence right for parameterisation and the Reference Parameterisation is considered to be 'royalties' to which section 128B of the ITAA 1936 applies. As such the fee will be subject to withholding tax. The support and maintenance fee is not considered to be 'royalties' to which section 128B of the ITAA 1936 applies. | Detailed Reasoning - Detailed reasoning: The term royalty is defined in section 995-1 of the Income Taxation Assessment Act 1997 (ITAA 1997) to have the meaning given by subsection 6(1) of the ITAA 1936. Subsection 6(1) of the ITAA 1936 defines 'royalty' or 'royalties' to include: 'any amount paid or credited, however described or computed, and whether the payment or credit is periodical or not, to the extent to which it is paid or credited, as the case may be, as consideration for- (a) the use of or the right to use, any copyright, patent, design or model, plan, secret formula or process, trademark, or other like property or right;… (c) the supply of scientific, technical, industrial or commercial knowledge or information; (d) the supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any property or right as is mentioned in paragraph (a), ……..or any such knowledge or information as is mentioned in paragraph (c)……' Under the Copyright Act 1968, a number of rights, including rights to reproduce (other than the making of a back-up copy), modify or adapt a computer program, are exclusive rights of the copyright owner. The copyright owner may, however, authorise another person to do what would otherwise be an infringement of copyright. Payments for the right to do acts comprised in the copyright are considered to come within paragraph (a) of the definition of 'royalty', being amounts paid as consideration for the use of, or the right to use, copyright in the computer program. The term 'copyright' is not defined in the ITAA 1936 and, for the purposes of the definition of 'royalty' in subsection 6(1) of the ITAA 1936, is taken to have the same meaning as it has under the Copyright Act 1968 . In determining whether or not a payment is for the use of copyright, it is important to distinguish between a payment for the right to use the copyright in a program and the right to use the program itself. A payment for the right to use the program itself only allows the licensee to operate or run the program on a computer. On the other hand, a payment for the right to use the copyright in a program allows the licensee to modify, adapt or copy, or otherwise do what would ordinarily be the exclusive right of the copyright owner. However, payments solely for the right to import and/or distribute the software, without any licence to use the copyright are not royalties (paragraph 20 of TR 93/12 Income tax: computer software). TR 93/12, states at paragraph 3 that a payment is considered to be a royalty for the purposes of the ITAA 1936 where the payment is: (a) consideration for the granting of a license to reproduce or modify the computer program in a manner that would, without such license, constitute an infringement of copyright (paragraph (a) of the definition of royalty). Examples include payments for the right to manufacture copies of program from a master-copy for distribution, and payments for the right to modify or adapt a program. (b) consideration for the supply of know-how (paragraph (c) of the definition of royalty). Payments for the supply of the source code or algorithms of a program are, prima facie, considered to come within this paragraph.' A right to produce, reproduce or exploit a work or other subject matter in which copyright subsists will be a payment for the use of the copyright, whether or not the right is actually used by the person paying the royalty (Taxation Ruling IT 2660). Payments for the granting of a license which allows only simple use of the software, i.e. allows the end-user to run the software on a single computer or a computer network but does not otherwise permit any use of the copyright in the program is not generally a royalty (sub-paragraph 4(b) of TR 93/12). A copy of a software program is frequently acquired under a licensing arrangement. Under these arrangements the end-user is granted a licence to use the software, i.e. to run the program and to make a back-up copy of the program. A licence is granted to use the software either on a single computer, or on a specified number of the licensee's computers or network servers. The licence may also specify that the software may only be used on the licensee's computers at certain locations (Site Licence) or may limit the number of simultaneous users. The licence also purports to limit the end-user's powers to deal with the software, e.g. it cannot be transferred or hired without the permission of the licensor. Under such licence agreements, neither copyright in the program nor property in the tangible carrying media is transferred to the end-user; the software and all copies made of it remain the property of the software manufacturer or developer (paragraph 26 of TR 93/12). Paragraphs 27 and 28 of TR 93/12 provide: 27. Payments for any licence for simple use of computer software (i.e. where the end-user acquires only the right to run the program, whether on a single computer only or on the licensee's computer network, and does not acquire any rights to use the copyright in the program) are not royalties for purposes of income tax law. It is arguable that some part of the amount paid for the acquisition of computer software under a licensing arrangement is attributable to an express or implied licence to use the copyright in the program. For example, it may be that the act of loading a program onto the hard disk of a computer would, without permission from the copyright owner, be an infringement of copyright (see Sheppard J in Damson and Ors v. Autodesk Inc and Amor (1990) 96 ALR 57 at p. 88). Although the amount attributable to such express or implied licence would strictly be a royalty, being an amount paid 'for the use of, or the right to use, any copyright' (paragraph (a) of the definition), it is accepted that the amount, if quantifiable, is likely to be minimal. For this reason, it has been decided that no apportionment of the licence fee paid in respect of the software is necessary to take account of this amount. 28. It is also accepted that, in the case of packaged software, payments for the acquisition of software under a licensing arrangement does not ordinarily involve the supply of technical knowledge or information for purposes of paragraph (c) of the definition of royalties. Where the purchaser or licensee obtains nothing more than a set of coded computer instructions, without the underlying source code, it cannot be said that knowledge or information about the program in the relevant sense of know-how has been transferred. Paragraph 29 of TR 93/12 states that payments for a licence for simple use only of computer software are not royalties, irrespective of whether the software is acquired by a distributor for sub-licensing to end-users or by end-users directly. In determining the liability to pay tax in Australia it is necessary to consider not only the domestic income tax laws but also any applicable double tax agreements. Section 5 of the International Tax Agreements Act 1953 (Agreements Act) states that, subject to the provisions of the Agreements Act, any provision in an Agreement listed in section 5 has the force of law. The tax treaty between Australia and country W is listed in section 5 of the Agreements Act. The Agreement is located on the Austlii website (www.austlii.edu.au) in the Australian Treaties Series database. An article defines 'royalties' as: The term "royalties" in this Article means payments (including credits), whether periodical or not and however described or computed, to the extent to which they are consideration for the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trade-mark, or other like property or right, or industrial, commercial or scientific equipment, or for the supply of scientific, technical, industrial or commercial knowledge or information, or any assistance of an ancillary and subsidiary nature furnished as a means of enabling the application or enjoyment of such knowledge or information or any other property or right to which this Article applies, or for the use of, or the right to use, motion picture films, films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, or for total or partial forbearance in respect of the use of a property or right referred to in this paragraph. There is no discrepancy between the definition of the word 'royalty' in the Agreement and the definition in subsection 6(1) of the ITAA 1936: See also subsection 3(8) of the Agreements Act. Generally, payments by the end-user, or by the distributor, for the simple use of software are not royalties even if the end-user also obtains the right to download the software on the end-user's own computer network or to make a back-up copy. However, payments for the right to make copies from a master-copy or payments for the right to modify the software or payments to obtain the source code are royalties. Generally, payments for services will not constitute a payment of a royalty. However, payments for services that are ancillary to or part and parcel of, enabling relevant technology, information, know-how, copyright, machinery or equipment to be transferred or used may constitute royalties. Paragraphs 43 to 46 of TR 93/12 considers contracts for the supply of software where they also provide for ongoing assistance/services and whether payments for such assistance are royalties within the meaning of subsection 6(1) of the ITAA 1936. Contracts for the supply of software sometimes also provide for certain on-going assistance, such as bug-fixing, training or maintenance. Where this occurs, it is necessary to consider whether payments for such assistance are royalties by reason of paragraph (d) of the definition in the Act (paragraph 43 TR 93/12). Paragraph (d) of the definition includes as royalties payments for the supply of assistance which is ancillary and subsidiary to, and furnished as a means of enabling the application or enjoyment of, any property, right or know-how covered by paragraphs (a) to (c) of the definition. Thus, payments for assistance relating to software are royalties within the meaning of the definition in subsection 6(1) where the assistance is subsidiary and ancillary to the right to use copyright or the supply of know-how (paragraph 44 TR 93/12). In the case of contracts for the acquisition of packaged software, where there will generally be no transfer of know-how or a right to use copyright, any assistance provided by the software house or distributor will not come within the definition (paragraph 45 TR 93/12). However, in those cases where there is a transfer of know-how or a right to use copyright in the software, it will be necessary to determine whether any payments for ancillary services are royalties. It should be noted that only those payments for assistance which relates to the supply of know-how or the right to use the copyright will be royalties. Payments for assistance which relates to the use of the software rather than the transfer of know-how or the use of the copyright will not fall within the definition in paragraph (d) (paragraph 46 TR 93/12). | Detailed Reasoning - Core Modules: Y a non-resident company, with no permanent establishment in Australia, has entered into a software licensing arrangement with an Australian resident company X. Y will only provide a simple licence to X in respect of the Core Modules. X does not have any rights to modify, adapt, or copy the Core Modules (other than to make back-up copies and exercise its usage rights); and the source code for the Core Modules will be held by a separate Escrow Provider and will only be released to X on the occurrence of certain events. While the Agreement allows X to grant rights to customers to use the software, this right does not amount to X being provided with any form of ownership rights over the software and amount to the granting at a limited sub-licence. In particular, while customers of X may use the software, the customers are not permitted to install or operate their own instance of the software. | Detailed Reasoning - Conclusion: The payments made to Y by X for the licence to use, maintain and support, copy, adapt, and the transfer amongst affiliated companies of all software forming part of the Core Modules are not 'royalties' to which section 128B of the ITAA 1936 applies. | Detailed Reasoning - Parameterisation and the Reference Parameterisation: The Agreement gives X the right to modify and adapt the Parameterisation and Reference Parameterisation, accordingly the fees payable for Parameterisation and Reference Parameterisation will be royalties and subject to withholding tax. | Detailed Reasoning - Support and maintenance fee: The definition of royalty includes "any assistance of an ancillary and subsidiary nature furnished as a means of enabling the application or enjoyment of such knowledge or information or any other property or right". However, where there is no transfer of know-how or a right to use copyright, any assistance provided by the software house or distributor will not come within the definition. Support and Maintenance is provided only for Core Modules, therefore the payments of ongoing support and maintenance fees (covering support, upgrades and new releases) are not royalties to which section 128B of the Income Tax Assessment Act 1936 applies.