Private ruling: Taxation of royalties under the country x convention
Date of advice: 20 February 2018
Published: June 2018

Ruling: Q1: Is Company X, a resident of Country X, liable to pay withholding tax in respect of payments received from Company Y, under a License Agreement (‘the Agreement’) pursuant to subsection 128B(5A) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: Yes. Payments received by Company X under the Agreement are ‘royalties’ for the purposes of the double tax agreement between Australia and Country X (‘the Country X Convention’) that satisfy the requirements of subparagraph 128B(2B)(b)(i) of the ITAA 1936. | Q2: If the answer to Question 1 is in the affirmative, what is the rate of withholding applicable to royalty payments received by Company X under the Agreement? | A2: The rate of withholding applicable to royalty payments received by Company X under the Agreement is the rate prescribed in the Country X Convention.


Relevant legislative provisions: Subsection 6(1) of the ITAA 1936 | Subsection 128B(5A) of the Income Tax Assessment Act 1936 | Subparagraph 128B(2B)(b)(i) of the Income Tax Assessment Act 1936 Royalties Article of the Country X Convention | Reasons for decision | While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision. | Question 1 | 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. | Liability for 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) deals with royalties, as defined in subsection 6(1) of the ITAA 1936, and relevantly applies to income that consists of a royalty derived by a non-resident that: | ‘is paid by a resident and is not an outgoing wholly incurred by the payer in carrying on business in a foreign country at or through a permanent establishment of that person in that country (subparagraph 128B(2B)(b)(i) of the ITAA 1936)’ | Definition of ‘royalty’ | The term ‘royalty’, for the purposes of subsection 128B(5A) of the ITAA 1936, is defined in subsection 6(1) of the ITAA 1936. | In determining liability to Australian tax on foreign sourced income it is necessary to consider not only the income tax laws but also any applicable double tax agreement DTA) contained in the International Tax Agreements Act 1953 (the Agreements Act). Company X is a Country X resident for income tax purposes. It is therefore necessary to consider the definition of the term ‘royalty’ under the Country X Convention. | Where there is a conflict between the definitions of royalty for the purposes of Australia's domestic tax law and that in a particular DTA, the definition in the DTA will override the subsection 6(1) definition (subsection 3(9) of the Agreements Act. The term 'royalty' is defined in the Country X Convention in identical terms to the definition of that term under subsection 6(1) of the ITAA 1936. | Paragraph 3 of Article 12 (‘Article 12(3)’) defines ‘royalty’ to mean: | payments or credits, whether periodical or not, and however described or computed, to the extent to which they are made 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; | (b) ... | (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 such property or right as is mentioned in subparagraph (a),...or any such knowledge or information as is mentioned in subparagraph (c); or | (e) .. | Characterisation of payments involving transfer of computer software under Australia’s DTAs | The Courts and the Commissioner hold the view that ‘The Organisation for Economic Cooperation and Development Commentary (‘the Commentary’) on the Model Convention for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital may be used as extrinsic material which can assist in interpreting taxation treaties: Theil v. Federal Commissioner of Taxation (1990) 171 CLR 338; (1990) 94 ALR 647; (1990) 64 ALJR 516; (1990) 90 ATC 4717 at 4720, 4722-3 and 4727; (1990) 21 ATR 531; [1990] HCA 37 and paragraph 90 of Taxation Ruling TR 2001/13. | The Commentary on the Royalties Article in Australia’s DTAs provides that a licence to reproduce and distribute a product is the grant of a right to use the copyright in the product. In these circumstances payments made for the grant of such rights are royalties. | Characterisation of payments from Company Y to Company X under the Agreement | In accordance with guidance provided by the Commentary, in determining the character of the payments from Company Y to Company X, it is necessary to examine the nature of the rights that Company Y has acquired under the Agreement. | Company X grants to Company Y under the Agreement a licence to reproduce and distribute to end-users (customers), Company X’s product. Thereby Company X grants Company Y a right to use the copyright in the product | Further the Agreement provides that Company Y shall pay to Company X a fee per item for each item of the Company X product sold to an end user. | Payments made as consideration for the use of, or the right to use copyright are defined as ‘royalties’ under the Country X Convention. | Accordingly, payments by Company Y to Company X under the Agreement are ‘royalties for the purposes of the Country X Convention. | In conclusion, Company X is liable to pay withholding tax in respect of payments received from Company Y under the Agreement, pursuant to subsection 128B(5A) of the ITAA 1936. | Question 2 | Subsection 128B(5A) of the ITAA 1936 provides that a person who derives income to which this section applies that consists of a royalty is liable to pay income tax upon that income at the rate declared by Parliament in respect of income to which this subsection applies. | The withholding rate is 30% of the gross royalty amount. However, regulation 42 of the Taxation Administration Regulations 1976 provides at paragraph (b) that where the royalty is paid to a resident of a country with which Australia has a double tax agreement (DTA), then the rate of withholding is the rate provided for in the relevant DTA. In the present circumstances Company X, the recipient of the royalty payments from Company Y, is a resident of Country X and therefore the royalty withholding rate provided in the Country X Convention will apply. | The Royalties Article of the Country X Convention provides that the tax charged in the Contracting State where the royalties arise shall not exceed 10 per cent of the gross amount of the royalties. | As a result Company Y is required to withhold from payments made to Company X at a rate of 10% of the gross royalty payments made to Company X under the Agreement.


Relevant facts: Company X is a Country X resident company for income tax purposes. | Company X does not carry on its business at or through a permanent establishment in Australia. | Company Y is a resident company carrying on business in Australia. | Company X entered into an Agreement with Company Y. The Agreement grants a non-exclusive licence to Company Y to reproduce, distribute and transmit Company X’s product to end users. | Company Y shall pay to Company X under the Agreement, a fee for each item of Company X’s product sold. | Payments made by Company Y under the Agreement are not outgoings wholly incurred by Company Y in carrying on a business in a foreign country at or through a permanent establishment in that country.