Private ruling: License of Intellectual Property
Date of advice: 24 April 2020
Published: June 2020
Ruling period: 1 January 20XX to 31 December 20XX
Date scheme commenced: XX XXXX 20XX

Ruling: Q1: Does Article 12(2) of the Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 Australia ( UK DTA ) apply to limit the Australian withholding tax under the License Agreement to 5 percent of the gross amount of the royalties? | A1: Yes | Q2: Does Article 12(6) of the UK DTA apply to any part of the royalties under the License Agreement? | A2: No | Q3: Does Article 7 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting [2019] ATS 1 (MLI) as applicable to the UK Treaty apply to any part of the royalties under the License Agreement? | A3: No

Relevant facts and circumstances: 1. The X Group is headquartered in the Country A. 2. The Head Company of the X Group is a Country A incorporated and tax resident. 3. The X Group entered into contractual arrangements with an Australian Group. 4. The contractual arrangements between the X Group and the Australian Group are governed by a number of legal agreements including services and Licence Agreements. 5. Under the License Agreement, the X Group grants the Australian Group a non-exclusive, non-transferrable license to use the IP of the X Group, which is owned by one of its subsidiary companies (IP Co). 6. The Australian Group is permitted to use the licensed IP for certain purposes and not for any other purpose. 7. The Australian Group must pay IP Co royalties as specified in the Licence Agreement. 8. All royalties that are subject to Australian withholding tax shall be grossed up so that the net amounts received by IP Co after withholding tax deduction shall equal the amounts to which IP Co would otherwise have received if no tax was payable. The gross-up is limited to 5% withholding tax.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 128B(2B) | Income Tax Assessment Act 1936 section 177D | Income Tax Assessment Act 1936 paragraph 177DA(1)(b) | Income Tax Assessment Act 1936 paragraph 177J(1)(b) | International Tax Agreements Act 1953 subsection 4(2) | International Tax Agreements Act 1953 subsection 17A Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 Australia Article 12 | Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting [2019] ATS 1 Article 7

Reasons for decision: Summary: Article 12(2) of the Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 Australia ( UK DTA ) applies to limit the Australian withholding tax under the License Agreement to 5 percent of the gross amount of the royalties. | Detailed Reasoning - Detailed reasoning: Royalties: Legislative Framework Under Australian domestic tax law income that consists of a royalty is subject to withholding tax where it is paid by a resident to a non-resident, except where it is wholly incurred by the payer in carrying on business outside Australia at or through a permanent establishment (subsection 128B(2B) of the Income Tax Assessment Act 1936 (ITAA 1936)). The provisions of subsection 128B(2B) are modified by the International Tax Agreements Act 1953 ( Agreements Act ). Relevantly: · subsection 17A(1) limits the amount of domestic withholding tax on 'royalties' to 5 percent as set out in Article 12(2) of the UK DTA, · subsections 17A(4) and (5) limit the scope of the domestic definition of 'royalties' to the scope of the definition of 'royalties' in Article 12(3) of the UK DTA, and · subsection 4(2) gives primacy to the definition of 'royalties' in Article 12(3) of the UK DTA in the event of possible inconsistency or conflict, Therefore, the definition of 'royalties' in Article 12(3) of the UK DTA is the definition that applies for the purpose of determining the extent to which the UK DTA limits the operation of section 128B of the ITAA 1936. Royalties: Article 12(3) of the UK DTA Article 12(3) of the UK DTA relevantly provides as follows: The term 'royalties' in this Article means 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) the supply of scientific, technical, industrial or commercial knowledge or information; (c) the supply of any ancillary and subsidiary assistance that is furnished as a means of enabling the application or enjoyment of any such item as is mentioned in subparagraph (a) or (b) of this paragraph; (d) the use of or the right to use: (i) motion picture films; or (ii) 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; or (e) total or partial forbearance in respect of the use or supply of any property or right referred to in this paragraph. Payments for services are not royalties unless they fall within subparagraph (c) of the definition above, being ancillary to the application or enjoyment of the relevant right or information. In the present case, the X Group grants the Australian Group a non-exclusive, non-transferrable license to use the X Group's IP that is owned by its subsidiary IP Co pursuant to the Licence Agreement. The X Group IP was created by the X Group in Country A and was in existence before the Licence Agreement was entered into. The Australian Group is only permitted to use the licensed IP for specific purposes and the scope of use is well defined under the Licence Agreement. The legal ownership of the IP remains with the X Group at all times. The Australian Group must pay IP Co royalties according to the Licence Agreement. In addition to this licence arrangement, the services performed by the X Group are separately priced under various services contracts. Accordingly, it is considered that the royalties payable by the Australian Group to IP Co pursuant to the Licence Agreement represent consideration for the use of the X Group IP. These payments are therefore royalties under Article 12(3)(a) for the purposes of the UK DTA. It is noted that in Taxation Ruling TR 2004/17 Income tax: indemnification of royalty withholding tax , the Commissioner considers that the recipient of a royalty payment, whose royalty withholding tax liability is indemnified by another person, and the relevant indemnity amount can be said to be consideration for the use of any copyright, etcetera, then the indemnity amount will also be a royalty. Consequently, the gross-up amount payable by the Australian Group under clause 6.2(d) of the Licence Agreement will also be treated as a royalty. | Summary: Article 12(6) of the UK DTA does not apply to any part of the royalties under the License Agreement. | Detailed Reasoning - Detailed reasoning: Article 12 of the UK DTA allocates taxing rights in respect of royalties paid or credited between residents of Australia and Country A, and allows both countries to tax royalties but limits the tax of the country of source to 5% of the gross amount of royalties beneficially owned by residents of the other country. However, where a special relationship exists between the payer and the beneficial owner of the royalties, the 5% limitation on source country tax will apply only to the extent that the royalties are not excessive. In this regard, Article 12(6) of the UK DTA states: Where, by reason of a special relationship between the payer and the beneficial owner of the royalties, or between both of them and some other person, the amount of the royalties paid or credited exceeds, for whatever reason, the amount which might reasonably have been expected to have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess paid or credited shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention. The term 'special relationship' is not defined in the UK DTA; however, the Explanatory Memorandum (EM) to the International Tax Agreements Amendment Bill 2003 (which gives the force of law in Australia to the UK Treaty) provides examples of where a special relationship might exist: 1.144 Examples of cases where a special relationship might exist include payments to a person (either individual or legal): · who controls the payer (whether directly or indirectly); · who is controlled by the payer; or · who is subordinate to a group having common interests with the payer. In the present case, although the Australian Group has an equity interest of less than 5% in Head Co, it is evident that the Australian Group neither possesses effective control over any of the X Group nor has any other relationship with any other entities within the Group. The negotiation between the Australian Group and the X Group were led by senior technical and commercial executives from each group respectively, and it is considered that the contract arrangements were the outcome of real bargaining and commercial negotiations between two independent parties dealing with each other at arm's length. Therefore, it is considered that there is no special relationship between the Australian Group and IP Co, and Article 12(6) will not apply. | Summary: Article 7 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting [2019] ATS 1 (MLI) as applicable to the UK Treaty does not apply to any part of the royalties under the License Agreement. | Detailed Reasoning - Detailed reasoning: Article 7 of the MLI seeks to address treaty abuse and it applies what is often referred to as the principal purposes test ( PPT ) to Covered Tax Agreements (CTAs). Both Australia and Country A have chosen to adopt the PPT in the UK DTA. More specifically, Article 7(1) provides that a treaty benefit will not be granted where it is reasonable to conclude, having regard to all relevant facts and circumstances that: · one of the principal purposes of an arrangement or transaction was to obtain the benefit (directly or indirectly), and · granting such a benefit in the circumstances would not accord with the object and purpose of the provisions of the CTA. Benefits to which the PPT may apply In the present case, the reduced royalty withholding tax rate under the UK DTA could be considered a "benefit" to which the PPT could apply. PPT Broadly, the PPT seeks to distinguish genuine commercial arrangements whose use of the CTA is consistent with the object of the treaty, from arrangements used to secure treaty benefits by a means that amounts to an improper use of the treaty, or treaty abuse. Thus the PPT will not operate to deny a benefit if granting that benefit in the relevant circumstances would be in accordance with the object and purpose of the CTA 'Principal' is not defined in the MLI, although there is some guidance, including paragraph 177DA(1)(b), paragraph 177J(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936), and the OECD Base Erosion Profit Shifting (BEPS) work on Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (OECD Report on Action 6). Importantly, the PPT has a lower threshold test than the 'sole or dominant' purpose test in the existing section 177D of the ITAA 1936 and it needs to be established objectively. In the present case, the following factors are relevant: · the X Group is primarily a Country A based group with its core management, key technical, engineering and R&D teams residing in Country A. It had no foreign subsidiaries, operations or foreign-based employees prior to the Australian Group transaction. · There are no entities involved in the transaction apart from Country A and Australian resident entities. These entities have not been established in these countries just for the purpose of obtaining access to the UK DTA, but have existing commercial reasons for their tax residency. · The arrangement is necessary to achieve the intended commercial objectives of both the Australian Group and the X Group, and the establishment of all entities in the X Group is commercially justifiable. · The Licence Agreement is part of a broader commercial arrangement, which has been negotiated and agreed upon by independent parties dealing with each other at arm's length. · The arrangement does not involve the transfer or assignment of any X Group intellectual property. The Australian Group contracted directly with IP Co, which removes the complication for the X Group intellectual properties to be sub-licensed to another X Group entity. · The arrangement does not involve a change in the character of payments or a mischaracterisation of payments. · There appears to be no discrepancy between the substance of what is achieved under the licensing arrangement and the legal form of the arrangement. · The arrangement does not involve the use of hybrid entities or instruments. Based on the detailed commercial and contractual arrangements between the Australian Group and the X Group, it is considered that Article 7 of the MLI as applicable to the UK Treaty will not apply to any part of the payments made under the Licence Agreement between the parties.