Taxation Ruling TR 2004/17



Ruling: 22. A person whose RWT liability is indemnified by another person will be liable to pay RWT on the indemnity amount to the extent that the indemnity amount is paid or credited as consideration for any of the matters listed in paragraphs (a) to (f) of the royalty definition in subsection 6(1) of the ITAA 1936. 23. Where an indemnity amount can properly be said to be 'consideration' for any of the listed matters it will be a royalty within the subsection 6(1) definition. In each case this will depend upon the proper construction of the agreement under which the indemnity is given. 24. Where the agreement contains an indemnity clause of the kind set out in paragraph 11 and, pursuant to that clause, an amount is paid or credited that is properly attributable to the grant of a right that satisfies the definition of royalty in subsection 6(1) (such as the right in the example in paragraph 10), the amount so paid or credited will itself be a royalty. 25. If, upon a proper construction of the agreement, the indemnity amount is found to be paid as consideration for a matter not falling within the subsection 6(1) definition, it will not be a royalty and will not be subject to RWT. | The Commissioner's view: 26. The Commissioner's view is that a person who is indemnified for a RWT liability where some or all of the indemnity is itself consideration paid or credited for any matter answering the description in paragraphs (a) to (f) of the royalty definition (subsection 6(1) of the ITAA 1936) will, to that extent, be liable for RWT on the indemnity amount. The indemnity amount in that situation will itself be a royalty. 27. Whether the indemnity amount is such 'consideration' will in each case be a question of construction of the agreement under which the indemnity was paid. | Royalty definition: 28. Royalty is defined in subsection 6(1) of the ITAA 1936 beginning as follows: 29. The definition is inclusive. Payments or credits that are 'royalties' within the ordinary meaning of that term come within its scope. So too do the types of payments or credits listed in paragraphs (a) to (f) of the subsection. [7] 30. The definition makes it clear that an amount that is not a royalty within the ordinary meaning of 'royalty' may yet answer the description in subsection 6(1), no matter how the amount is described or computed and whether it is paid or credited periodically or not, where it is paid or credited 'as consideration for' a matter listed in the definition. | However described or computed: 31. The form of a payment or credit and the way in which it is computed will not be conclusive in determining whether or not it is a royalty under the definition; nor will the description given to it in any agreement between the parties. [8] 32. If, having regard to the substance of the contract, a payment or credit falls within the scope of the definition, it will be a royalty whether it is paid in a lump sum or periodically. Unlike the ordinary meaning of royalty, it is not necessary for the payment or credit to be calculated by reference to the degree of use of the property, right or know-how. For example, in the case of a film, it will be a royalty whether it represents an amount calculated by reference to each showing, a lump sum to cover an agreed number of showings or is a share of the gross or net takings for exhibition of the film. [9] 33. It follows also that RWT indemnity amounts are not precluded from being a royalty merely because they are described as an 'indemnity of tax' or similar. 34. In addition, the definition makes it clear that it is not important how the amount is computed and so the fact that a RWT indemnity amount is calculated by reference to withholding tax does not preclude it from being a royalty. | Periodical: 35. The subsection 6(1) definition of royalty makes it clear that the payment or credit need not be periodical. It can be a one-off payment or credit. | As consideration for: 36. To the extent that an amount is paid or credited as consideration for any matter listed in paragraphs (a) to (f) of the subsection 6(1) definition, it will be a royalty. An RWT indemnity amount so paid or credited will thus be a royalty. 37. Whether a particular amount is so paid or credited is a question of fact [10] and will depend in each case on a proper construction of the agreement under which it was given, that is, whether it constitutes any part of the price of obtaining or securing one or other of the listed matters. 38. Consideration has been defined as the act or promise offered by the one party and accepted by the other as the price of that other's promise. [11] 39. Valuable consideration was defined in Currie v. Misa (1875) LR 10 Exch 153 at 162 as: 40. The indemnification of RWT is thus capable of being 'consideration' or 'consideration paid or credited'. | The use of, or the right to use: 41. Some of the listed matters are described in terms of 'the use of, or the right to use' various items of property, such as copyright, patent, design, equipment, visual images or sounds, spectrum etc. The question thus arises whether an RWT indemnification can be properly regarded as consideration 'for the use of or the right to use' property. 42. In Commissioner of Stamp Duties (N.S.W .) v. J.V . ( Crows Nest) Pty Ltd (1986) 7 NSWLR 529; 86 ATC 4740; (1986) 17 ATR 1086 the question was whether a franchisee's covenant to pay the franchisor a service fee was consideration 'for the use of property' (goodwill being the property in that case) and thus 'rent' within the extended definition of that term in the Stamp Duties Act 1920 (NSW). McHugh JA (with whom Samuels JA agreed) said in relation to the modern meaning of 'rent': [12] 43. His Honour's comments support the proposition that where the user under an agreement for the use of property has an obligation to indemnify or reimburse the owner for a liability that would otherwise fall on the owner, the obligation is not, by reason alone of the indemnity or reimbursement, precluded from being 'consideration for the use of the property'. The same reasoning, in the Commissioner's view, applies to an obligation to indemnify a RWT liability. [13] 44. In David Securities Pty Ltd and Others v. Commonwealth Bank of Australia (1992) 175 CLR 353; (1992); 92 ATC 4658; (1992) 24 ATR 125 the High Court considered the claim by borrowers for restitution of certain moneys that they had paid to a bank under the 'grossing up' clause of a loan agreement. 45. The clause required the borrowers' interest payments to include an additional amount which ensured that the net amount received by the bank would not be reduced by the interest withholding tax the borrowers might be required to deduct. The borrowers alleged that they paid over the additional amounts in the mistaken belief that the statutory liability for withholding tax was theirs and not the bank's. 46. Mason CJ, Dean, Toohey, Gaudron and McHugh JJ of the majority commented in a joint judgement that the loan agreement was such that it was severable into its relevant parts and the consideration could be 'broken up' or apportioned; various obligations of the one party could be related to the consideration given by the other. [14] 47. The Court found on the facts that the borrowers had no indebtedness in respect of withholding tax, the discharge of which could form consideration for the moneys they paid. The payments were therefore not made for good consideration. [15] 48. Notwithstanding the particular factual finding, the case is authority for the principle that the severability or otherwise of an agreement into its relevant parts will be relevant in identifying or apportioning the consideration given for particular contractual obligations. [16] In the case of an agreement to indemnify RWT that principle will be relevant in deciding whether the indemnity obligation is consideration for any of the matters answering the description in section 6(1), that is, whether the indemnity fits the description of 'royalty'. 49. In Commissioner of State Revenue (Vic) v. Royal and Sun Alliance Insurance Australia Ltd [17] the Supreme Court of Victoria, Court of Appeal, considered whether the amount representing the goods and services tax (GST) payable by an insurer on the insurance policies it issued, and which amount it on-charged to the insured, should be treated as part of 'premiums' and 'gross premiums' for the purposes of the relevant part of the Stamps Act 1958 (Vic). 50. The word 'premium' as it appeared in the context of that Act bore in the Court's view its ordinary meaning which was 'the consideration, usually in the form of a monetary obligation, paid or payable by the insured for the grant or renewal of insurance cover or of other rights under a policy of insurance'. 'Gross premiums' referred to the total of all such sums received. 51. The Court held that notwithstanding that the insurer had charged a separate amount for GST, and separately designated it in the actual policies, the amount did form part of the 'premium' or 'gross premiums' for the purposes of the Stamps Act 1958 . That is, the GST 'reimbursement' was consideration of the kind described in the definition. 52. In reaching its conclusion the Court per Ormiston JA observed that: 53. A contrasting case is Aktiebolaget Volvo v. Federal Commissioner of Taxation [19] concerning payments made by an Australian resident company, Volvo Australia Pty Ltd ('Volvo Australia'), to its non-resident parent under an agreement made in 1972. The payments were made in consideration for the parent forbearing from supplying certain products to any person or corporation in Australia other than Volvo Australia itself. 54. The Commissioner included these payments as 'royalties' in the parent company's assessable income for the years ended 30 June 1974 to 1976 inclusive. One of the Commissioner's contentions was that the payments fell within the ordinary meaning of that term. The Commissioner argued that the payments were made in consideration of the grant of a right to the goodwill that the parent company had in Australia, particularly in the word 'Volvo' and associated symbols, and the rights which interdiction of competition in the exploitation of a licence to sell Volvo products in Australia would confer. 55. The Supreme Court of Victoria rejected the argument, pointing out that there was nothing in the agreement itself which conferred rights in goodwill - notwithstanding that the agreement may have rendered more valuable whatever of the goodwill the Australian subsidiary had or might acquire - and the payments were not made in consideration of the grant of any such right. 56. The cases illustrate that each agreement for the indemnity of RWT must be considered on its own facts and it is a matter of construction of the contract in each instance whether an indemnity amount can be related to a matter that answers the description in the subsection 6(1) definition. 57. Similarly, an indemnity amount may be paid or credited under an agreement other than the one under which the royalty that was paid or credited gave rise to the initial RWT liability. For example, X may have a RWT liability arising out of a copyright licence agreement with Y which, under a separate agreement, Y agrees to indemnify as partial consideration for X giving Y the use of a trade-mark. Again, the indemnity is given as consideration for the use of property. 58. On the other hand if Y indemnifies X's RWT liability as consideration for X giving Y the right to renew a royalty agreement with X there will be no RWT on the indemnification amount. [20] This is because such right is not a right of the kind listed in the royalty definition and does not otherwise answer the description of any of the matters listed. [21] 59. As a further example, a contract for the lease of certain equipment might contain the clauses in paragraphs 10 and 11. Upon a proper construction of the contract an amount paid by the lessee pursuant to the clause in paragraph 11 is found to be in substance part of the consideration for, and solely for, the lessor granting the lease. The payment in that case is a royalty notwithstanding the amount is described in the clause as the payment of withholding tax. | To the extent: 60. The subsection 6(1) definition allows apportionment of amounts in the sense that it makes an amount a royalty to the extent to which it is paid or credited as consideration for the matters listed in paragraphs (a) to (f) of the definition. In some instances, an agreement under which a RWT indemnification is paid or credited may be a 'divisible contract', which is separable into parts so that different parts of the consideration may be assigned to severable parts of the performance, for example, an agreement for payment pro rata. [22] Whether an obligation to pay or credit a RWT indemnification amount is divisible from other obligations under the agreement is a question of construction (the process by which a Court determines the meaning and legal effect of a contract). [23] | The CYB case distinguished: 61. In CYB the question on appeal before the Court was the 'proper characterisation', for IWT purposes, of the amounts by which the borrower was required to 'gross-up' on account of withholding tax the interest payments it made to the lender. [24] 62. To be subject to IWT those amounts had to be characterised as 'interest' within the meaning of subsection 128A(1). That subsection defined interest as, 'interest includes an amount in the nature of interest, not being an amount referred to in subsection 26C(1)'. [25] 'Interest', the Court said, bore its ordinary meaning, which was 'the return, consideration, or compensation for the use or retention by one person of a sum of money belonging to, or owed to, another, and that interest must be referable to a principal'. [26] 63. The Court, quoting the primary judge, agreed that the amounts in question 'do not have the character of a return or profit to the lender for the use of money advanced to the borrower, howsoever calculated or ascertained', and that the indemnification amounts were neither 'interest' nor 'in the nature of interest'. 64. In the words of the primary judge, Cooper J: [27] 65. It is the Commissioner's view that the CYB decision is distinguishable from and not applicable to the RWT indemnification question in that for the indemnification amount to have been 'interest' it had to be more than simply consideration for the use of the loan monies; it also had to have the character of interest and be referable to the principal sum borrowed. In the case of an RWT amount no such additional qualification is necessary; the amount merely needs to be consideration for one or other of the matters listed in subsection 6(1). 66. In the example at paragraph 59 the indemnification of RWT is found to be part of the consideration (the price) for the lessee obtaining the lease of the equipment. That quality is sufficient in our view for the indemnification amount to be a 'royalty'. | Conclusion: 67. For the reasons given, it is the Commissioner's view that an indemnification of RWT will be a royalty in terms of the definition of royalty contained in subsection 6(1) if and to the extent to which, on a proper construction of the agreement under which it is paid or credited, it is paid or credited as consideration for any of the matters listed in paragraphs (a) to (f) of the definition of royalty in subsection 6(1). | Gross up: 68. Based on the Commissioner's approach, where: the total RWT on both the initial royalty and indemnification amount is calculated as: the RWT on the indemnification amount alone is calculated as: | Deductibility: 69. RWT indemnification amount is deductible to the person paying or crediting it to the extent that the requirements of deductibility under section 8-1 of the ITAA 1997 or 51(1) of the ITAA 1936 are satisfied and section 26-25 of the ITAA 1997 or section 221YRA of the ITAA 1936 does not apply. 70. The alternative view is that RWT indemnification payments are not royalties. This view relies on three arguments. The first argument is that the Commissioner's view, expressed herein, is inconsistent with the decision in CYB. However, as indicated earlier, CYB is distinguishable because the subsection 6(1) definition of royalty is not confined in the way interest was held to be in the CYB case. The definition of royalty is wide enough to include consideration paid or credited by way of the indemnification of tax for the matters listed in paragraphs (a) to (f) of subsection 6(1). 71. The second argument is that the RWT indemnification amount is not calculated by reference to the rights bargained for under the contract and so cannot be paid as consideration for those rights; rather it is calculated by reference to the royalty withholding tax. The manner of computation of the indemnity, this argument goes, was a factor for the Court in CYB in finding against the Commissioner. Against this, the Commissioner would distinguish CYB, again on the grounds that unlike 'interest' an amount may be a royalty under subsection 6(1) no matter how it is computed. 72. Finally, it is said that if the parties describe the amount as an RWT indemnification, then the amount is an indemnification of tax and not an amount paid as consideration for the rights under the agreement. However, as explained earlier, the description given to an amount is not conclusive of its characterisation as a royalty under subsection 6(1) and therefore that description does not preclude it from being a royalty.

Examples: Example 1: 73. Ausco, a company resident in Australia, has a contract with Japanco, a company resident in Japan, under which it pays royalties to Japanco for the use of copyright. The royalty payment is $10 million per year. The contract includes an indemnification of royalty withholding tax clause under which Ausco agrees to indemnify Japanco for any royalty withholding tax so that Japanco is to receive the $10m net of Australian RWT. 74. Under article 9(1) of the Japanese Agreement, Australia can tax the royalty [28] but the tax so charged is not to exceed 10% of the gross amount of the royalty. Australia exercises its taxing right. [29] Thus Japanco has a liability to pay [30] and Ausco a requirement to withhold [31] the following RWT amount: RWT = 10% * (1/(1-1/10)) * $10m RWT = $1.111m 75. Of this amount, the RWT on the indemnification amount itself is: 10% * (0.1/0.9) * $10m = $0.111m | Example 2: 76. The situation is the same as in example 1 except that Japanco is a resident of Hong Kong. The RWT rate is 30%. [32] Japanco has a liability to pay and Ausco a requirement to withhold the following RWT amount: RWT = 30% * (1/(1-3/10)) * $10m RWT = $4.286m 77. Of this amount, the RWT on the indemnification amount itself is: 30% * (0.3/0.7) * $10m = $1.286m 78. In subsection 6(1) of the ITAA 1936 'royalty' or 'royalties' is defined as follows: 79. Below is a detailed contents list for this draft Taxation Ruling: Commissioner of Taxation 15 December 2004 Subsection 17A(5) of the International Tax Agreements Act 1953 provides: In Crows Nest , however, McHugh JA did not accept Olney J's view. Referring at NSWLR 539; ATC 4747; ATR 1095 to the Yanchep case, McHugh JA said he understood Olney J to mean that 'if a payment by the lessee was directed to indemnifying a liability of the lessor, it was not a right to use property' and then said: 'The distinction which His Honour appears to make does not seem satisfactory. For it seems to call for a different result depending on whether the lessor calculates a single lump sum payment to compensate him for the cost of letting and maintaining his property or whether he segregates his various overheads from the net return which the letting of property gives'. The Commissioner, with respect, considers McHugh JA's to be the better view. Previously released in draft form as TR 2004/D8

Appendix: The Commissioner's view: 26. The Commissioner's view is that a person who is indemnified for a RWT liability where some or all of the indemnity is itself consideration paid or credited for any matter answering the description in paragraphs (a) to (f) of the royalty definition (subsection 6(1) of the ITAA 1936) will, to that extent, be liable for RWT on the indemnity amount. The indemnity amount in that situation will itself be a royalty. 27. Whether the indemnity amount is such 'consideration' will in each case be a question of construction of the agreement under which the indemnity was paid. | Royalty definition: 28. Royalty is defined in subsection 6(1) of the ITAA 1936 beginning as follows: 29. The definition is inclusive. Payments or credits that are 'royalties' within the ordinary meaning of that term come within its scope. So too do the types of payments or credits listed in paragraphs (a) to (f) of the subsection. [7] 30. The definition makes it clear that an amount that is not a royalty within the ordinary meaning of 'royalty' may yet answer the description in subsection 6(1), no matter how the amount is described or computed and whether it is paid or credited periodically or not, where it is paid or credited 'as consideration for' a matter listed in the definition. | However described or computed: 31. The form of a payment or credit and the way in which it is computed will not be conclusive in determining whether or not it is a royalty under the definition; nor will the description given to it in any agreement between the parties. [8] 32. If, having regard to the substance of the contract, a payment or credit falls within the scope of the definition, it will be a royalty whether it is paid in a lump sum or periodically. Unlike the ordinary meaning of royalty, it is not necessary for the payment or credit to be calculated by reference to the degree of use of the property, right or know-how. For example, in the case of a film, it will be a royalty whether it represents an amount calculated by reference to each showing, a lump sum to cover an agreed number of showings or is a share of the gross or net takings for exhibition of the film. [9] 33. It follows also that RWT indemnity amounts are not precluded from being a royalty merely because they are described as an 'indemnity of tax' or similar. 34. In addition, the definition makes it clear that it is not important how the amount is computed and so the fact that a RWT indemnity amount is calculated by reference to withholding tax does not preclude it from being a royalty. | Periodical: 35. The subsection 6(1) definition of royalty makes it clear that the payment or credit need not be periodical. It can be a one-off payment or credit. | As consideration for: 36. To the extent that an amount is paid or credited as consideration for any matter listed in paragraphs (a) to (f) of the subsection 6(1) definition, it will be a royalty. An RWT indemnity amount so paid or credited will thus be a royalty. 37. Whether a particular amount is so paid or credited is a question of fact [10] and will depend in each case on a proper construction of the agreement under which it was given, that is, whether it constitutes any part of the price of obtaining or securing one or other of the listed matters. 38. Consideration has been defined as the act or promise offered by the one party and accepted by the other as the price of that other's promise. [11] 39. Valuable consideration was defined in Currie v. Misa (1875) LR 10 Exch 153 at 162 as: 40. The indemnification of RWT is thus capable of being 'consideration' or 'consideration paid or credited'. | The use of, or the right to use: 41. Some of the listed matters are described in terms of 'the use of, or the right to use' various items of property, such as copyright, patent, design, equipment, visual images or sounds, spectrum etc. The question thus arises whether an RWT indemnification can be properly regarded as consideration 'for the use of or the right to use' property. 42. In Commissioner of Stamp Duties (N.S.W .) v. J.V . ( Crows Nest) Pty Ltd (1986) 7 NSWLR 529; 86 ATC 4740; (1986) 17 ATR 1086 the question was whether a franchisee's covenant to pay the franchisor a service fee was consideration 'for the use of property' (goodwill being the property in that case) and thus 'rent' within the extended definition of that term in the Stamp Duties Act 1920 (NSW). McHugh JA (with whom Samuels JA agreed) said in relation to the modern meaning of 'rent': [12] 43. His Honour's comments support the proposition that where the user under an agreement for the use of property has an obligation to indemnify or reimburse the owner for a liability that would otherwise fall on the owner, the obligation is not, by reason alone of the indemnity or reimbursement, precluded from being 'consideration for the use of the property'. The same reasoning, in the Commissioner's view, applies to an obligation to indemnify a RWT liability. [13] 44. In David Securities Pty Ltd and Others v. Commonwealth Bank of Australia (1992) 175 CLR 353; (1992); 92 ATC 4658; (1992) 24 ATR 125 the High Court considered the claim by borrowers for restitution of certain moneys that they had paid to a bank under the 'grossing up' clause of a loan agreement. 45. The clause required the borrowers' interest payments to include an additional amount which ensured that the net amount received by the bank would not be reduced by the interest withholding tax the borrowers might be required to deduct. The borrowers alleged that they paid over the additional amounts in the mistaken belief that the statutory liability for withholding tax was theirs and not the bank's. 46. Mason CJ, Dean, Toohey, Gaudron and McHugh JJ of the majority commented in a joint judgement that the loan agreement was such that it was severable into its relevant parts and the consideration could be 'broken up' or apportioned; various obligations of the one party could be related to the consideration given by the other. [14] 47. The Court found on the facts that the borrowers had no indebtedness in respect of withholding tax, the discharge of which could form consideration for the moneys they paid. The payments were therefore not made for good consideration. [15] 48. Notwithstanding the particular factual finding, the case is authority for the principle that the severability or otherwise of an agreement into its relevant parts will be relevant in identifying or apportioning the consideration given for particular contractual obligations. [16] In the case of an agreement to indemnify RWT that principle will be relevant in deciding whether the indemnity obligation is consideration for any of the matters answering the description in section 6(1), that is, whether the indemnity fits the description of 'royalty'. 49. In Commissioner of State Revenue (Vic) v. Royal and Sun Alliance Insurance Australia Ltd [17] the Supreme Court of Victoria, Court of Appeal, considered whether the amount representing the goods and services tax (GST) payable by an insurer on the insurance policies it issued, and which amount it on-charged to the insured, should be treated as part of 'premiums' and 'gross premiums' for the purposes of the relevant part of the Stamps Act 1958 (Vic). 50. The word 'premium' as it appeared in the context of that Act bore in the Court's view its ordinary meaning which was 'the consideration, usually in the form of a monetary obligation, paid or payable by the insured for the grant or renewal of insurance cover or of other rights under a policy of insurance'. 'Gross premiums' referred to the total of all such sums received. 51. The Court held that notwithstanding that the insurer had charged a separate amount for GST, and separately designated it in the actual policies, the amount did form part of the 'premium' or 'gross premiums' for the purposes of the Stamps Act 1958 . That is, the GST 'reimbursement' was consideration of the kind described in the definition. 52. In reaching its conclusion the Court per Ormiston JA observed that: 53. A contrasting case is Aktiebolaget Volvo v. Federal Commissioner of Taxation [19] concerning payments made by an Australian resident company, Volvo Australia Pty Ltd ('Volvo Australia'), to its non-resident parent under an agreement made in 1972. The payments were made in consideration for the parent forbearing from supplying certain products to any person or corporation in Australia other than Volvo Australia itself. 54. The Commissioner included these payments as 'royalties' in the parent company's assessable income for the years ended 30 June 1974 to 1976 inclusive. One of the Commissioner's contentions was that the payments fell within the ordinary meaning of that term. The Commissioner argued that the payments were made in consideration of the grant of a right to the goodwill that the parent company had in Australia, particularly in the word 'Volvo' and associated symbols, and the rights which interdiction of competition in the exploitation of a licence to sell Volvo products in Australia would confer. 55. The Supreme Court of Victoria rejected the argument, pointing out that there was nothing in the agreement itself which conferred rights in goodwill - notwithstanding that the agreement may have rendered more valuable whatever of the goodwill the Australian subsidiary had or might acquire - and the payments were not made in consideration of the grant of any such right. 56. The cases illustrate that each agreement for the indemnity of RWT must be considered on its own facts and it is a matter of construction of the contract in each instance whether an indemnity amount can be related to a matter that answers the description in the subsection 6(1) definition. 57. Similarly, an indemnity amount may be paid or credited under an agreement other than the one under which the royalty that was paid or credited gave rise to the initial RWT liability. For example, X may have a RWT liability arising out of a copyright licence agreement with Y which, under a separate agreement, Y agrees to indemnify as partial consideration for X giving Y the use of a trade-mark. Again, the indemnity is given as consideration for the use of property. 58. On the other hand if Y indemnifies X's RWT liability as consideration for X giving Y the right to renew a royalty agreement with X there will be no RWT on the indemnification amount. [20] This is because such right is not a right of the kind listed in the royalty definition and does not otherwise answer the description of any of the matters listed. [21] 59. As a further example, a contract for the lease of certain equipment might contain the clauses in paragraphs 10 and 11. Upon a proper construction of the contract an amount paid by the lessee pursuant to the clause in paragraph 11 is found to be in substance part of the consideration for, and solely for, the lessor granting the lease. The payment in that case is a royalty notwithstanding the amount is described in the clause as the payment of withholding tax. | To the extent: 60. The subsection 6(1) definition allows apportionment of amounts in the sense that it makes an amount a royalty to the extent to which it is paid or credited as consideration for the matters listed in paragraphs (a) to (f) of the definition. In some instances, an agreement under which a RWT indemnification is paid or credited may be a 'divisible contract', which is separable into parts so that different parts of the consideration may be assigned to severable parts of the performance, for example, an agreement for payment pro rata. [22] Whether an obligation to pay or credit a RWT indemnification amount is divisible from other obligations under the agreement is a question of construction (the process by which a Court determines the meaning and legal effect of a contract). [23] | The CYB case distinguished: 61. In CYB the question on appeal before the Court was the 'proper characterisation', for IWT purposes, of the amounts by which the borrower was required to 'gross-up' on account of withholding tax the interest payments it made to the lender. [24] 62. To be subject to IWT those amounts had to be characterised as 'interest' within the meaning of subsection 128A(1). That subsection defined interest as, 'interest includes an amount in the nature of interest, not being an amount referred to in subsection 26C(1)'. [25] 'Interest', the Court said, bore its ordinary meaning, which was 'the return, consideration, or compensation for the use or retention by one person of a sum of money belonging to, or owed to, another, and that interest must be referable to a principal'. [26] 63. The Court, quoting the primary judge, agreed that the amounts in question 'do not have the character of a return or profit to the lender for the use of money advanced to the borrower, howsoever calculated or ascertained', and that the indemnification amounts were neither 'interest' nor 'in the nature of interest'. 64. In the words of the primary judge, Cooper J: [27] 65. It is the Commissioner's view that the CYB decision is distinguishable from and not applicable to the RWT indemnification question in that for the indemnification amount to have been 'interest' it had to be more than simply consideration for the use of the loan monies; it also had to have the character of interest and be referable to the principal sum borrowed. In the case of an RWT amount no such additional qualification is necessary; the amount merely needs to be consideration for one or other of the matters listed in subsection 6(1). 66. In the example at paragraph 59 the indemnification of RWT is found to be part of the consideration (the price) for the lessee obtaining the lease of the equipment. That quality is sufficient in our view for the indemnification amount to be a 'royalty'. | Conclusion: 67. For the reasons given, it is the Commissioner's view that an indemnification of RWT will be a royalty in terms of the definition of royalty contained in subsection 6(1) if and to the extent to which, on a proper construction of the agreement under which it is paid or credited, it is paid or credited as consideration for any of the matters listed in paragraphs (a) to (f) of the definition of royalty in subsection 6(1). | Gross up: 68. Based on the Commissioner's approach, where: the total RWT on both the initial royalty and indemnification amount is calculated as: the RWT on the indemnification amount alone is calculated as: | Deductibility: 69. RWT indemnification amount is deductible to the person paying or crediting it to the extent that the requirements of deductibility under section 8-1 of the ITAA 1997 or 51(1) of the ITAA 1936 are satisfied and section 26-25 of the ITAA 1997 or section 221YRA of the ITAA 1936 does not apply. 70. The alternative view is that RWT indemnification payments are not royalties. This view relies on three arguments. The first argument is that the Commissioner's view, expressed herein, is inconsistent with the decision in CYB. However, as indicated earlier, CYB is distinguishable because the subsection 6(1) definition of royalty is not confined in the way interest was held to be in the CYB case. The definition of royalty is wide enough to include consideration paid or credited by way of the indemnification of tax for the matters listed in paragraphs (a) to (f) of subsection 6(1). 71. The second argument is that the RWT indemnification amount is not calculated by reference to the rights bargained for under the contract and so cannot be paid as consideration for those rights; rather it is calculated by reference to the royalty withholding tax. The manner of computation of the indemnity, this argument goes, was a factor for the Court in CYB in finding against the Commissioner. Against this, the Commissioner would distinguish CYB, again on the grounds that unlike 'interest' an amount may be a royalty under subsection 6(1) no matter how it is computed. 72. Finally, it is said that if the parties describe the amount as an RWT indemnification, then the amount is an indemnification of tax and not an amount paid as consideration for the rights under the agreement. However, as explained earlier, the description given to an amount is not conclusive of its characterisation as a royalty under subsection 6(1) and therefore that description does not preclude it from being a royalty. | Example 1: 73. Ausco, a company resident in Australia, has a contract with Japanco, a company resident in Japan, under which it pays royalties to Japanco for the use of copyright. The royalty payment is $10 million per year. The contract includes an indemnification of royalty withholding tax clause under which Ausco agrees to indemnify Japanco for any royalty withholding tax so that Japanco is to receive the $10m net of Australian RWT. 74. Under article 9(1) of the Japanese Agreement, Australia can tax the royalty [28] but the tax so charged is not to exceed 10% of the gross amount of the royalty. Australia exercises its taxing right. [29] Thus Japanco has a liability to pay [30] and Ausco a requirement to withhold [31] the following RWT amount: RWT = 10% * (1/(1-1/10)) * $10m RWT = $1.111m 75. Of this amount, the RWT on the indemnification amount itself is: 10% * (0.1/0.9) * $10m = $0.111m | Example 2: 76. The situation is the same as in example 1 except that Japanco is a resident of Hong Kong. The RWT rate is 30%. [32] Japanco has a liability to pay and Ausco a requirement to withhold the following RWT amount: RWT = 30% * (1/(1-3/10)) * $10m RWT = $4.286m 77. Of this amount, the RWT on the indemnification amount itself is: 30% * (0.3/0.7) * $10m = $1.286m 78. In subsection 6(1) of the ITAA 1936 'royalty' or 'royalties' is defined as follows:


What this Ruling is about | Class of person/ arrangement | Preamble: The number, subject heading, What this Ruling is about (including Class of person/arrangement section), Date of effect, and Ruling parts of this document are a 'public ruling' for the purposes of Part IVAAA of the Taxation Administration Act 1953 and are legally binding on the Commissioner. Taxation Rulings TR 92/1 and TR 97/16 together explain when a Ruling is a 'public ruling' and how it is binding on the Commissioner. | What this Ruling is about: 1. This Ruling considers the extent, if any, to which the recipient of a royalty payment, whose royalty withholding tax liability is indemnified by another person, is liable to pay royalty withholding tax on that indemnity. | 2. That is, it considers the question of whether and to what extent a person who derives a royalty upon which they are liable under subsection 128B(5A) of the Income Tax Assessment Act 1936 (ITAA 1936) to pay royalty withholding tax (RWT) and who is then indemnified for that liability by another person, is liable to pay RWT on the amount of the indemnity. The question turns on whether the indemnity amount is itself a 'royalty'. | 3. In Commissioner of Taxation v. Century Yuasa Batteries Pty Ltd (1998) 82 FCR 288; 98 ATC 4380; (1998) 38 ATR 442 ('CYB') the Full Federal Court ruled on a matter concerning the indemnity of interest withholding tax. It decided that the lender in that case was not liable for interest withholding tax (IWT) on the amounts by which the borrower 'grossed up' the payments of interest it made to the lender to ensure that, after any deduction or withholding on account of tax, the lender received the full amount of interest it otherwise would have received under the loan agreement. This ruling considers whether the decision in that case applies equally to RWT indemnities. | 4. In this Ruling 'royalty' means royalty as defined in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) which in turn adopts the meaning in subsection 6(1) of the ITAA 1936. (See paragraph 78 for the definition of royalty.) | Background: 5. In CYB the question of IWT liability turned on whether the amounts by which interest was grossed-up could properly be said to be 'interest' or 'in the nature of interest' within the meaning of the then IWT definition of 'interest' in subsection 128A(1) of the ITAA 1936. | 6. The parties accepted that the term 'interest' bore its ordinary meaning which, the Court said, is 'the return, consideration, or compensation for the use or retention by one person of a sum of money belonging to, or owed to another, and that interest must be referable to a principal'. [1] | 7. The Court ruled that the amounts by which the interest payments were grossed-up did not fit the description of interest (or the statutory extension as it then was) and that the amounts were 'neither interest nor in the nature of interest but were an indemnity against [the lender's] liability for income tax'. [2] | 8. In the light of that case industry uncertainty may have arisen concerning the treatment of RWT indemnities, specifically whether the amounts by which royalty payments are grossed up to reflect the indemnity fit within the definition of 'royalty' for RWT purposes. | Example of a RWT indemnity clause: 9. The example below relates to a lease of equipment and the indemnification of RWT. However, such a clause could also arise in other contracts so the Ruling should not be read as being limited to equipment leases. In the example the RWT indemnity clause is designed to ensure that the person obtaining the RWT indemnity receives amounts under the contract equivalent to the amounts contracted for, not reduced by RWT. | 10. A contract for the use of equipment may contain a clause along the following lines: | In consideration of the terms and covenants contained in this agreement the lessor agrees to lease to the lessee and the lessee agrees to hire from the lessor certain equipment. | 11. The following is considered to be an example of a standard RWT indemnity clause: | The lessee shall pay all Australian taxes including withholding taxes. Where the lessee is unable to make any payment to the lessor without a deduction or withholding the lessee shall immediately pay such additional amount so that the net amount received by the lessor will equal the full amount received had no such deduction or withholding been made. | Legislative Context: 12. RWT is a liability imposed by the combined operation of subsection 128B(5A) and either subsection 128B(2B) or subsection 128B(2C) of the ITAA 1936. It is imposed on a person who derives royalty income to which subsection 128B(2B) or 128B(2C) applies. RWT is payable on the gross amount of the royalty at the rate declared by Parliament. That rate is currently 30% of the gross amount of royalty, [3] generally reduced to either 10% or 5% under Australia's tax treaties. [4] | 13. By subsection 128B(2B) of the ITAA 1936 RWT applies to income that consists of a royalty derived by a non-resident and: | 14. The liability for RWT is further extended under subsection 128B(2C) of the ITAA 1936 to two other situations where a PE is involved, namely: | 15. RWT is not payable on a royalty where a tax treaty applies and either subsection 17A(4) or 17A(5) of the International Tax Agreements Act 1953 operates to exclude the royalty from the scope of the RWT provisions. [5] An example of a royalty excluded by the operation of subsection 17A(5) is an equipment royalty paid to a United States resident. | 16. Australia's tax treaties contain their own definitions of 'royalty' which are similar but not identical to the definition in subsection 6(1) of the ITAA 1936. This ruling applies to a transaction that is a 'royalty' satisfying both subsection 6(1) and 128B(5A) provided subsection 17A(4) or 17A(5) does not exclude the transaction (as mentioned in paragraph 15) from the RWT provisions. | 17. Where a royalty falls within both a tax treaty definition and subsections 6(1) and 128B(5A), and the treaty operates to limit the rate of Australian tax on the royalty without precluding the application of subsection 128B(5A) to the royalty, this ruling will still apply. | Class of person/arrangement: 18. This Ruling contains the Commissioner's opinion on the way in which a tax law or tax laws apply to the class of person and class of arrangements described below. | 19. The class of person to which this Ruling applies are persons who derive royalties upon which they are liable to pay RWT under the combined operation of subsection 128B(5A) and either subsection 128B(2B) or 128B(2C) of the ITAA 1936 (see paragraphs 12 to 17), and who are indemnified for that tax. | 20. The class of arrangements to which this Ruling applies are arrangements by which a person's liability for RWT is fully or partly indemnified by another person. | Date of effect: 21. This Ruling applies to years of income commencing both before and after its date of issue. However, the Ruling does not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 21 and 22 of Taxation Ruling TR 92/20). | " royalty " or " royalties " includes 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 ... [the matters listed in paragraphs (a) to (f) of the definition]. [6] | ... some right, interest, profit or benefit accruing to the one party, or some forbearance, detriment loss or responsibility, given, suffered, or undertaken by the other. | That definition is concerned with whether the payment - whatever its purpose - is part of the consideration for the right to use premises. It is immaterial that the payment may reimburse the lessor in respect of one of his obligations if the payment is part of the consideration for the use of the property. In most, if not all cases, a payment made by a lessee of rates and taxes owing by the lessor is made as part of the consideration for the use of the premises and for no other purpose. | [T]he artifice of designating some of the consideration as fire services levy, stamp duty or GST, though acceptable in practice (and indeed in law), could not detract from the fact that the cover would not be granted unless the whole of the stipulated sums had been paid, whether called premiums, GST or whatever ... The total amount to be paid was (and still is) in fact the premium, unless by law it can be otherwise characterised or understood. [18] | [The indemnification amounts] are not calculated by reference to the principal sum advanced and are not in the nature of an additional return or profit to [the lender] on the money advanced over and above the interest calculated and payable under clauses 5 and 17 ... That the additional payments were a cost to the applicant of obtaining the use of the funds does not convert the payments to 'interest' in the hands of the lender where they are referable to costs and liabilities incurred by the lender as a consequence of the loan transaction itself coming into existence and being given effect to by the parties to it. | Example of a RWT indemnity clause | The use of, or right to use | Footnotes: section 128B of the Assessment Act (which deals with liability for withholding tax) does not apply to the excluded royalties.'


Related rulings: TR 92/1 TR 92/20 TR 97/16 IT 2660
Legislative references: ITAA 1997 8-1 ITAA 1997 26-25 ITAA 1997 995-1 ITAA 1936 6(1) ITAA 1936 26C(1) ITAA 1936 51(1) ITAA 1936 128A(1) ITAA 1936 128B(2B) ITAA 1936 128B(2B)(a) ITAA 1936 128B(2B)(b)(i) ITAA 1936 128B(2B)(b)(ii) ITAA 1936 128B(2C) ITAA 1936 128B(2C)(a) ITAA 1936 128B(2C)(b)(i) ITAA 1936 128B(2C)(b)(ii) ITAA 1936 128B(5A) ITAA 1936 177F(2A) ITAA 1936 221YRA TAA 1953 Pt IVAAA TAA 1953 Sch 1 12-280 ITAA 1953 17A(4) ITAA 1953 17A(5) ITAA 1953 Sch 6 Article 9(3) Income Tax (Dividends, Interest, and Royalties Withholding Tax) Act 1974 7(c) Stamps Act 1958 (Vic) Taxation Administration Regulations 1976 42
Case references: Aktiebolaget Volvo v. FCT 78 ATC 4316 (1978) 8 ATR 747
Other references: Cheshire & Fifoot's Law of contract, 8th edn, Lexis Nexis Butterworths, Australia, 2002, para. 4.10 Chitty on Contracts, 28th edn, vol. 1, Sweet & Maxwell, London, 1999