Draft Guideline Released On Low-Risk Payments Relating to Software Arrangements

On 6 August 2025, the Australian Taxation Office (ATO) issued Draft Practical Compliance Guideline PCG 2025/D4 Low-risk payments relating to software arrangements – ATO compliance approach (the Draft Guideline). As with other Practical Compliance Guidelines (PCG) issued by the ATO, the Draft Guideline purports to set out the ATO’s ‘practical administration approach to assist taxpayers in complying with relevant tax laws’. As the Draft Guideline’s title suggests, it is concerned with payments relating to software arrangements.

Revised Position On Royalties

As described in RSM Australia’s previous Tax Insight on issuance of Draft Taxation Ruling TR 2024/D1 Income tax: royalties – character of payments in respect of software and intellectual property rights (TR 2024/D1)[1], the ATO’s position on royalties through to 2021 had been aligned with the OECD and Australia’s global treaty partners insofar as it related to distinguishing payments for the sale or distribution of software from payments for the use of copyright or intellectual property. The ATO’s reconsideration of its position on royalties, which was reflected in the withdrawal of administratively binding guidance that had stood for close to three decades (viz. Taxation Ruling TR 93/12 – Income tax: computer software) and subsequent issuance of TR 2024/D1, broadly coincided with key judicial developments such as the decision of the Federal Court in Oracle Corporation Australia Pty Ltd v Commissioner of Taxation (Stay Application) [2024] FCA 1262[2] (Oracle case) and the Full Bench of the High Court granting the Commissioner of Taxation’s application for special leave to appeal following earlier decisions by the Federal Court in proceedings involving Pepsico, Inc (PepsiCo case) (which, as announced on 8 August 2025, will be handed down on Wednesday 13 August 2025). 

The certainty surrounding the ATO and the Court’s position on royalties will not be impacted by the Draft Guideline as it is a risk assessment tool only. For that certainty Taxpayers will need to await the final decision on PepsiCo and a possible Oracle case.

Draft Guideline

The Draft Guideline will apply to arrangements entered into both before and after the date of issue. As it is a PCG, the relevant disclosures (if required) will be made through future year company income tax return schedules. 

As is often the case with PCG risk ratings, the Draft Guideline utilises the ATO’s tried and tested traffic light system to signify which ‘risk zone’ an entity may fall into depending on their facts and circumstances. What is surprising is that there are only two risk zones provided in this Draft Guideline – White and Green (i.e., no risk and low risk). It is therefore clear that the Draft Guideline is intended to provide a baseline level of assurance to taxpayers of what the ATO considers to be low risk. 

Risk Zones

Arrangements will fall into the ‘white’ risk zone where the ATO consider further risk assessment is not required. This will be so if any the following apply and there has been no material change to relevant conditions since the applicable event:

• There is a settlement agreement or advance pricing agreement (“APA”) between the Taxpayer and the ATO, where the terms of such expressly cover the Australian withholding tax outcomes related to the arrangement for the current year, and those conditions are met.
• A court or tribunal has decided (in a proceeding to which the taxpayer was a party) that a payment under the arrangement does or does not constitute a royalty.
• The income year was subject of a review or audit of the arrangement and the ATO provided a 'low risk' rating (or a 'high assurance' rating as part of a justified trust review), specifically in relation to the royalty risk of the arrangement.

Important considerations for the above concern the explicit notion of the APA/settlement/low risk rating being relevant to the withholding tax outcomes and royalty risk. If, as a software distributor, you have an APA that covers the arm’s length nature of your Australian operating margin but is silent on withholding taxes, you are not in the white zone.

Arrangements will fall into the ‘green’ risk zone where an undissected payment is in relation to the acquisition of:

• software acquired solely for private or domestic use,
• software which is
  • installed and used in the course of your own business
  • generally available to the public from other sources and is not substantially customised, and
  • not further sold, licensed or otherwise exploited as a primary object of your business
• finished tangible goods of which software is an inherent or practically inseparable part, the software is to enable the tangible goods to perform their intended function, and the goods are acquired for resale to retail customers, or
• software copies stored on physical media in the course of a business of reselling the software copies and you and your associates do not require or have the rights to use offshore IP (for example, the right to sublicence any IP).

ATO Examples

Four examples are included in the Draft Guideline, following the above bulleted points for what arrangements fall into a ‘green’ risk zone, namely software for domestic use, software for business use that is generic in nature, software in tangible goods that allows the tangible good to perform its intended function, and software stored on physical media. 

Considerations

The Draft Guideline will have limited application, but this is arguably by design. With the High Court’s decision on PepsiCo to be released on 13 August 2025, the ATO have given examples that for many would seem well aligned with common concepts of low risk (there will be limited arguments on physical media given taxpayers had almost 30 years to digest TR 1993/12 before it was withdrawn). 

However, the ATO’s clarification of arrangements it considers to be low risk is helpful. TR 2024/D1 was drafted in such broad way that even some of the low risk arrangements discussed in the Draft Guideline could have potentially been caught. Therefore, taxpayers that have arrangements that are similar to the low risk examples provided in the Draft Guideline can take some comfort that their arrangements are not the focus of the ATO’s reformed position of what types of arrangements will attract royalty withholding tax.  

One continued area of ambiguity is the concept of economic value and what is classed as a “communication” of intellectual property. This area of ambiguity can be seen in Example 4 which specifically considers the distribution (i.e., communication) of software contained in washing machines. It could be argued that the automation and ‘smartness’ of the device presents material economic value to the end user and the distributor in selling the washing machines has used a right of the IP Holder to communicate the embedded software. However, others may just want clean clothes and argue that the software is an inherent and practically inseparable part of the washing machine (it controls how much detergent the clothes get!). 

This does mean that there will still be some conjecture regarding an arrangement’s categorisation into the Green Zone and should that position be taken the support required to evidence that will be paramount. As with all ATO expectations, they again highlight in the Draft Guideline that they will examine arrangements if a Taxpayer is unable to provide evidence in support of their self-assessment.

Take-Aways

There isn’t a lot to take away from the Draft Guideline – at its core it is a risk assessment framework only. Maintaining contemporaneous evidence in support of relevant disclosures continues to be an ATO push, while there is also some level of certainty provided concerning the ATO’s position as it relates to the Examples provided. Outside of this, the Draft Guideline performs its role of developing a risk assessment framework. 

One point to note though, does anyone still buy CDs?

The ATO has invited comments on the Draft Guideline by no later than 17 September 2025. 

Please contact your local RSM Advisor if you would like to discuss the potential implications of the Draft Guideline for your organisation