The ATO has released a further revised draft taxation ruling TR 2024/D1 for consultation. This replaces TR 2021/D4, which has now been withdrawn, which itself replaced TR 93/12, which was also withdrawn. 

The draft ruling considers when an amount paid under a software arrangement is subject to royalty withholding tax. It seeks to significantly expand the definition, particularly by asserting that software distributors/SaaS providers make cost of sales payments which are royalties. It does this by having regard to circumstances that have not previously been relevant in defining “royalties”, and extending beyond accepted OECD guidance. 

Reviewing the history of this matter, there appears to bato royaltiese a resolute determination to expand the definition of royalty beyond its existing meaning. However, rather than expand the number of examples to bring out, this latest draft ruling has contracted them as compared to the prior draft. One of the core examples still contains a factual assumption regarding the issuance of End User Licence Agreements which is inconsistent with commercial practice in the SaaS space.

“Simple Distribution” considered a royalty: There are various deep concerns with this project, which many commentators have raised, though these have largely been dismissed or not discussed. Indeed, one of the concerns emanates from the concept of a “simple” distribution right not being a royalty, which the draft ruling now dismisses with a simple statement that this proposition cannot be accepted for the reasons set out in the ruling. However, this proposition is entirely consistent with what was previously set out in TR 93/12, which reflected the established position for some 28 years.  

Out of step with OECD and Treaty Partners: The position is out of step with the OECD guidance and positions of our key Tax Treaty partners. When read in context, the OECD guidance specifically calls out distribution arrangements as arrangements that should not ordinarily be captured under the royalties article but instead taxed under the business profits article – though the ruling has taken an extremely narrow interpretation of this. 

As such, the position is out of step with our Tax Treaty partners’ positions. It would be completely unacceptable for Australia to now impose royalty withholding tax on software distribution payments, and the US Inland Revenue Service to deny the US IP owner a credit for such royalty withholding tax on the grounds that Australia has imposed tax not in accordance with the Tax Treaty. This outcome is entirely plausible.

If there is to be such a profound change made to the definition of “royalty” for tax law purposes, it should be made by the appropriate branch of Government, being the Legislature through an Act of Parliament, after due consultation with our Tax Treaty partners. royalties

Uncertainty: The draft ruling, if finalised in its current form, provides significant uncertainty about the correct treatment of software distribution arrangements, especially involving whether distribution arrangements for SaaS providers should be treated as royalties. It will likely lead to companies being forced to take positions that are not in line with the guidance and create potential disputes with the ATO, particularly if a company finds itself in a position that any withholding tax is not creditable in the recipient jurisdiction due to different interpretations of what a royalty is.

Aside from the above concerns, the progression of this matter (which is still uncertain) has taken so long that a retrospective start date of its new position being 1 July 2021 is unacceptable. At the very least, any position should be prospective only given the extensive delay thus far.

Action: Groups operating in the software sector need to consider this draft ruling closely, and consider making a submission on particular points of concern, and consider whether their facts and current positions are likely to lead to a conflict with the draft ruling – and if so, how they plan to address that conflict.

The draft ruling is open for public comment until 1 March 2024.

A royalty or not a royalty, that is the question

The ATO provides a summary of examples in TR 2024/D1 for payments that are characterised as royalties and payments that would not be characterised as royalties.

In this regard, the ATO considers the following payments are characterised as a royalty where they are paid as consideration for one or more of the following:

  • the grant of a right to use IP, regardless of whether that right is exercised – for example, the grant of the right to reproduce a computer program, regardless of whether or not that right is exercised.ato royalty information
  • the use of an IP right – for example, the use of a copyright right consists of doing an act in respect of a copyright work that is the exclusive right of the copyright holder, such as authorising the communication of a computer program.
  • the supply of know-how in relation to an IP right referred above.
  • the supply of assistance furnished as a means of enabling the application or enjoyment of the supply.
  • the sale by a distributor of hardware with embedded software, where the distributor is granted or uses rights in the IP of the software.

Conversely, the ATO considers the following payments are not royalties:

  • consideration that is wholly for the grant of a right to distribute copies of a computer program, without the use of, or right to use, the copyright or another IP right.the changes to ato royalty
  • consideration for the transfer of all rights relating to the copyright in software.
  • payments from a distributor that are consideration wholly for the acquisition of hardware with embedded software, provided that the distributor does not use, and is not granted the right to use, any copyright or another IP right in the embedded software.
  • payments from a distributor that are consideration wholly for the acquisition of physical carrying media on which software is stored, provided that the distributor does not use, and is not granted the right to use, any copyright or another IP right in the embedded software.
  • consideration for the provision of services that are unrelated to any IP right or any knowledge or information.

Definition of royalty

The draft ruling defines a royalty as an amount paid for the use of, or right to use, any copyright or other like property or right. However, such payments may also be for the use of, or right to use, other intellectual property (IP) rights, or otherwise fall within the definition of a ‘royalty’.

The draft ruling provides a detailed explanation of the elements of a royalty, including:

  • Described or computed: The draft ruling confirms that how a payment is described or computed either in an underlying legal agreement or invoice is not determinative in analysing whether the payment is a royalty for withholding tax purposes. A theme throughout the draft ruling is that the substance of the agreement will prevail over its legal form regardless of whether the agreement is a “distribution” agreement and / or the payment is characterised as “royalty-free”.
  • Consideration: The draft ruling states that the consideration is unlikely to be detechanges to royaltiesrminative in the assessment of whether a payment is a royalty. Consideration for a royalty can be monetary or non-monetary, fixed or variable, periodic or lump sum, or contingent on certain events or outcomes. The draft ruling also clarifies that the consideration can be paid by a third party on behalf of the payer or recipient.
  • The extent of the payment: The draft ruling states that the payment must be for the use of, or right to use, IP rights. This means that the payment must be referable to the IP rights and not to other factors such as services, goods, facilities, or know-how. The draft ruling also states that the payment must be made in respect of each act of use or right to use IP rights.

In the context of software distribution, the ATO’s position is that if the end-user of the software is paying a distributor for the use of IP rights (which are granted by the distributor to the end-user), then it follows the distributor must have an entitlement to, and make use of, those IP rights to earn income. The conclusion the ATO draw from this is that the payments the distributor makes under an agreement will be royalties. This arguably contravenes the ATO’s earlier position in TR 93/12 as well as OECD commentary, by failing to acknowledge the concept of a “simple” distribution right.

Domestic law and tax treaties

A significant improvement to TR 2024/D1 is the inclusion of the ATO’s view on the interaction between the domestic tax law definition and the tax treaty definition of royalty. In summary, the draft ruling states that:

  • The ATO’s interpretative approach is to begin with the text of the article with regard being had to the context, object, and purpose of the treaty provisions.
  • Treaties allocate tax rights which are given effect by domestic law.proposed expansion of royalty definition
  • The domestic law definition applies in the absence of a tax treaty or where a tax treaty does not contain a definition of royalty.
  • The tax treaty definition applies where there is a tax treaty that contains a definition of royalty. However, this does not exclude the application of the domestic law definition where it is broader than the tax treaty definition.
  • The tax treaty definition prevails over the domestic law definition where there is a conflict between them. However, this does not prevent the application of Australia’s anti-avoidance rules.

In general, the ruling deals predominately with a “standard tax treaty definition” of royalty which prevails in the majority of Australia’s bilateral and multilateral treaties. However, the draft ruling does acknowledge that there are treaties where the definition of ‘royalty’ or ‘royalties’ materially varies including Australia’s treaties with the US, Mexico, and Singapore.

Scenario 1 of the draft ruling covers the application of the Article 13 of the Australia/Ireland tax treaty amongst other generalised examples of how to apply the domestic law and tax treaty definitions in different scenarios involving software arrangements.

Copyright Act 1968

The standard tax treaty definition of a royalty includes…the use of, or right to use, any copyright. As a result, the draft ruling provides comprehensive guidance on how the ATO interpret and apply the Copyright Act 1968 in relation to software arrangements. The draft ruling states that:

  • Copyright is an undefined term in the standard tax treaty definition and therefore has the meaning under the Copyright Act 1968.
  • A computer program is a literary work for the purposes of the Copyright Act 1968. A computer program includes any source code, object code, executable code, or any other form of expression that can be executed by a computer.royalty definition
  • The Copyright Act 1968 defines exclusive rights to the copyright owner including reproducing the work in a material form; communicating the work to the public; making an adaptation of the work; entering into a commercial rental agreement; and authorising a person to do an act.
    • A reproduction of a computer program occurs when a copy is made in any material form. This includes copying from one medium to another, such as from a CD-ROM to a hard drive, or from one device to another, such as from a server to a client device. For example, the ATO consider reproduction may occur under cloud computing when a software component is downloaded onto a computer or device.
    • A communication of a computer program occurs when it is made available online or electronically transmitted. This includes streaming, downloading, uploading, or accessing a computer program over the internet or a network. Specifically, the Commissioner is of the opinion that software may be “made available online” under a SaaS model.
    • A commercial rental of a computer program occurs when a copy of the computer program is leased or hired for a fee. This does not include a licence to use a computer program or a subscription to access a computer program online.

The draft ruling also provides examples of how to determine whether a payment is for the use of, or right to use, any of the copyright rights in relation to software arrangements.

Extent to which payments are royalties

The draft ruling provides guidance on how to determine the extent to which payments under software arrangements are royalties for the purposes of determining whether it is appropriate to apportion the payment into royalty and ‘non-royalty’ components. The draft ruling states that:

  • The character of the payment depends on the legal rights and obligations of the parties under the software arrangement, and not on the labels or descriptions used by them.proposed royalty change  

  • The payment must be apportioned between the royalty and non-royalty components where the software arrangement covers multiple rights or obligations, such as services, goods, facilities, or know-how. The apportionment must be based on objective evidence and reflect the economic substance of the software arrangement.
  • The payment may be wholly or partly a royalty where the software arrangement involves a licence, a sale, a lease, a subscription, or a hybrid of these.

The draft ruling also provides examples of how to apportion payments under different types of software arrangements. Although the ability to apportion payments appears, (at least in the view of the ATO) to apply in limited circumstances and the ATO provide an abundance of case law (in varying contexts) to support the argument that it is more commonly the case in a software distribution arrangement that the IP rights are not separable and cannot be performed without use of the IP rights granted such that the entirety of the consideration will be characterised as a royalty.

Application to modern software distribution arrangements

The draft ruling provides guidance on how to apply the royalty definition to various kinds of modern software arrangements that are commonly seen in practice. These include:

  • Software-as-a-service (SaaS): This is an arrangement where the payer accesses and uses software that is hosted and maintained by the recipient over the internet or a network. In the context of SaaS models, the payments will generally be characterised as a royalty where the copyright owner licenses the software to an intermediary (such as a distributor), and the intermediary sublicenses the software to the end-user.changes to royalty definition
  • Cloud computing: This is an arrangement where the payer accesses and uses various IT resources, such as servers, storage, databases, networks, platforms, applications, or analytics, that are provided by the recipient over the internet or a network. The draft ruling states that a payment under a cloud computing arrangement is generally not a royalty, unless the payer obtains a right to reproduce, communicate, or commercially rent any IP rights embedded in the IT resources.

Scenario 1, which includes an Australian distributor entering into an End User License Agreement (or “EULA”) with the customer, is considered by the ATO to constitute a royalty. Unhelpfully, the Australian distributor issuing an EULA is very seldom the commercial practice. It is not clear whether the ATO consider the payment would constitute a royalty where the intellectual property owner entered into the EULA’s directly with Australian customers, which is by far the more common occurrence.

OECD Commentaries

The ATO in their analysis of the Commentaries on Article 12 of the Model Tax Convention take a particularly narrow view, in particular, of paragraph 14.4 to assert the OECD itself place significant qualification and limitation on the application of the example provided. In general, the views expressed in TR 2024/D1 arguably diverge from international consensus.

In Paragraph 12 of the Commentary on Article 12 concerning the taxation of royalties, the OECD acknowledge that “whether payments received as consideration for computer software may be classified as royalties poses difficult problems”.

The preceding paragraphs acknowledge the various copyrights that may exist over a particular software. Specifically, paragraph 14.2 states that the ease of reproducing computer programs has resulted in distribution arrangements in which the transferee obtains rights to make multiple copies of the program for operation within its own business. The OECD view these arrangements would not be considered royalties for the purposes of Article 12.what the proposed changes to the definition of royalty mean

In paragraph 14.4 of the OECD Commentaries, it is acknowledged that a common arrangement between a software copyright holder and a distribution intermediary frequent will grant the distribution intermediary the ‘right’ to distribute copies of the program without the right to reproduce that program. The OECD state that where a distributor makes payments to acquire and distribute software copies (without the right to reproduce the software) the rights in relation to these acts of distribution should be disregarded in analysing the character of the transaction for tax purposes.

However, in respect of a SaaS or cloud distribution the ATO view the act of authorising the right to ‘communicate’ the software, such as through making it available online, as an exclusive right of the copyright owner such that this would constitute a right to use copyright which would be considered a royalty. This seems at odds with the OECD Commentary at Paragraph 14.4 which suggest these rights should be disregarded in analysing the character of the transaction for tax purposes with the exception of the right to reproduce the software, something which is entirely different to simply making the software available online.

What is “necessary” for the commercial intermediary to distribute “copies” of the software program will vary across software businesses. Furthermore, given the most recent Model Tax Convention Commentary was issued in 2017, there is no substantive analysis of SaaS arrangements in the context of royalties.

Date of Effect

Similar to statements in TR 2021/D4 (where the ATO indicate that the draft ruling is proposed to apply both before and after its date of issue) TR 2024/D1 does not provide an exact commencement date. TR 2021/D4 was originally designed to replace TR 93/12 with the latter being withdrawn from 1 July 2021. While there has not been a substantial change to the Commissioner’s view between the two draft rulings, greater clarification in relation to the effective date and / or the compliance approach to be taken by the Commissioner in relating to existing and historical positions would assist in providing greater certainty to taxpayers in respect of their arrangements.


TR 2024/D1 extends the types of payments in respect of software and intellectual property rights that the ATO consider to be royalties and therefore the payments that are subject to royalty withholding tax. Taxpayers that make payments for software should consider TR 2024/D1 in the context of their software and intellectual property rights arrangements both in substance and legal form.


If you would like to learn more about the topics discussed in this article, please contact your local RSM office.