Taxation Ruling TR 2021/D4 - Income tax: royalties - character of receipts in respect of software

Tax Insights

The ATO has released an initial draft, for comment, of its updated guidance on the classification of royalties in relation to software, in TR 2021/D4.Income tax: Royalties

This has been long-awaited given the last version of this guidance is in TR 93/12, which has now been withdrawn effective from 1 July 2021.

With the significant development in technology and globalisation over the last 28 years, it is timely for the ATO to provide clear guidelines that are relevant to a modern world, with the distribution of software a key aspect to many businesses.

Examples of Royalties and “Non-Royalties”

Specifically, the ATO has provided eight examples:



1. Licence to reproduce software

3. Licence for simple use of software (by end user)

2. Licence to modify software (including access to source code)

6. Software distribution agreement conferring right to distribute shrink-wrap software

4. Software distribution agreement conferring right to enter end user licensing agreements

8. Services ancillary to the simple use of software

5. Software distribution agreement conferring right to enter cloud services agreements


7. Services ancillary to the modification of software


In providing these examples, the ATO has also elaborated on three aspects of the royalty definition:

  • Consideration for the grant of a right to do something in relation to software that is the exclusive right of the owner of the copyright in the software (such as reproduce, adapt, or “communicate” to the public).
  • Consideration for the supply of know-how in relation to software.
  • Consideration for the supply of assistance furnished as a means of enabling the application or enjoyment of the supply.

Impact on Software Distributors

In this regard, the ATO has made it clear that it considers a payment made by a software distributor for the right to sub-licence the use of software to be a royalty. This is the case whether the software is distributed by way of physical carrying media, digital download or cloud-based technology such as software-as-a-service (but not where it is distributed by way of shrink-wrap packaging – which is seldom relevant with modern technology). Such a payment is considered by the ATO to be a royalty because it is for the right to do something in relation to software that is the exclusive right of the copyright owner. In such cases, the distributor is paying for the right to stand in the shoes of the copyright owner and exploit the copyright in the software in order to derive income.

In taking this position, the ATO appears to be adopting a very strict interpretation of what constitutes a right that is reserved for the copyright owner – further clarification could be useful as to why this is not also a “simple” right in the same sense of the example at item 3.

It is likely that for some groups, particularly those with arrangements akin to items 4 and 5 above, the positions reached by the ATO could result in royalties (and withholding tax obligations) now arising, which may be different to how they have previously treated their arrangements.


CloudCo has recently made its software available to customers on a subscription basis and the cloud infrastructure on which the software is hosted is located overseas and is owned and controlled by CloudCo.

AusCo, an Australian subsidiary of CloudCo, sells subscriptions to customers in Australia. AusCo and CloudCo have entered into a cloud distribution agreement which sets out the terms on which AusCo is permitted to sell the subscriptions. Under the agreement, CloudCo grants AusCo the right to enter into cloud services agreements with customers specifying the terms on which the customer can use the software. AusCo acknowledges that it does not otherwise have the right to do anything that is the exclusive right of CloudCo as the copyright owner.In return for the grant of these rights, AusCo pays a monthly cloud distributor fee to CloudCo which is calculated by reference to subscription sales and renewals over the preceding month. When purchasing a subscription, customers confirm (by clicking a box on CloudCo's website) that they agree to the terms of the cloud services agreement with AusCo. If a customer does not renew its subscription at the end of the subscription period, its access to the cloud services is cancelled. Under the cloud services agreement, AusCo grants the customer a non-exclusive, non-transferrable licence to access the software and use it for its intended purpose. The agreement otherwise limits the customer's use of the software.

The monthly cloud distributor fee which AusCo pays to CloudCo is a royalty because the fee secures the grant of the right to distribute the software by way of sub-licensing the use of the software to customers.

Income Tax: Royalties

Impact on New Operations

The broad reaching definition of a royalty payment may impact on the structuring options used by companies when starting their business plans in Australia and should be carefully considered at the outset of an arrangement. While a service-based model instead of a distributor style arrangement may be contemplated, it is also important to consider the relevance of the Multinational Anti-Avoidance Law (MAAL) for groups that are, or may soon become, Significant Global Entities (SGEs).

Groups that are SGEs and are already subject to the MAAL, and which restructured into software distribution models in order to comply with the MAAL, will likely feel particularly aggrieved by this development.

Importance and recommended next steps

The definition of a royalty is of paramount importance for most international groups as it can significantly change the overall tax rate, with cross border royalty payments likely to attract royalty withholding tax. The royalty withholding tax rate is currently 30% (unless reduced under a Double Tax Agreement). The underlying royalty payment will be denied as an income tax deduction to the extent withholding tax has not been paid.

In light of the ATO’s recent updated guidance, it is critical that taxpayers review their current arrangements, both formal and informal, to determine whether they have any payments, particularly licence fees, that may be considered royalties. Particularly for Australian distributors, this will require a careful consideration of their operating models, including whether they have rights which are the exclusive rights of the copyright owner.

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