ATO tax evaluation: characterization of software program paperwork

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On June 25, 2021, the Australian Tax Office published its draft judgment on Income Tax: License Fees – Nature of Income Related to Software (TR 2021 / D4), which replaces the previous judgment on Income Tax: Computer Software (TR 93/12).

The draft decision has been updated to reflect the major technological changes that have occurred in the software industry over the past three decades and includes examples of packaged software over physical media, digitally downloaded software, and cloud-based software-as-a. -Service (SAAS).

The central theses

The draft decision focuses on three main activities (software licensing, software distribution, and software services). The conclusions of the draft decision are summarized in the table below.

Particularly noteworthy is the increased interaction between copyright law and tax law when determining whether a “license fee” arises.

The publication of the draft decision is to be welcomed insofar as it provides the ATO guidelines on a number of different software agreements which, in contrast to the types of agreements previously dealt with in TR 93/12, are better aligned with what is currently on the market. For example, the draft decision addresses digital and SAAS distribution methods.

The draft decision was adopted on the basis that interested parties can submit comments and opinions, but only a short period of time for submitting comments. We are aware that the ATO conducted some industry consultations prior to the publication of the draft decision.

Once the final decision is made, the ATO has proposed that it apply both before and after the date of issue.

Affected companies should review the draft decision to determine whether both historical and future positions on WHT royalties are consistent with the position of the ATO or whether these arrangements could be improved to support the position adopted. This can include companies that sell software through cloud services or with whom parties to a license agreement have a software or source code trust agreement.

Structure of the draft decision

Increased interaction with copyright law

The draft judgment emphasizes the technical aspects of Australian copyright law and its interaction with Australian tax law. The ATO regards an amount as a royalty in that it is consideration for being granted a right to do something that is the exclusive right of the copyright owner. With reference to the Copyright Act, the ATO believes that these rights in relation to software (a literary work) relevantly include the right to reproduce the work in tangible form; the right to edit the work; and the right to show the work to the public.

The draft decision illustrates these core concepts using eight examples from the areas of software licensing, software distribution and software services.

Software licensing (examples 1 to 3)

Examples 1 to 3 agree with the previous TR 93/12 and show that payments for the “simple use” of software do not represent license fees, but payments for the right to reproduce for resale or for the right to change or adapt software (including access to the source code) represent a license fee.

“Ease of use” of software is defined as the process of using software for the purpose for which it was developed or is intended to be used. In these circumstances, any use of the copyright required to enable the software to be used as a working product is merely accidental and therefore the associated payments are not royalties.

Software distribution (examples 4 to 6)

Examples 4 and 5 consider software distribution agreements that give the vendor the right to enter into contracts with customers or end users. Deviating from the previous TR 93/12, the ATO now takes the view that, although customers or end users ultimately only receive a license for simple use, a distinction should now be made between transactions in which the software is subject to a license agreement and transactions in which the software is purchased directly from the customers / end users. In the former situation, the payments made by the distributor to the copyright owner for the right to distribute software through sublicensing constitute a license fee.

In contrast, Example 6 deals with the distribution of shrink-wrapped software. In this case, the related payments are not treated as royalties as these distributions do not relate to the distributor’s use of the copyright.

Software services (examples 7 and 8)

Examples 7 and 8 consider auxiliary services for changing or using software. Payments for the provision of assistance that enable the use or enjoyment of the software constitute a license fee, but payments for the provision of services in connection with the modification or creation of software do not.

As applied, the draft decision states that the provision of assistance necessary for an end-user to exercise the right to reproduce and modify software constitutes a license fee (Example 7); while assistance with the simple use of software is not paid for (example 8).