Income Tax: Character of Receipts in Respect of Software - Meaning of ‘Royalties’

The ATO released draft Taxation Ruling (TR) 2021/D4 (draft ruling) on 25 June 2021. The draft ruling outlines the Commissioner of Taxation's view as to when certain types of software-related payments would be considered royalties for Australian income tax purposes (and therefore possibly subject to royalty withholding tax). However, for the purposes of Australia’s double tax agreements, the definition may be overridden by the definition of 'royalty' in the agreement.

This is an area where existing guidance has not kept pace with technological change. The prevailing guidance prior to the issuance of the draft ruling was nearly 30 years old (TR 93/12 Computer Software now withdrawn). Unfortunately, while the digital economy and the associated tax consequences were somewhat simpler in 1993, the landscape is somewhat more complicated in practice today, which results in the new draft guidance also being more complicated than TR 93/12. 

In an attempt to mitigate this complexity, the draft ruling seeks to provide a number of examples of when payments may or may not be classified as royalties. These examples are intended to cover a wide range of commercial arrangements in order to provide guidance to a broad range of taxpayers.

Software for ‘simple use’

Previously under TR 93/12, the provision of software for ‘simple use’ was treated as a sale of goods and not considered to be a licence of copyright for tax purposes. At the time that the ruling was issued, software was typically contained on floppy discs and sold in ‘shrink wrapped’ boxes, and therefore the ruling took a pragmatic view based on industry practice at the time.

Since then a number of different digital business models have developed as the concept of 'software' has evolved. Further, software has evolved to be distributed not just through retail physical shops or floppy discs, but more commonly via digital download, e.g. distribution via the internet, or via cloud computing where users use the software in the cloud without downloading the software on to individual devices. Although simple use software can no longer be treated as the sale of goods, the draft ruling still generally treats a payment for ‘simple use’ of software as not being a royalty.

When software-related payments are royalties 

However, the underlying software itself, as well as the rights that end users have to modify and utilise the software, have continued to evolve as the digital economy and its products and services have become increasingly complex.

Under the draft ruling, the ATO has formed a view that certain receipts in respect of software (outside of its physical packaging where available) are considered receipts for intangible/intellectual property, and therefore should be considered a royalty payment.

In particular, the consideration that a type of arrangement may constitute a royalty is linked to payment for “the grant of a right to do something in relation to software that is the exclusive right of the owner of the copyright.” This concept of the “exclusive right of the owner” of the software copyright is the key issue in assessing whether a payment should be considered a royalty.

The position adopted by the ATO in the draft ruling has regard to the Copyright Act 1968 when considering the exclusive rights of the owner. This is a somewhat legal interpretation which in practice will leave taxpayers a far cry from the pragmatic guidance of TR 93/12, which may cause compliance problems for some clients.

Summary of examples

The draft ruling indicates that the character of receipts from the licensing and distribution of software will depend on consideration of all facts and circumstances of the particular case. 

The draft ruling contains a number of examples of what amounts are characterised as royalties (or not) illustrated through various scenarios of software that is developed, modified, used, distributed and serviced. The examples in the draft ruling generally include:


Royalty (Y/N)

Licence to reproduce software


Licence to modify software including access to source code


Licence for the simple use of software


Software distribution agreement conferring the right to enter into end user licence agreements (EULA)


Software distribution agreement conferring the right to enter into cloud services agreements


Software distribution agreement not conferring copyright


Services ancillary to the modification of software (particularly in an integrated form without services and software being separately priced)


Services ancillary to the simple use of software


Where there is ambiguity in facts or circumstances, the taxpayer should take reasonable care to determine and where appropriate 'apportion' the amount that may be characterised as royalty. 

Date of application

The draft ruling has been released for a month-long consultation period. Comments are due by 23 July 2021.

Once the ruling is finalised, it is intended to apply to before and after its date of issue, except where it conflicts with the terms of settlement of a dispute agreed to before the date of Issue of the Ruling. 

Further, the ATO recognises that TR 93/12 can be relied upon for periods prior to 25 June 2021 to the extent that taxpayers have previously relied on the earlier guidance.

BDO's observations

Australian taxpayers who make software related payments to non-residents, particularly if they have not previously treated those payments as royalties, need to review historic and current arrangements in light of the draft ruling as a matter of priority.

The draft ruling may cause challenges for taxpayers who operate software distribution based activities who have previously been subject to a Multinational Anti Avoidance Law (MAAL) related restructure that resulted in more revenue and expenses sitting onshore. Consequently, Australian royalty withholding tax may now apply to software-related payments to foreign copyright owners. Before the MAAL restructure such payments would have been paid by non-resident entities and not subject to Australian royalty withholding tax.

Given the broad range of fact patterns to which the draft ruling can apply, and the potential royalty withholding tax impact of existing or new software-related payments, please contact your local BDO Tax or Transfer Pricing expert if you may be affected by this draft ruling.