ATO releases critical guidance on software related payments and intangibles migration arrangements

This article was originally published on the ITR website and is reproduced with permission from the publisher.

In this update, we review crucial new government guidance on tax and related issues involved with software licensing and distribution and intangibles migration arrangements.

On January 17, 2024, the Australian Taxation Office released its updated guidance on firstly, draft Taxation Ruling TR 2024/D1, which deals with the characterisation of payments related to software and related intellectual property rights, and secondly, Practical Compliance Guideline PCG 2024/1 on intangibles migration arrangements.

Earlier ATO guidance on the draft ruling and the PGC has effectively been withdrawn.

Firstly, draft TR 2024/D1 provides the ATO’s views on when cross-border payments related to software arrangements are properly regarded as royalties and thus subject to Australian royalty withholding tax. Generally, the characterisation of cross-border payments as royalties will be determined under the relevant double tax agreement definition and/or the section 6(1) definition in the Income Assessment Act 1936.

There has been significant interest in the taxation treatment of software licensing and distribution arrangements for multinational entities and this draft ruling replaces and updates the earlier guidance provided in draft TR 2021/D4. The ATO has also issued a compendium dealing with responses to issues raised with respect to the previous draft ruling.

The ATO provides specific guidance on when cross-border payments will be characterised as a royalty and includes, amongst other things, consideration paid for:

• The grant of a right to use IP;
• The use of an IP right;
• The supply of know-how or assistance to enable the application or enjoyment of the IP; or
• In certain circumstances, the sale of hardware with embedded software.

The ATO also outlines certain cross-border payments that are not royalties and the likely circumstances in which an apportionment of the consideration between the royalty component and the non-royalty component would be necessary. It also provides various analyses of different scenarios to assist multinational entities.

This draft ruling is critically important for distributors of software-related products and services and the ATO has welcomed comments on the draft ruling on or before March 1, 2024.

Secondly, PCG 2024/1, which deals with intangibles migration arrangements, was finalised and released on 17 January 2024. It replaces earlier drafts PCG 2021/D4 and PCG 2023/D2 and provides important guidance to multinational entities.

The guidance covers the potential application of Australia’s general anti-avoidance rules (including diverted profits tax) or the transfer pricing rules to cross-border related party arrangements involving the migration of intangible assets, and the mischaracterisation and non-recognition of Australian activities connected with intangible assets.

In the updated guidelines the ATO has provided its risk assessment framework which enables taxpayers to assess their risk profile related to the development, enhancement, maintenance, protection and exploitation of intangibles. Importantly, the ATO provides 15 examples of intangibles migration arrangements and sets out its supporting documentation and other evidence expectations.

The draft Tax Ruling and the updated Practical Compliance Guideline each provide critical guidance to taxpayers on tax and related structuring and risk management issues associated with software licensing/distribution and intangibles migration arrangements.

Further, the PCG 2024/1 is separate from and does not address the proposed multinational tax integrity measure associated with non-deductible payments relating to intangible assets connected with low corporate tax jurisdictions as announced as part of the 2022-23 Australian Budget.