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A controversial draft ruling on software royalties meddles with 30 years of precedent and should be left for the government to decide, they say.
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Experts sound alarm over ‘flawed’ ATO royalty ruling
08 February 2024
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10 minute read
Tax experts have slammed the ATO’s move to expand the definition of a royalty in a draft ruling as “inappropriate”, “deeply concerning” and capable of tarnishing Australia’s international reputation if finalised.
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They said TR 2024/D1, which classed payments made under simple software distribution agreements as royalties, was the culmination of a “deeply concerning” three-year project to change settled tax principles.
“There appears to be a resolute determination to expand the definition of royalty beyond its existing meaning,” tax partner Liam Delahunty, director Liam Telford and senior manager Tristan Hedley wrote on RSM’s website after the ruling was released last month.
“It seeks to significantly expand the definition, particularly by asserting that software distributor providers make cost of sales payments as royalties. It does this by having regard to circumstances that have not previously been relevant in defining royalties.”
Mr Delahunty told Accountants Daily he believed the ATO’s actions were “inappropriate” and that only the government should be able to legislate a shift of that magnitude.
“For a matter that is so significant, this really should be something for the government to pass legislation to make clear what it thinks the position is,” he said.
Instead, he said the ATO had dismissed stakeholder concerns and commercial realities, especially with how it classed “simple distribution agreements” as royalties, “entirely inconsistent” with established principles under TR 93/12.
“While it’s very understandable there is a need to modernise the guidance as the digital economy evolves, this expansive approach is inconsistent with every other major country’s approach and OECD established guidance,” Mr Delahunty said.
He said the expanded definition meant royalty withholding tax would apply to software as a service (SaaS) providers, sellers of digital downloads and physical copies of software, despite already paying income tax and GST.
“The proposed expansion of taxing rights adds a further additional tax which will put us out of step with key trading partners,” Mr Delahunty said, which would harm Australia's international reputation. "There's definitely a sense that Australia is taking it too far."
“There are hundreds, if not thousands of technology providers that are deploying software as a service where this potentially creates issues for Australian subsidiaries. But it doesn’t just affect big tech, but also start-ups selling software that you buy online.”
RSM also took issue with the way the ATO wrote the ruling and its retrospective start date. “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,” it said.
Mr Delahunty said the “flawed” guidance had “missed the mark” by using examples which were uncertain and failed to reflect “commercial reality”.
“The initial ruling provided in 2021 for comment had a number of examples. Some of which were not reflective of commercial reality. The latest guidance significantly reduces the number of examples,” he said.
“This is likely to create uncertainty and potentially litigation to resolve the matter, which will complicate compliance for groups operating in Australia.”
He urged the ATO to reconsider its position before finalising the ruling. “It’s very important the ATO considers submissions and also the position of our key trading partners carefully, and the likelihood of uncertainty arising over the next number of years,” he said.
RSM’s concerns were echoed by other tax experts, including fellow mid-tier firm William Buck which said the ruling created “significant uncertainty” for taxpayers. It said the ruling's retrospective application meant multinational groups would miss their annual compliance obligations that came with offshore royalty payments and also held out little hope of the ATO listening to stakeholder submissions.
It said "it is unlikely that the ATO will significantly change their views” from the draft ruling, after retaining the bulk of its previous ruling, TR 2021/D4.
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