Distributor payments deemed software royalties to non-entity
A recent case before the Federal Court of Australia has highlighted the importance of understanding the difference between payments to non-resident entities vs royalty payments. It's an important issue because not understanding the difference can cost the buyer significantly in terms of withholding tax and payments not being deductible.
Payments were made to a Canadian company under a distribution agreement to acquire the source code for a computer program that could then be on-sold to customers. Payments were made by an Australian taxpayer to obtain copies of the software, rather than being given the code by the seller to manipulate and on-sell. Such payments, which are considered royalties for the use of intellectual property, are subject to withholding tax where the payments are made to non-resident entities.
It's a subtle difference but one the ATO interpreted to mean that the buyer should have withheld tax from the payments. By failing to do so, the Australian taxpayer is now liable to pay a penalty equal to the amount they failed to withhold. In a very technical case, the Court applied a very narrow meaning to the term source code.
The issue was whether these payments were consideration for the use of copyright or the right to use source code in a computer program which is limited to enable the effective use of the program by the end user.
This is an important issue because taxpayers that make similar payments without considering the withholding tax implications will end up incurring the economic loss of the withholding tax. This is because royalty arrangements often require the payer to make payments to the copyright provider without withholding tax. This means the taxpayer suffers the economic burden of paying the tax and this is not deductible.
Any misinterpretation of the Australian tax laws means the taxpayer will have miscalculated the cost of receiving the benefit of the royalty.
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Last updated March 2014. This article is provided for information purposes only and should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.
This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.