Impending changes to guidance for royalty withholding tax on software licences after Oracle decision

The Oracle decision clarifies that where there’s a dispute about the existence of a royalty, the parties may apply for a stay of the domestic proceedings to first exhaust their rights under the MAP. 

The underlying royalty case involved the copyright in software programs owned by Oracle Ireland, which it licenced to Oracle Australia, who then distributed the programs throughout Australia. Under various agreements, Oracle Ireland granted Oracle Australia a right to market, promote, distribute, sell and, in some cases, copy, licences for certain software programs. Oracle Australia was permitted enter ‘end user licences’ for the software programs and use the programs to provide training/support to end users, grant trials and in some cases, reproduce the programs. As consideration for the provisions of these rights, Oracle Australia paid a fee to Oracle Ireland calculated in accordance with the revenue and costs of the program.

Oracle Australia did not withhold royalty withholding tax on the licence fee. The Commissioner held that the licence fee was a royalty under the double tax agreement between Australia and Ireland (DTA) and imposed a penalty on Oracle Australia for failing to withhold tax from the payments of the licence fee. Penalties for failure to withhold royalty withholding tax are equal to the amount that should have been withheld.

Oracle Australia began the objection process in Australia’s domestic legislation, while Oracle Ireland requested the MAP which is available under the terms of the double tax agreement between Australia and Ireland (DTA). The MAP aims to prevent double taxation by allowing the relevant jurisdictions to negotiate directly over certain tax liabilities outlined in the DTA. 

The Full Federal Court allowed a stay of the domestic proceedings, noting that they could not continue at the same time as the MAP and the taxpayer should have a choice as to which proceedings to pursue.

A key issue in both the Federal Court and Full Federal Court hearings was the complexity, confusion and inconsistency around the definition of ‘royalty’ and the application of royalty withholding tax in the context of software. This was raised by the Commissioner who argued that the Oracle decision is critical to the application of Australian copyright law and that a determination would provide guidance to both the ATO and taxpayers about the application of royalty withholding tax. 

The Commissioner noted that there is tension with the USA Treasury about Australia’s approach to the taxation of software distributions particularly in relation to the Commissioner’s position documented in Draft Taxation Ruling TR 2024/D1. He also noted that the USA Treasury has gone so far as to write to the Commissioner of Taxation to ask that the TR 2024/D1 be withdrawn or revised.

Despite this, the Full Federal Court was not convinced that this should cause an urgency for the domestic proceedings to continue and noted the facts in Oracle are specific to the taxpayers.

However, the case serves as a warning to taxpayers licencing software internationally to carefully consider the application of royalty withholding tax given the complexities in interpreting the legislation. It also indicates that the Commissioner may well issue further updates to TR 2024/D1 in light of pressure from the USA and taxpayers should expect changes to the draft when the final taxation ruling is issued.