🌏 Should a domestic definition of royalties be able to expand on the definition found in (a) bilateral tax treaties or (b) international tax practice?
By and large, Latin American tax treaties follow the United Nations Model Convention when it comes to Art. 12 (“Royalties”). Unlike its equivalent in the OECD – OCDE Model Convention, Art. 12(2) of the UN Model enables the source jurisdiction – oftentimes a net capital importer – to impose a WHT on royalty payments made to a beneficial owner in the treaty partner jurisdiction. This makes it all the more important to accurately distinguish between “business profits” (which would be subject to Art. 7(1) in the absence of a PE) and “royalties”. The former would be unburdened by a local WHT while the latter would be subject to a WHT.
In the cover piece of Tax Notes International this week, Vincent Ooi and Kerrie Sadiq discuss a draft ruling issued by the Australian Taxation Office (ATO) in which the agency outlines its views on when an amount paid under a software arrangement is subject to a local WHT. The article is titled “Australia’s Definition of Royalties: Overreach or Evolution?” and here are some of its highlights:
➡ The ATO draft ruling was released in January 2024 (https://bit.ly/4d0sV03). Apart from the more usual definitions of royalties (e.g., use of IP rights), the ATO includes in the list “the sale by a distributor of hardware with embedded software, where the distributor is granted or uses rights in the IP of the software.”
➡ The key point of the draft ruling, however, is the ATO’s view that “if a software distributor is granted the right to do something regarding software that is the copyright owner’s exclusive right, the payment made for that right constitutes a royalty.” Even if the contractual rights provided to the distributor do not include the right to modify or adapt the distributed software.
➡ Among the rights that are exclusive to the copyright owner is what the ATO calls the “authorisation right”. The ATO’s position is that “a payment by the distributor for the right to authorize another person (such as the end user) to use the copyright in the software [is] a royalty because the payment is for the right to do something regarding software that is the exclusive right of the copyright owner.”
➡ In terms of whether this conflicts with tax treaties or not, the ATO finds that “the standard tax treaty definition of royalty contains the term ‘copyright’ but does not define it.” Therefore, it follows that “the term is undefined and can take its meaning from the domestic definition in Australian income tax law.”
The authors say that it is unlikely that the ATO will change its views on any finalized version of the ruling. They also explain that the Australian Full Federal Court’s decision in the Pepsi case (favorable to the taxpayer) adds to the uncertainty for MNEs operating in the country. Their article is available here: https://bit.ly/4fkhi5P
