Australia: Software Licence Agreement – Definition of royalties under the Australia/US tax treaty

Last Updated: 8 May 2011


The recent Federal Court decision in International Business Machines Corporation v FCT [2011] FCA 35 demonstrates a potential reversal of the ATO's practice towards royalties in respect of payments made under software licensing and/or distribution agreements. Taxpayers should carefully review the terms of their existing, or proposed, software licensing/distribution arrangements to ensure that they are treating the payments correctly for royalty withholding tax purposes in light of this decision.


Under Australian domestic taxation law, royalties paid by an Australia resident to a foreign resident are subject to withholding tax under section 128B(5A) of the Income Tax Assessment Act 1936 (ITAA36). These provisions are subject to the terms of any applicable double tax agreement.

The application of the royalty definitions in both Australian domestic tax law and its tax treaties to arrangements involving software has been an area of much uncertainty in recent years.

In this regard, the Australian Taxation Office (ATO) released Taxation Ruling TR 93/12 in May 1993, which outlined its views on the nature and assessability of payments from the marketing of computer software, in particular in relation to whether or not such payments are royalties. In addition, the OECD in its more recent versions of the Model Tax Convention has included detailed commentary on the application of 'Article 12: Royalties' to software arrangements.

However, until the IBM case, there had been little to no judicial consideration in Australia of the circumstances in which payments under a software licence and/or distribution arrangement will constitute a 'royalty' for withholding tax purposes. Although there have been cases considering the interpretation and application of Australian treaties, for example, McDermott Industries (Aust) Pty Ltd v FCT (2005) ATC 4398 and Unisys Corporation Inc v FCT (2002) ATC 5146, these cases considered different matters such as permanent establishment issues. For these reasons, many taxpayers have relied on ATO administrative practice to date in respect of software license boundaries,  however, this will likely not be the appropriate position following the IBM case.


The relevant facts were as follows:

The two taxpayers, International Business Machines Corp (IBM Corp) and IBM World Trade Corporation (IBM World) (together, the US Corporations) were both US-resident corporations.

Under a Software Licence Agreement (SLA) signed on 1 April 1987, the US Corporations granted various rights to an Australian subsidiary, IBM Australia Pty Ltd (IBM Aus), in respect of the use, distribution and marketing of IBM software. In consideration for these rights, IBM Aus paid a fee equal to 40% of its sales revenue.

From 1987 to 31 December 2002, IBM Aus remitted royalty withholding tax to the ATO, on the full amount of the payments under the SLA at the then applicable rate of 10%.

For the period 1 January 2003 to 31 December 2004, IBM Aus only remitted royalty withholding tax on part of the payments under the SLA, at the rate of 5% (which applied from 1 July 2003) in accordance with a binding private ruling it obtained from the ATO.

Following the expiry of the private ruling, IBM Aus continued to withhold tax from the payments under the SLA on the same basis as in the private ruling. On 12 May 2006, IBM Aus sought a refund of part of the withholding tax paid to the ATO for periods prior to the application of the private ruling, on the basis that part of those payments did not constitute 'royalties'.

The ATO rejected the refund request and subsequently applied royalty withholding tax to the full amount of the payments under the SLA, starting from the date that the private ruling expired. The taxpayers sought declarations from the court that they were only liable to withholding tax on part of the payments received under the SLA.

Key Issues

The key issue in this case was whether the whole amount or only part of the payments made by IBM Aus to the taxpayers under the SLA constituted 'royalties' for the purposes of the Treaty.


Based on the language of the SLA and the nature of the rights it granted, Bennett J held that the full amount of the payments received by the US Corporations under the SLA constituted royalties for the purposes of the Treaty and were thus wholly subject to withholding tax. In her judgment, Bennett J summarised the definition of "Royalties" in Article 12(4) of the Treaty, as payments for:

  • the use or right to use an IP right (whether exercised or not);
  • the use or right to use another like property or right;
  • the supply of certain knowledge/information; or
  • assistance furnished to enable the application or enjoyment of an IP right or certain knowledge/information.

Her Honour reviewed the SLA and determined that it granted various rights to IBM Aus that would give rise to a royalty, including:

  • (Non-exclusive rights 'under IBM's Copyrights, Mask Work Rights, and Patents' to licence and distribute copies of IBM software) These allowed IBM Aus to carry out matters that would otherwise infringe the various IP rights held by the US Corporations. Although IBM Aus could have potentially distributed the software without infringing those IP rights, the SLA was drafted in such a manner to ensure that any rights as were necessary were granted. Thus, payments under the SLA that were attributable to these rights fell within Article 12(4)(a)(i) of the Treaty;
  • (The right to use all of IBM's Trademarks) For the same reasons in relation to the rights above, payments under the SLA that were attributable to these rights also fell within Article 12(4)(a)(i) of the Treaty;
  • (Access to the 'knowledge and technical knowhow' of the US corporations) Payments under the SLA that were attributable to these rights clearly fell within the definition of royalties in Article 12(4)(b)(i) of the Treaty, as payments for 'the supply of scientific, technical, industrial or commercial knowledge or information owned by any person'; and
  • (Ancillary matters) Payments under the SLA that were attributable to the supply of assistance of an "ancillary or subsidiary nature" fell within the definition of royalties in Article 12(4)(b)(ii) of the Treaty.

Importantly, Bennett J rejected the taxpayers' submission that the SLA also granted a distinct 'right to distribute', separate from the IP-related rights above. In this regard, her Honour stated that the SLA did not 'look like a distributor licence', as contended by the taxpayers. In particular, there was no reference in the SLA that the payments were for the grant of general distribution rights. Rather, the detail of the SLA concerned the IP rights to be granted to IBM Aus. The subject matter of the SLA was the grant of these IP rights and not the grant of rights to use, distribute and market the software.

Thus, taking the whole of the SLA into account, Her Honour held that it was clear that the SLA granted all IP rights to IBM Australia as were necessary for the distribution of the relevant software products. The SLA was not a distribution agreement which conferred distribution rights independently of the grant of IP rights. Any distribution rights granted by the SLA were referable to, and part of, the bundle of IP rights granted under the SLA.

On this basis, Her Honour held that the whole amount of the payments made under the SLA were royalties for the purposes of the Treaty.

We note that the taxpayers have not yet indicated whether they will appeal the decision although we consider it likely.

Implications for taxpayers

Taxpayers should be aware that the ATO may potentially be adopting a more aggressive position in respect of the application of royalty withholding tax to software licence and distribution arrangements. Even if taxpayers have previously obtained a favourable private ruling in respect of royalty withholding tax, there is a risk that the ATO will adopt a more aggressive approach once the ruling has expired.

In this regard, foreign residents that have entered, or are intending to enter, into software distribution arrangements with an Australian distributor should carefully review the terms of their existing, or proposed, arrangements to ensure that they are treating the payments made by the Australian distributor correctly for royalty withholding tax purposes.

In particular, if the foreign resident does not intend to grant any IP rights (or other rights that can give rise to a royalty) under its software distribution arrangements, it is critical that the relevant agreement be drafted appropriately such that it is clear that the agreement is for the grant of distribution rights only and no rights in the IP are granted to the Australian distributor.

Alternatively, if the taxpayer intends to provide separate distribution rights and IP rights to the Australian distributor, the relevant agreement should be appropriately drafted such that it is clear that two distinct rights are being granted, with only the payments attributable to the IP rights constituting a royalty. Another option may be for two separate agreements to be prepared – one for the distribution rights and the other for the IP rights.

© DLA Phillips Fox

DLA Phillips Fox is one of the largest legal firms in Australasia and a member of DLA Piper Group, an alliance of independent legal practices. It is a separate and distinct legal entity. For more information visit

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.