Taxing intellectual property for multinationals in Australia: international misalignment?

Angela Wood

Clayton Utz, Melbourne

anwood@claytonutz.com

Andy Bubb

Clayton Utz, Melbourne

abubb@claytonutz.com

Amahl Weeramantry

Clayton Utz, Melbourne

aweeramantry@claytonutz.com

The Australian Taxation Office (ATO) continues to focus on multinationals and profit shifting, with a strong emphasis on the taxation of intellectual property (IP). Some elements of its views are likely to be at odds with those of the Organisation for Economic Co-operation and Development (OECD), creating a material risk that taxpayers will need to seek relief through a mutual agreement procedure (MAP), where it is available.

Key updates include:

• the ATO’s views on software arrangements, including its draft public ruling and a forthcoming practical compliance guideline (PCG);
• ATO litigation involving Pepsi, Oracle and Coca-Cola; and
• emerging issues in regard to ATO audits, including related to the use of servers and other IT infrastructure.

With Australia being a jurisdiction with a high corporate tax rate (30 per cent), the ATO’s primary concerns are typically:

• the potential for transfer mispricing; and
• the mischaracterisation of payments as not including a royalty and, therefore, not subject to royalty withholding tax (RWT).

The ATO typically reviews the arrangements of multinational groups using a combination of transfer pricing, withholding tax, anti-avoidance rules and various other substantive provisions. 

The ATO’s views on royalties

The ATO first moved on royalties for the technology sector in 2021, withdrawing Taxation Ruling (TR) 93/12 and replacing it with draft TR 2021/D4 on software arrangements.[1] TRs express the ATO’s interpretation of the law and are binding on the ATO, meaning a taxpayer is protected from any tax and penalty consequences if it acts in accordance with the ATO’s views set out in the TR. The updated draft ruling was significantly more detailed than the previous version, which in broad terms had provided that the simple use of IP would not result in RWT being payable. The update took a rights-based approach, analysing whether the actions of the Australian entity would require a licence from the copyright owner in order to not be in breach of Australian copyright law. Any actions which would require such a licence are said to result in a royalty and, therefore, the application of RWT. 

Three years later, the ATO issued an updated draft TR 2024/D1.[2] The ruling was more expansive, further explaining the circumstances that would trigger a royalty in the ATO’s view under Australian copyright law. This update was focussed on situations where an Australian entity exercises rights that would not be permitted under Australian copyright law without it having a licence from the copyright owner. The examples given included situations in which an Australian entity did any of the following acts:

• reproduce the work in a material form (eg, installing software on a computer or device);
• communicate the work to the public (eg, making software available through cloud-based technology);
• make an adaptation of the work or a substantial part of it;
• enter into a commercial rental agreement; or
• authorise one of the above acts.

The United States Department of the Treasury has written to its Australian counterpart to express its concern that the ATO ‘continues to advocate interpretations of the Australia–US tax treaty that conflict with both the terms of the treaty as well as the Commentaries to the OECD Model Tax Convention’.[3]

The views set out in the draft ruling, as flagged above, take a position beyond those expressed by the OECD. In particular, the most significant disconnect occurs in relation to multinationals who have traditional software distribution models. In these scenarios, the distribution activities of the Australian entity, although not having any right, title or interest in respect of the software, may be treated by the ATO as giving rise to a royalty.

The ATO’s interpretation may be most problematic where it is inconsistent with that of other jurisdictions, particularly under a double tax treaty where the counterpart nation characterises the income as business profits and not royalties. This may cause further difficulties for taxpayers when seeking to access foreign income tax offsets.

While both draft rulings explain the circumstances in which the ATO considers a royalty to arise, neither addresses the difficult question of how any implied royalty might be calculated. This question arises in the Pepsi and Oracle litigation (discussed below) and the ATO may address it, in part, in its forthcoming PCG. The PCG will outline the ATO’s administrative approach to assessing the risk level of taxpayers’ software arrangements. The ATO has publicly stated that the PCG will include:

• a safe harbour for certain specified arrangements that involve the use of copyright by an end user or tangible goods, using the example of washing machines or cars; and
• a risk assessment calculation that compares the amount of any recognised royalty against the relevant costs of the offshore entity (no more specific details are available yet). 

The ATO’s rulings and PCG, as mentioned above, both concern software arrangements, for which copyright law is the most relevant. However, the ATO may apply a similar approach to taxpayers using other forms of IP, such as trademarks or patents, asking whether the Australian entity performs any activities that would require a licence to use that IP.

The ATO has put the finalisation of TR 2024/D1 and the PCG on hold until after the High Court of Australia has issued its judgment in regard to the Pepsi litigation. 

ATO litigation: the Pepsi, Oracle and Coca-Cola cases

Cases between the ATO and Pepsi, Oracle and Coca-Cola are currently progressing through the Australian courts and related to the application of RWT.  

Pepsi

On 2 and 3 April 2025, the High Court of Australia heard the ATO’s appeal in the Pepsi matter. The case concerns whether RWT or the diverted profits tax (DPT) applies to Pepsi's arrangements with Schweppes Australia. The case is the first in relation to Australia’s DPT, which commenced from July 2017. The DPT forms part of Australia’s general anti-avoidance provisions and is designed to ensure that the tax paid by multinationals reflects the economic substance of their activities in Australia.

Broadly, Pepsi US entered into a ‘royalty-free’ bottling arrangement with Schweppes. The parties contractually agreed to pay solely for concentrate, with a royalty free IP licence to use the associated IP (eg, bottling instructions, trademarked brand names and labelling). Under the bottling agreement, Pepsi Australia was nominated as the seller of concentrate to Schweppes; all payments for concentrate were made by Schweppes to Pepsi Australia.

The RWT issue involves the High Court needing to confirm the correct approach for identifying an embedded/implied royalty, including taking into account past cases on the meaning of ‘consideration’. The ATO also argues that the DPT applies because the principal purpose of the structure was to avoid RWT. 

A judgment is expected in the second half of 2025. The High Court is Australia’s superior court, so it will provide significant authority on these issues. Of the seven justices, two are former preeminent tax barristers (Justices Gordon and Steward), so they bring a particularly high degree of understanding of the competing arguments.

Oracle

This case primarily concerns the meaning of royalty in the software context, so it will be highly relevant to the ATO’s draft ruling and PCG. Oracle Australia purchased software and hardware from Oracle Ireland in return for a sublicence fee, including for the use of computer programs copyrighted by Oracle Ireland.  

The Federal Court of Australia has not yet engaged with the substantive royalty issue; however, the Federal Court refused to grant a stay in Oracle’s litigation against the ATO, which carries implications for multinationals considering their tax dispute resolution options in Australia.[4] Oracle had sought the stay so that a MAP (and possibly binding arbitration) between Australia and Ireland under the tax treaty could continue. Oracle has appealed the judgment to refuse a stay to the Full Federal Court.

The ATO’s evidence in Oracle was that there are approximately 15 other taxpayers whose software distribution arrangements require consideration of the definition of royalty for Australian tax purposes. In these circumstances, the Court highlighted that a judicial determination of the royalties question would be of public interest.

Coca-Cola

Although no court documents are on the public record yet, Coca-Cola has also filed proceedings against the ATO in connection with what has been reported as a case having similar issues to that of Pepsi. No hearing date has been set yet, so the case may not be heard until 2026.

Emerging issues in regard to ATO audits

In addition to the ATO’s focus on the abovementioned issues, we are seeing the ATO develop its thinking in relation to how the technology sector might be taxed in Australia. One example is whether certain technology infrastructure that is located in Australia, with involvement to some degree by an offshore parent company, might result in a permanent establishment in Australia for the parent company. The ATO has made public comments about this in connection with the use of data centres.[5] There is not yet any tax-related case law on these issues and we are not aware of any in the pipeline, meaning that the amounts at stake are likely to be very significant by the time a court weighs in on these issues. 

Conclusion

The ATO’s focus on these issues is likely to only intensify following the High Court’s judgment in Pepsi and with the progression of the Oracle litigation. The ATO’s decision to not finalise its draft ruling or PCG pending Pepsi reflects the current go-slow approach on these issues; however, the ATO nonetheless continues to gather information and form views about other taxpayers. Multinationals may find that the ATO speeds up considerably following the forthcoming judicial guidance. 

While the law (and the ATO’s views) remains in a state of flux, multinationals with operations in Australia, particularly those in the technology space, may benefit from reviewing any historical arrangements in light of TR 2024/D1 to assess whether the ATO may view any arrangements as high risk.