12 September 2014
The Full Court of the Federal Court of Australia recently dismissed an appeal by an Australian software distributor concerning the treatment of payments to a Canadian software licensor as royalties subject to withholding tax. The dispute involved whether or not an exclusion provided for in the Australia-Canada tax treaty was applicable. The dismissal of the appeal effectively upheld an earlier court ruling on the matter.
The Australia-Canada tax treaty article on royalties includes the provision that the term "royalties" does not include payments or credits made as consideration for the supply of, or the right to use, source code in a computer software program, provided that the right to use the source code is limited to such use as is necessary to enable effective operation of the program by the user.
Based on this provision, the Australian distributor submitted that payments to the Canadian licensor under the distribution agreement should be excluded from royalty withholding tax because it had the right to use, and used, the software to produce templates and to procure end user licenses, and that both uses were necessary for the effective use of the software program.
The key element in the court's decision was the distribution agreement between the Australian distributor and the Canadian licensor, which includes a clear distinction between source code and executable code. Under the agreement executable code was provided while source code was not. Therefore, the exclusion provision of the treaty does not apply. As a counter, the distributor claimed that the right to use computer software implies the right to use the source code. The claim that was rejected by the court.
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