ATO in stand-off with US tech giants over software tax grab

The Australian Taxation Office is in a stand-off with the US trade agencies and tech giants over plans to tax billions of dollars’ worth of software transactions for the first time – a move that the US Treasury has warned could trigger a treaty dispute between the two countries.

The issue arose because software is no longer sold in a box with manuals – the transaction is now all digital. As a result, the Tax Office has been developing a new ruling on payments for software, focusing on what it sees as the substance of what consumers pay for: intellectual property.

The change to how consumers buy software has led the Tax Office to target billions of dollars’ worth of software transactions for the first time. Credit: AP

The problem for foreign tech groups is that this means a royalty withholding tax (RWT) now applies. For US companies, this would mean the payment received from their distributors would attract a 5 per cent tax if it is deemed to be IP-related, not payment for services.

The ATO’s proposed ruling has been described by US trade groups such as the US National Foreign Trade Council as “gross overreach”. The US Council for International Business has called it “highly destabilising and contentious for cross-border business and transactions with Australia”.

In 2022, the US Treasury said it had “strong concerns” over an earlier iteration of the proposed change as it was contrary to long-standing internationally accepted treaty interpretation and warned that if the draft ruling was applied, it “could lead to treaty disputes”.

“Such an interpretation would also create a concerning imbalance in the benefits provided under the Australia tax treaty,” it said.

Local law firms have also weighed in.

“This is likely to capture arrangements businesses would not otherwise consider to be royalties (such as subscription fees for a software as a service (SaaS) solution),” KWM partner Jerome Tse said on the law firm’s website in January.

The National Foreign Trade Council’s head of international tax policy, Anne Gordon, described the measure as gross overreach and said the impact for its members, which include Microsoft, would be significant.

“I can tell you it is billions of dollars in transactions” that would be affected, Gordon said, without saying which members would be impacted. “For NFTC members, the revenue (tax) impact could be somewhere in the $US100 million range.”

Microsoft declined to comment.

The Tax Office has explained its reasoning for the change that has drawn so much ire.

“The ATO is concerned that some multinationals involved in software distribution have mischaracterised payments as a payment for a service (not subject to RWT), rather than as a payment for the use of intellectual property (and a royalty subject to RWT),” a spokesperson said.

The nub of the matter is that the Tax Office considers a software payment as a royalty – and subject to the withholding tax – where it is the “right to use any copyright or other kinds of IP”. It did acknowledge the pushback from the tech industry and its supporters.

Software used to come in a box with manuals, but its switch to being sold predominantly online has caught the ATO’s attention.Credit: AP

“The view of many stakeholders who made submissions to the ATO during consultation is that the payments are not royalties which would be subject to Australian RWT and are instead payments for services.

“The draft ruling was open for public comment until 1 March; we are currently carefully considering the responses we have received. We are grateful for the detailed feedback provided to us during the public consultation period,” the ATO said.

What is not known is if the US Treasury is still at odds with the proposed change.

In August 2022, a US Treasury Department official wrote to Australia’s top official in charge of Treasury’s corporate and international tax division, Marty Robinson, expressing its concerns over an earlier version of the draft ruling.

“We are concerned that the preliminary views expressed in the draft ATO ruling, if applied by Australia to interpret the US-Australia tax treaty, could lead to treaty disputes,” it said.

The US Treasury did not respond to inquiries. The Australian Treasury Department said the issue was a matter for the ATO.

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