When you make a certain payment (eg. dividends, interest and royalties) to non-residents you are required to withhold and remit tax to the Australian Taxation Office (“ATO”). A non- resident can be an individual, company, partnership, trust or super fund.
In relation to the royalty payments you are required to withhold 30% from the gross amount of royalties you pay to foreign residents. However, if the payment is made to resident of a country with which Australia has a double tax agreement (”DTA”), you may be required to withhold less tax or no tax at all. A DTA is a special agreement that Australia has entered into with over 40 countries. The tax treaties prevent the same income being taxed more than once.
If you fail to make the required withholding you may be liable for significant penalties equal to the amount that was required to withhold. Furthermore, no income tax deductions can be claimed for a royalty payment where the liability to withheld has arisen and you failed to comply. Once the required withholding tax has been remitted to the ATO you are entitled to claim a tax deduction for the royalty payment.
In 2014 the Full Federal Court was considering whether the payments that the taxpayer made to a Canadian developer of software were royalties for the purpose of the Australian-Canada DTA and, consequently, subject to withholding tax. The taxpayer argued that the payments were excluded from the definition of royalties under an exception to the DTA. However, the Court found that the payments did not meet the exclusion. As a result, the taxpayer was liable to pay a penalty for failing to withhold tax from the payments for the 2007 to 2011 income years.
Currently, the ATO is conducting reviews of payments made to software developers to examine whether the provisions in relation to royalty withholding tax have been complied with. Furthermore, there is no statutory time limit for the ATO to amend an assessment to recover the shortfall of withholding tax.
If you require clarification or if you receive an audit letter from the ATO, do not hesitate to contact one of our Tax Accountants to obtain further information. You can contact us at The Quinn Group on 02 9223 9166 or fill out an online enquiry here.