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The Commissioner issued Taxpayer Alert TA 2018/2 on 20 November 2018. This alert raises his concerns with arrangements involving the supply of tangible goods and/or services which are connected with the use of intellectual property owned by an offshore supplier or its offshore associate. Below we discuss whether the Commissioner’s approach in TA 2018/2 will apply to all arrangements involving intangible assets in cross-border supply contracts based on the current definitions of a royalty under the tax law.
TA 2018/2 addresses the potential existence of a royalty payment embedded in the consideration which is expressed to be paid solely for the tangible good or service.
Importers and distributors of products sourced from related and unrelated offshore suppliers should review their current arrangements, as TA 2018/2 could potentially apply to them resulting in either transfer pricing adjustments being made (in the case of related parties), or the imposition of Australian royalty withholding tax on payments made to foreign suppliers where there is currently no withholding made.
The article below is a summary of the key points from TA 2018/2.
The ATO’s concern arises in two (2) contexts:
The intangible assets to which TA 2018/2 applies are those defined as such in the OECD
Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 at Chapter IV: Intangibles and include trademarks, copyright, designs, know how, patents, secret formulas or processes or similar property or rights.
These are assets which are:
… property, assets and rights that are not physical assets or financial assets, which are capable of being controlled for use in commercial activities..
TA 2018/2 applies to royalties which meet the definition of ‘royalty’ under subsection 6(1) of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act) or under any applicable Australian tax treaty.
The definition of ‘royalty’ under subsection 6(1) of the 1936 Act is an expanded definition and includes, among other things, the use of industrial commercial or scientific equipment.
The Commissioner states that arrangements which involve related parties exhibit the following features:
Arrangements which involve the supply of finished goods to an Australian entity and the use of an intangible asset is incidental to that supply.
The Commissioner states:
For example, this Alert does not apply to resellers of finished tangible goods where the activity of reselling the goods involves an incidental use of a brand name that appears on the goods and the related packaging. Whether a use is incidental in this sense will depend on an analysis of the true relationship and activities of the parties. The fact that an arrangement fails to expressly provide for the use of an intangible asset does not, in itself, determine that a use is incidental.
It would appear that in the context of distributors of imported finished goods, whereby the Australian distributor is permitted to use the foreign supplier's trademark in the sale of the good, no embedded royalty will be found. Therefore, no Australian withholding tax liability should arise. This is provided that no separate intellectual property right is conferred on the Australian distributor for which a separate payment is made – whether under the global supply agreement, or under a separate licence agreement.
TA 2018/2 contains two (2) examples.
Example 1 involves the following facts:
The Commissioner states that:
This characterisation may not appropriately recognise the exploitation of relevant intangible assets or the functions performed and the risks assumed in connection with those intangible assets.
Example 2 involves the following facts:
The Commissioner has the same concerns as in Example 1.
The Commissioner’s concerns arise in three (3) ways:
The question as to whether intangible assets are being used and in circumstances where there should be a royalty payment is a complex one. It requires not only an analysis from a tax perspective, but a very clear and comprehensive understanding of the nature of the arrangements themselves – and whether intangible assets are in fact being used in a way that warrants a separate royalty payment.
For supply arrangements whereby the supplier seeks to place restrictions and burdens on the Australian recipient as a means of protecting their intangible assets rather than to confer on the Australian recipient positive rights of use of intangible assets, these arrangements should attract a different characterisation to that which TA 2018/2 gives. These arrangements may well properly fall outside the royalty withholding tax regime on the basis that there is no such use of intellectual property under the relevant definitions contained in the tax law.
Australian distributors and manufacturers should therefore carefully review their cross-border supply arrangements to determine the risk of TA 2018/2 applying to their arrangements.
 TA 2018/2 can be accessed via the link: https://www.ato.gov.au/law/view/pdf/tpa/ta2018-002.pdf
 Refer to TA 2018/2.
 Section 26-25 of the 1997 Act denies a deduction for an interest or royalty payment where there has been a failure to withhold an amount under the TAA.
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