The case related to payments made by Task to CaseWare International Inc (CWI) for the right to market and distribute CWI software to end users pursuant to end user licences and to make copies of the software for distribution.
The court held that if payments made by Task to CWI under the distribution agreement were royalties, they were subject to withholding tax under the applicable taxing statutes.
According to court documents, the question at trial was whether the payments fell within an exclusion provided by Article 12(7) of the Canadian Double Tax Agreement (DTA), namely whether they were “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”.
Task submitted that the payments were not royalties as a result of the operation of this provision.
The commissioner of taxation issued a notice under section 16-30 of Schedule 1 to the Taxation Administration Act (TAA) to Task to pay an administrative penalty of $352,822 for failing to withhold 10 per cent from the payments as required by Div 12 of Sch 1 to the TAA.
The court found that for the text of Art 12(7) of the Canadian DTA to apply, it was necessary for Task to satisfy two limbs.
First, the payments Task made to CWI under the distribution agreement between Task and CWI had to be made as consideration for (a) the supply of source code in a computer software program or (b) the right to use source code in a computer software program (Art 12(7)).
Second, if the payments Task made to CWI were as consideration for one of those elements, then (and only then) did the proviso in Art 12(7) become relevant. The proviso was that if there was a supply, or a right to use source code, the use of the source code had to be limited to such use as is necessary to enable effective operation of the program by the user (Art 12(7)).
The court found Task had failed to satisfy the first limb and as such consideration of the second limb was not appropriate.
The court found the computer software payments in dispute are in fact subject to royalty withholding tax (RWT).
Craig Cooper, director of tax services, RSM Bird Cameron, said the contractual analysis adopted by the court confirms that software distributors must ensure their distribution agreements are appropriately drafted so they accurately characterise the arrangement, and therefore the nature of the software payments made, in order to avoid the imposition of RWT.
“The decision reflects the judicial difficulty in dealing with the concepts of computer software, source code, object code and the related rights for which computer software payments are made.”
Mr Cooper said he believes that Australian jurisprudence seems to struggle to articulate a clear approach to interpreting domestic tax law where it is affected by international tax obligations to which Australia is subject.
“Irrespective of whether one believes the correct result was reached on the RWT point, the Full Federal Court’s reasoning, with respect, leaves a sense of discomfort. The relevant law was found in the Canadian Double Tax Agreement, but in analysing that provision, the Full Court adopted what was inherently a domestic tax law approach to interpretation."
“Australian taxpayers, the ATO, and ultimately Australian courts will increasingly be called upon to analyse Australian domestic tax law provisions in light of international tax obligations. Greater clarity around the approach to this interaction is required,” Mr Cooper said.