Finding the green: Draft ATO PCG sets out low-risk software payments

The Australian Taxation Office (ATO) has released draft Practical Compliance Guideline PCG 2025/D4, which sets out when the ATO will consider certain cross-border software payments to be ‘low risk’ for royalty withholding tax purposes (Draft PCG).

The Draft PCG is a welcome development and introduces a two-zone risk framework (white and green), which offers a practical ‘safe harbour’ for taxpayers that fall within these categories.  The ATO will not apply resources to review ‘low risk’ arrangements which fall within these zones.  The Draft PCG is designed to be read together with Taxation Ruling TR 2024/D1, which sets out the ATO’s position on when an amount paid under a software arrangement is a royalty and subject to royalty withholding tax. While these low risk clarifications are welcomed, considerable legal uncertainties remain in respect of a number of software payments.

The Draft PCG is open for comment until 17 September 2025.

Background

Over the past five years, the ATO has been iteratively revising its public advice and guidance in relation to payments for software and intangibles arrangements more broadly.  This guidance has included:

• the ATO’s income tax ruling concerning the character of payments in respect of software and intellectual property rights (TR 2021/D4, which was revised as TR 2024/D1 (see KWM Insight here));
• the ATO’s practical compliance guideline concerning the mischaracterisation and migration issues for intangible assets by international related parties (PCG 2021/D4, which was replaced by PCG 2023/D2 (see KWM Insight here) and PCG 2024/1 (see KWM Insight here)).

In parallel with these regulatory developments, there has also been:

• the release of exposure draft legislation aimed at preventing multinationals from claiming tax deductions for payments relating to intangibles connected with low corporate tax jurisdictions (see KWM Insight here). This measure will no longer be proceeding; and
• Federal Court cases that have raised these issues, including Oracle Corporation Australia Pty Ltd v Commissioner of Taxation (Stay Application) [2024] FCA 1262 (see KWM Insight here) and PepsiCo, Inc v Commissioner of Taxation [2024] FCAFC 86 (PepsiCo) (currently pending decision in the High Court of Australia) (see KWM Insight here).

Against this backdrop, the ATO has now released the Draft PCG.

Summary

The Draft PCG is designed to allow taxpayers to self-assess their compliance risk when determining whether a cross-border payment made to a non-resident relating to software is considered a royalty and subject to withholding tax.  In this case, the guidance provides a ‘white zone’ where further risk assessment is not required, and a ‘green zone’ where the ATO won’t review an arrangement other than to confirm that it falls within the zone.

The guidance also contains several examples of arrangements which are categorised in the ‘green zone’:

Observations

1. Concise guidance albeit uncertainty remains: As requested through the consultation process in relation to Draft TR 2024/D1, the Draft PCG provides concise, clear and specific guidance for a defined set of arrangements, such as private use and ancillary business use, which are included in the no risk, or low risk, category of cross-border software arrangements. As was also requested in the consultation process, the ATO has provided a series of clear examples of scenarios in which the ATO is unlikely to take compliance action.  While we welcome these safe harbours, it would be preferable for such examples to also be reflected in the finalisation of Draft TR 2024/D1. Considerable legal uncertainties remain in respect of a number of software payments.
2. ATO’s approach towards judicial authority: The ATO intends that PCG 2025/D4 will continue to apply irrespective of the High Court’s decision in the PepsiCo appeal, albeit the ATO has recognised that it may, if necessary, need to update Draft TR 2024/D1. In this context, the ATO makes the comment that “[W]e must apply the law in accordance with Federal or High Court authorities”. This is a welcome acknowledgement in light of recent controversy within the tax community on the status of intermediate appellate court authority.
3. A partial return to ‘simple use’: The ‘green zone’ appears to reintroduce aspects of the ‘simple use’ safe harbour that was a feature of the ATO’s previous software ruling TR 93/12. By specifying that payments for purely private/domestic use software, internal, generally-available business tools, shrink-wrap copies acquired for resale, and finished goods with incidental embedded code are low risk, the ATO has implicitly acknowledged that many day-to-day software purchases and uses do not raise royalty issues. This is welcomed and will be a relief for many businesses that were not clear on what the ATO’s expectations were in relation to their standard software licences as a consequence of statements in Draft TR 2024/D1. This is in direct contrast with the ‘alternative views’ set out in Appendix 2 of Draft TR 2024/D1, which rejected the ‘simple use’ concept, and demonstrates a practical approach on the part of the ATO.
4. Australian distributors of software and the ATO’s approach towards IP law: The confirmation that certain use cases are ‘low risk’ is welcomed. However, we consider that many of these examples do not involve the exercise of IP rights and that it would be preferable for such concessions to also be reflected in the finalisation of Draft TR 2024/D1. For example, Example 3 indicates that payments by Australian distributors to offshore software wholesalers for the right to distribute software on physical media, where the Australian distributors do not have rights to copy, modify or sublicence the software, are low risk arrangements. The ATO’s guidance does not consider circumstances in which an Australian distributor makes payments for the right to distribute copies of a software program otherwise than in physical form, but it is difficult to see a policy reason for treating the distribution of software in physical form and electronic form in different ways. The ATO’s approach in relation to Example 3 should be consistent with the position that payments made by an Australian entity to an offshore entity for SaaS offerings should not be regarded as ‘royalties’ in circumstances where the Australian entity acts merely as a reseller of the software.