Putting royalties on the map: Oracle denied stay of domestic tax proceedings

Cross-border payments made by multinational software companies with operations in Australia, usually to related parties, remain a key area of ATO focus.  The controversy with the ATO is whether such payments are subject to royalty withholding tax. The ATO has released two versions of a draft tax ruling titled ‘Income tax: royalties - character of payments in respect of software and intellectual property rights’ (the latest being TR 2024/D1 – see our January insight article here), which continues to create political controversy, including with the US Department of Treasury and amid submissions that the draft ruling is contrary to accepted OECD principles.  These legal issues are at the centre of the dispute between the Oracle group and the ATO, with at least 15 other multinationals facing similar disputes with the ATO.

Late last week, the Federal Court denied an application by the Oracle group for a temporary stay of domestic tax proceedings pending the conclusion of a mutual agreement procedure (MAP) under the Ireland-Australia double taxation agreement (DTA). A MAP is a formal tax process of treaty negotiations between Australia and the counterparty country.  In Oracle Corporation Australia Pty Ltd v Commissioner of Taxation (Stay Application) [2024] FCA 1262 (Oracle) Perram J determined that the “powerful considerations” (at [82]) ordinarily operative in favour of granting a stay of domestic proceedings pending resolution under a MAP were in this case outweighed by the public interest in a final appellate determination of what constitutes a “royalty” for the purposes of Australia’s numerous tax treaties.

Key takeaways

Resolving disputes via Australia’s treaty network vs Australia’s domestic judicial processes

Under Australia’s broad DTA network, global technology companies can elect to resolve certain cross border tax disputes through a MAP. Some double taxation agreements also allow for binding arbitration between the countries should the MAP negotiations fail.

However, the ATO cannot agree to an outcome in a MAP if an Australian court has already determined the dispute. Accordingly, while it is important strategically for a taxpayer to protect their right to pursue domestic litigation should a MAP or arbitration be unsuccessful by commencing domestic proceedings within statutory time limits, it is also normally in a taxpayer’s interest to seek a stay of those proceedings to allow the MAP to proceed. This is because MAPs can often take some years to resolve.

Our experience is that taxpayers can negotiate an agreed approach with the ATO or, if necessary, the Court, to prioritise MAP. This was not the case in Oracle however. Given the unique factors applicable to Oracle’s dispute, Perram J decided not to grant a stay of domestic proceedings, thus giving the proceedings primacy over any bilaterally agreed resolution.

Where to from here?

Recognising the outcome was perhaps controversial, Perram J also granted leave for Oracle to appeal the decision to the Full Federal Court. It is likely that Oracle will do so. In the meantime, those interested in this controversy will be keenly waiting for the High Court’s decision on whether to grant special leave to appeal PepsiCo, Inc v Commissioner of Taxation [2024] FCAFC 86 (PepsiCo), which also involves (purported) royalty payments for the use of intellectual property.  We expect the High Court to provide an update this half of November.

Background to Oracle dispute

The underlying dispute between the Oracle group and the Commissioner of Taxation concerns whether sublicence fees paid by Oracle Corporation Australia Pty Ltd (Oracle Australia) to Oracle Capac Services Unlimited Company (Oracle Ireland) under intercompany licencing arrangements – whereby Oracle Australia purchased enterprise software and hardware from Oracle Ireland and distributed these products in Australia - should be characterised as “royalties” within the meaning of Article 13(3) of the Ireland-Australia DTA (and therefore be subject to royalty withholding tax).

Unsurprisingly, the Commissioner considers they should, and has issued notices of non-resident royalty withholding tax to Oracle Ireland, as well as imposed penalties on Oracle Australia of around A$253m for failing to withhold amounts from the (alleged) royalty payments. In response, Oracle Ireland enlivened the MAP under the Ireland-Australia DTA (as modified by Article 16 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI)). Meanwhile, Oracle Australia, facing a 60-day time limit to do so, appealed to the Federal Court against the disallowance of its penalty objections.

The Oracle companies then applied for a temporary stay of the Australian proceedings to permit the MAP, including any binding arbitration proceedings, to reach its conclusion.

Further observations and implications

• The Federal Court has emphasised that the right to elect between the MAP and domestic proceedings ordinarily lies with the taxpayer. A competent authority such as the ATO should not generally be able to use time limits under domestic legislation to force a choice against MAP and in favour of domestic litigation.
• There is considerable force in the proposition that a Court should exercise its discretionary power to stay proceedings in cases where a taxpayer has commenced domestic proceedings to meet a time limit (for example, under section 14ZW of the Taxation Administration Act 1953), thereby permitting a MAP to proceed if that is what the taxpayer chooses. In our view, this should give taxpayers with current MAP negotiations on foot comfort that, absent some unique factor (such as those outlined below), the MAP and possibly arbitration proceedings should take precedence over domestic Part IVC litigation.
• Notwithstanding that the clear policy intent of Australia’s DTAs and the MLI (and of their incorporation under Australian law) is to permit taxpayers to choose between domestic remedies and MAP,^[1] Perram J ultimately considered that there were two unique factors weighing against the exercise of the Federal Court’s discretion to permit a stay in this case. The need for “a final appellate judicial determination of the [royalties] issue” (at [83]) was determinative in circumstances where:

1.  the ATO gave evidence that there were approximately 15 other taxpayers whose distribution arrangements required pressing judicial consideration of what constitutes a “royalty” under Australia’s DTAs (his Honour considered “a series of 15 arbitrations would give no guidance on the correct answer and each decision would provide no guidance to the Commissioner as to what he was to do with the other cases” (at [66])); and

2.  the ATO’s approach to the characterisation of royalties, particularly in the context of software distribution arrangements, has created friction with the United States – Perram J noted in particular the “strong concerns” regarding the ATO’s broad interpretation of royalties expressed by the US Department of Treasury in two letters to the Australian Government in 2022 and 2024 (at [63]).

• This decision follows our commentary (for instance, the insight article we published in May 2023) that the ATO’s increasing focus on intangibles (most recently in the aforementioned Draft TR 2024/D1), and in particular the concept of “embedded royalties”, is of concern internationally, including on the basis that the ATO’s stance may not align with internationally recognised OECD principles.
• While it is only a matter of time before the “final appellate determination for the guidance of all” sought by Perram J on the royalties issue (at [83]) is handed down, the Oracle litigation may be preceded by a possible High Court appeal (should special leave be granted) in PepsiCo.
• Acknowledging that his Honour’s decision to refuse the stay application has “a significant impact” on the taxpayers and on the administration of the tax system (at [88]), Perram J granted the Oracle companies leave to appeal to the Full Court (leave is required to appeal an interlocutory decision).
• If the refusal of the stay application is ultimately affirmed (including on appeal), it will likely mark the end of the parties’ MAP journey:
  • because the Commissioner, as an officer of the Commonwealth, is bound by Australian law to give effect to any decision of a domestic court, the Irish and Australian revenue authorities cannot reach an agreement which contradicts that final judicial determination; and
  • if a MAP nonetheless takes place even after a judicial determination, and the revenue authorities are unable to reach an agreement, the reservations made by Australia and Ireland in MLI Article 19(12) prevent the matter from proceeding to binding mandatory arbitration.
• Without expressing a concluded view on this issue, Perram J also considered it possible that the exercise of the Commissioner’s power under MLI Article 19(2) to suspend the MAP on the commencement of domestic proceedings may be reviewed under the Administrative Decisions (Judicial Review) Act 1977 (Cth) and/or the Judiciary Act 1903 (Cth) (at [52]). However, given the taxpayer had not commenced proceedings on this basis, it was not necessary for the Court to consider the validity of the MAP suspension.