International Business Machines Corp v Comm of Taxation (Federal Court of Australia)

Software License income is assessable as “Royalty”

International Business Machines Corporation & IBM World Trade Corporation (IBM), both US companies, entered into a “Software License Agreement” with IBM Australia, an Australian company, under which they granted the latter “the non-exclusive rights (i) to license and distribute copies of IBM Programs for their ultimate use by customers, (ii) to use such IBM Programs in revenue producing activities, (iii) to use such IBM Programs internally, (iv) to make or have made copies for the purposes described above, for distribution to affiliated companies etc“. In consideration, IBM Australia agreed to pay IBM a fee of 40% of the revenue billed for each copy of an IBM programme distributed to a third party. IBM Australia initially withheld tax on the payments on the basis that it constituted “royalty” under Article 12(4) of the Australia-USA DTAA though it later sought a refund on the basis that the whole payment was not royalty which was rejected by the Department. IBM filed an application for a declaration that the whole of the amounts received was not assessable as “royalty“. HELD dismissing the application:

(i) Under Article 12(4) of the Treaty, “royalty” is defined to mean “consideration for…the right to use any copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right” (Article 12(4)(a)(i)) or “…. the supply of technical … or commercial knowledge or information” or for “the supply of any assistance of an ancillary and subsidiary nature” to enable the application of the rights referred to in Article 12(4)(a)(i) or the knowledge/information referred to in Article 12(4)(b)(i) (Article 12(4)(b)(ii));

(ii) On facts, the argument that the SLA is in essence a distributorship agreement for the marketing of IBM computer programs and that the IP licenses granted to IBMA is only to enable it to carry on the function of a distributor is not acceptable. The SLA is not a distribution agreement which confers distribution rights independently of the grant of IP rights. There is no reference in the SLA to the payments being for the exercise of general distributorship rights. Rather, the payments are described as being for the acquisition of the stated IP rights. The detail of the SLA concerns the definition of IP and IP rights. There is no such detail with respect to distribution rights. The rights/content granted by the SLA are, in each case, rights/content of a kind contemplated by Article 12(4) and so the whole of the consideration is assessable as “royalty”.