Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Royalty Withholding Tax
Summary of proposed amendments
Purpose of amendment: Taxation Laws Amendment Bill (No. 5) 1992 will amend the Income Tax Assessment Act 1936 to introduce a final withholding tax of 30% on royalties paid or credited to non-residents in place of the current assessment basis of taxation.
The Bill will also amend section 17A of the Income Tax (International Agreements) Act 1953 to ensure that where Australia and another country have a double tax agreement that limits the tax imposed in the country from which royalties are paid (generally to 10%), the lesser rate is to apply. This will ensure that any reduction in the Australian tax rate is confined to cases where Australian residents getting royalties from other countries are entitled to the same lower tax rate in that other country.
A second bill, Income Tax (Dividends and Interest Withholding Tax) Amendment Bill 1992, will amend the Income Tax (Dividends and Interest Withholding Tax) Act 1974 to impose a final withholding tax of 30% upon royalties derived by non-residents.
The two bills will give effect to the Government's decision to introduce a final withholding tax for royalties paid or credited to, or otherwise dealt with on behalf of non-residents in place of the present assessment system. Film and video royalties are already taxed on a withholding basis.
The Government announced the change in the 1992-93 Budget. The new arrangements are to apply to royalties paid or credited from the commencement of the recipient's 1993-94 year of income. For most recipients this will be 1 July 1993.
Where the recipient is resident in a country with which Australia has concluded a double tax agreement (DTA), the rate of withholding tax will be limited to that specified in the agreement.
Over 85% of Australian royalty payments abroad are to countries with which a DTA limits the tax payment to 10% of gross royalties.
It should be noted, however, that Australia's DTAs generally provide that the withholding tax limitation does not apply where the royalties are effectively connected with an Australian permanent establishment (eg, a branch) or fixed base of a treaty country resident. In such a case, the royalties are taxable by assessment under the "business profits" article or "independent personal services" article of the DTA.
Income tax deduction - payer of the royalty
To prevent possible abuse, an income tax deduction for royalty payments to non-residents will not be allowable to the payer until any withholding tax payable is in fact paid to the Tax Office.
Film and video royalties will be subject to the same tax regime as any other royalties and will be taxed at the same rate.
Royalty definition to include electronic transmission fees
The definition of the term "royalty" will be amended to make it clear that it includes payments for the public transmission by satellite or cable, including payments for the use of such facilities in television and radio broadcasting whether or not the material is edited or the broadcast is delayed.
Amendments to the present withholding tax provisions
The Bill will align, as far as possible, the present withholding tax provisions for interest and dividends with royalties.
Date of Effect: The royalty withholding tax regime will first apply to amounts derived during the recipient's 1993-94 year of income. For most recipients of royalties this will be as from 30 June 1993 [Clauses 74 and 81].
How are royalties presently taxed?
Royalties (excluding film and video royalties) derived by non-residents are subject to Australian tax by normal assessment procedures. They form part of assessable income and Australian tax is imposed at the ordinary rate of tax applicable to the non-resident's taxable income on the net royalties after deduction of allowable expenses.
Where the recipient is resident in a country with which Australia has concluded a double tax agreement (DTA), the terms of the DTA generally provide for tax to be limited to 10% of the gross amount of the royalties. Where the royalties are effectively connected with a permanent establishment (e.g. a branch) in Australia they are taxed at normal rates with allowance for expenses incurred in deriving the royalty income.
Why is the Government introducing a final withholding tax for royalties?
There are several reasons.
The change will serve to counter tax avoidance, will produce administrative savings, will improve service to taxpayers through simplified administrative procedures, and will be in accord with the move to self-assessment.
How do other countries tax royalties?
The UK, USA, Japan, Germany, France, Italy, Canada, New Zealand and almost all other OECD member countries apply a flat rate withholding tax to the gross amount of royalty payments to non-residents.
Explanation of proposed amendments
Division 11A of Part III, which provides for a withholding tax on both dividends and interest paid to non-residents, is to be expanded to cover royalties paid to non-residents. The withholding tax on royalties is, as is the case with dividends and interest, to be a final tax to be deducted by the payer.
The present machinery provisions for the collection of interest and dividend withholding tax - Division 4 of Part VI - are also to be extended to cover royalty withholding tax.
Who will be liable for withholding tax?
From the commencement of the 1993-94 year of income royalties derived by a non-resident will, with certain specific exceptions, be liable for withholding tax where they are paid by an Australian resident, the Commonwealth, a State, or an authority of the Commonwealth or a State. This will not be the case where the royalty is an expense incurred in carrying on business through a permanent establishment (eg, a branch) offshore. It should be noted that in this latter case the royalty will not have an Australian source and the payment will generally not be deductible for tax purposes in Australia.
Royalties paid after the commencement of the 1993-94 income year are also liable to withholding tax if they are paid to a non-resident by another non-resident and they are an expense incurred in a business conducted by the payer through a permanent establishment (eg, a branch) in Australia [Clause 64].
Royalties derived by a resident of a country with which Australia has concluded a double tax agreement will generally not be subject to withholding tax if the royalty is derived in carrying on business in Australia through a permanent establishment (eg, a branch) in Australia. In this case the royalty will be treated as business income and liability will continue to be determined by assessment at normal rates of tax.
What is the rate of the royalty withholding tax?
30% of the gross amount of the royalty, subject to any reduction agreed on a reciprocal basis in a DTA.
That rate will be imposed by the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 .
What is the effect of Double Taxation Agreements on the rate of royalty withholding tax?
The terms of the DTAs generally provide for tax to be limited to 10% of the gross amount of the royalty. However, as mentioned above, if the royalty is "effectively connected" with a permanent establishment (eg, a branch) in Australia it is treated as business income and subject to tax by assessment at normal rates of tax. The standard rate is 15% in the case of New Zealand, Malaysia, Korea, Thailand, Fiji and Kiribati, up to 20% in the case of India and up to 25% in the case of the Philippines.
Section 17A of the Income Tax (International Agreements) Act 1953 is being amended to provide that where the rate of Australian tax payable under a DTA in respect of a royalty is less than the proposed 30% rate, the tax payable is to be at the lesser rate agreed in the DTA [Clause 88].
Deductions of Royalty Withholding Tax
Payers of royalties will have similar responsibilities to those of borrowers who are required to make interest withholding tax deductions from payments of interest to non-residents. They will be required to deduct withholding tax no later than the date the royalty is paid or credited to the non-resident. They will be required to deduct withholding tax in all cases where, the recipient is shown in the payer's records etc. as having an overseas address or where the payer is authorised to pay the royalty at a place outside Australia.
Where a royalty is paid to a person in Australia who receives the royalty on behalf of a non-resident, the person receiving the royalty will be obliged to deduct any necessary withholding tax when the royalty is received, whether or not that person actually remits the royalty to the non-resident [Clause 70].
Where the property of a royalty payer becomes vested in or under the control of a trustee, for example in a bankruptcy or liquidation, section 221YU is to be amended to ensure the trustee is liable to pay the withholding tax to the Commissioner [Clause 76].
The payer will be given a statutory defence to any claim under contract law by the non-resident for any amount deducted from a royalty payment deducted by the payer to meet withholding tax [Clause 77].
Failure to deduct withholding tax is to be an offence punishable under subsection 221YL(4A) by a maximum fine of $1000. However, where a person is convicted by a court of a failure to deduct, the court will be given power under section 221YL(4B) to also order the convicted person to pay to the Tax Office an amount not exceeding the deduction that should have been made [Clause 70].
As is the case with dividend and interest withholding taxes, the Commissioner will have the power to authorise, in special circumstances, an exemption from the liability to deduct royalty withholding tax or a variation in the amounts to be deducted [Clause 71].
This authority is necessary, for example, in cases where a trustee resident abroad receives royalties on behalf of an Australian resident beneficiary. Other cases arise where Australian residents arrange for their royalties to be remitted overseas during a temporary absence from this country.
Australian residents are subject to assessment under the general provisions of the law and, as the withholding tax provisions do not apply to income derived by them, an exemption from the liability to make deductions may be granted.
Withholding tax deducted to be forwarded to the Tax Office
A royalty deduction must be paid to the Tax Office by the 21st day of the month following the month in which the deduction was made. Failure or refusal to comply can carry, on conviction by a court, a maximum fine of $5000 and/or a maximum gaol term of 12 months [Clause 72].
A reconciliation statement must be forwarded to the Tax Office at the end of each year providing details of the deductions made. Failure to do so can result, on conviction by a court, in a maximum fine of $1000 [Clause 72].
The withholding tax regime provides for late payment penalty of 16% per annum. As with other types of late payment penalties, the penalty can be remitted or reduced by the Tax Office where there are special circumstances [Clause 72].
The Tax Office has released Taxation Ruling IT2570 which outlines the Tax Office's guidelines concerning the remission of late payment penalties.
Liability of person who fails to make deductions
A person who has refused or failed to make a deduction of withholding tax as required will be liable under section 221YQ to pay to the Tax Office the amount that should have been deducted, together with any late payment penalty which has been incurred [Clause 73] .
Although the person who makes the payment out of his or her own funds to the Tax Office will have a right of recovery of the tax from the non-resident recipient, there will be no right of recovery of any late payment penalty.
An amount paid to the Tax Office in these circumstances will be allowed as a credit against the withholding tax as if the deduction had been made at the appropriate time.
These rules are consistent with the rules applying in relation to withholding tax on dividends and interest [Clause 73].
Credits in respect of deductions made from royalties
A credit is allowed to a non-resident for any amount deducted from the royalty payment on account of Australian tax against the withholding tax liability [Clause 75].
Miscellaneous
No deduction for royalty payment until payment made to Tax Office
To prevent any possible abuse, an income tax deduction for royalty payments will not be allowable to the payer until the withholding tax has been paid [Clause 74].
Royalty definition to include electronic transmission fees
The definition of the term "royalty" in section 6 of the Income Tax Assessment Act 1936 will be amended to make it clear that it includes television transmission and radio broadcasts, and other transmission to the general public - whether edited or delayed - by means of satellite and cable. That technology has replaced, to a significant extent, film and video tapes. The payments are normally made to a person who has exclusive rights in relation to the matter which is the subject of the transmission or broadcast [Clause 59].
This will bring the tax treatment of royalties into line with the existing tax rules for film and video royalties. Accordingly, as the existing definition of "royalty" in section 6 includes payments for the use of or right to use films and video tapes, Division 13A of Part III of the Income Tax Assessment Act 1936 and the Income Tax (Film Royalties) Act 1977 are no longer necessary and are to be repealed [Clauses 65 and 80].
Collection of tax in respect of certain payments
Division 3B of Part VI of the Income Tax Assessment Act 1936 presently provides a collection mechanism for tax on royalties (other than film and video royalties), natural resource payments and the amounts withheld by investment bodies from income where the investor has not quoted a tax file number. All references to royalty payments are to be removed from the Division as the collection mechanism for royalty payments will now be contained in Division 4 - "Collection of withholding tax" [Clauses 66, 67 and 68].
Minor Technical Amendments
As a result of the repeal of Division 13A of Part III of the Act (film and video royalties), amendments will be made to sections 6C, 103 and 389 to remove any references to that Division [Clauses 60, 61 and 79].
Division 11A of Part III (Dividends and Interest paid to non-residents) will be expanded to also cover royalties paid to non-residents. Section 128A of that Division will be amended to define 'income' as including a royalty and to deem a royalty to have been paid where it is reinvested, accumulated, capitalised etc but not actually paid [Clause 63].
Subsection 255(2A) will be amended to remove any reference to a royalty as royalties will now be subject to the same collection mechanism as interest and dividends [Clause 78].