Assessability of payments made by an Australian entity to a New Zealand resident under a licence agreement

Do the payments made by an Australian resident entity to a New Zealand resident entity for the right to receive information under a licence agreement constitute a 'royalty' as defined in Article 12(3)(c) of the tax treaty between Australia and New Zealand (New Zealand Agreement)?

Yes. The payments made by an by an Australian resident entity to a New Zealand resident entity for the right to receive information under a licence agreement constitute a 'royalty' under Article 12(3)(c) of the New Zealand Agreement.

The taxpayer is a resident Australian entity.

The taxpayer entered into a direct contract with a New Zealand resident entity. The contract provides that the New Zealand entity would give all necessary information, to the taxpayer to enable the taxpayer to conduct its business activities.

The taxpayer agreed to pay the New Zealand entity for the receipt of the information in the form of a licence fee calculated according to a specified percentage of income the taxpayer received from using the information.

The contract contains a confidentiality clause saying that each party will keep entirely secret the terms of the contract and all information of a secret, confidential or proprietary nature concerning the business affairs of the other which may come to their knowledge as a result of performance of their obligations under the contract.

The contract also provided that taxpayer and the New Zealand entity may not assign the benefit of the contract without the other parties' consent.

The Australian and the New Zealand entities were established under specific legislation to carry on certain business activities with certain exclusive rights.

Subsection 995-1 of the Income Tax Assessment Act 1997 provides that the term 'royalty' has the meaning given by subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

Paragraph (c) of the definition of 'royalty' or 'royalties' in subsection 6(1) of the ITAA 1936 provides that the term 'royalty' includes any amount paid or credited, however described or computed, and whether the payment or credit is periodical or not, to the extent to which it is paid or credited, as the case may be, as consideration for the supply of scientific, technical, industrial or commercial knowledge or information.

The definition in subsection 6(1) of the ITAA 1936 is an inclusive definition. It includes not only the types of payments listed in the definition, but also payments that are royalties within the ordinary meaning of the term 'royalty'.

The ordinary meaning of a royalty was considered by the High Court of Australia in Stanton v. Federal Commissioner of Taxation (1955) 92 CLR 630; (1955) 11 ATD 1; (1955) 6 AITR 216. In considering the essence of a royalty, the High Court said: ...payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken...

Support for this view is found in paragraph 10(b) of Taxation Ruling IT 2660 which states that a common law royalty will have the following feature: The payment is made to the person who owns the right to confer that beneficial privilege or right - Barrett v. FC of T (1968) 118 CLR 666; Sherritt Gordon Mines Ltd; Case H9 76 ATC 39; 20 CTBR (NS) Case 64 . However the payment would still be a royalty if paid to another person or otherwise applied or dealt with at the direction of the owner.

In determining liability to tax on Australian sourced income received by a non-resident, it is necessary to consider not only Australian income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (Agreements Act).

Schedule 4 to the Agreements Act contains the New Zealand Agreement. Article 12 of the New Zealand Agreement governs the taxation of royalties. Article 12(1) of the New Zealand Agreement, royalties sourced from Australia, being royalties to which a resident of New Zealand is beneficially entitled, may be taxed in Australia. Article 12(2) of the New Zealand Agreement provides that royalties may be taxed at the rate of 10 per cent of the gross amount of the royalty payment.

Article 12(3)(c) of the New Zealand Agreement defines royalties to include payments of any kind, whether periodical or not, and however described or computed, to the extent to which they are made as consideration for the supply of scientific, technical, industrial or commercial knowledge or information.

Taxation Ruling IT 2660 states that the term royalty defined in Australia's double tax agreements is similar to the definition provided in subsection 6(1) of the ITAA 1936, except that the list of payments which are defined as royalties is intended to be exhaustive.

Taxation Ruling IT 2660 states that the main type of knowledge or information intended to be covered by the royalty definition is referred to as 'know-how'. 'Know-how' is described in IT 2660 as 'undivulged technical knowledge, information...that is necessary for the industrial reproduction of a product or process'. IT 2660 states that a contract for the supply or use of a 'product' which is already in existence (or substantially in existence) is more likely to be a contract for the supply of know-how and will give rise to a royalty.

The contract provides the taxpayer with access to all commercial information that is necessary to carry on certain parts of the business activities of the taxpayer. This information comes within the meaning of 'know how' in accordance with IT 2660. The contract is one for the supply of 'know-how' to the taxpayer as it involves the payment of a licence fee by the taxpayer for the use of commercial information which was exclusively available to the New Zealand entity. The amount of licence fee payable was determined by a specified percentage of income received by the taxpayer from activities undertaken through the use of the information received from the New Zealand entity.

The licence fee paid by the taxpayer to the New Zealand entity fits within the definition of royalty under Article 12(3)(c) of the New Zealand Agreement. Accordingly the royalties may be taxed in Australia at the rate of 10 per cent of the gross amount of the royalty under Article 12(2) of the New Zealand Agreement.