Royalty income is income received from allowing someone to use your property. Receipts arising from the development and marketing of computer software might be treated as royalty income.
Determination
TR 2021/D4 from ATO’s legal database outlines the following characteristics when the income is Royalty:
- consideration for the grant of a right to do something in relation to software that is the exclusive right of the owner of the copyright in the software. Examples include payments for the grant of a licence which permits
- the licensee to reproduce software or to modify or adapt software, and
- a distributor of software to sub-licence the use of the software, whether the software is distributed by way of physical carrying media, digital download or cloud-based technology.
- consideration for the supply of know-how in relation to software Examples include payments for the supply of source code relating to software
Example for above two conditions:
Alex – a developer develops system software for manufacturers of electricity smart meters. The software is specialised and performs various functions including interface with other devices, monitoring of power usage, and communication with a central monitoring platform in the event of a fault or outage.
Alex develops the software under contract with the manufacturers of the smart meters. The software is installed onto the smart meters and, under the terms of a license, the manufacturers are given access to the source code and are permitted to modify and make future updates to the software. The payments received by Alex are royalties this is because the manufacturers of the smart meters are given the right to modify the software, and the provision of the source code imparts unpublished technical information or know-how about the software.
- consideration for the supply of assistance furnished as a means of enabling the application or enjoyment of the supply.
The following amounts received are not royalties:
- consideration for the grant of a licence which allows only the simple use of software, that is, it allows the licensee or end-user to use the software for the purpose for which it was designed, but does not otherwise permit the end-user to use the copyright in the software.
- consideration for the grant of distribution rights in relation to software where the distributor is not permitted to do anything in relation to the software that is the exclusive right of the owner of the copyright in the software.
- consideration for the transfer of all rights relating to the copyright in software.
- proceeds from the sale of goods where hardware and software are sold to an end-user in an integrated form without being separately priced, or where physical carrying media on which software is stored is sold to an end-user, provided in either case that the end-user is only granted simple use rights.
- consideration for the provision of services in the modification or creation of software.
Example:
GamesHeaven is a retailer of computer games. It enters into a distribution agreement with GamesCo, a leading games developer, under which it is granted the non-exclusive right to distribute GamesCo’s computer games as a flagship partner.
The distribution agreement permits GamesHeaven to sell packaged games at its retail outlets across Australia. The packaged games contain ‘shrink-wrap’ end-user licence agreements which customers agree to be bound by when opening the games. The end-user licence agreements are between GamesCo and customers. GamesHeaven is not a party to the agreements.
The fees paid by GamesHeaven under the distribution agreement are not royalties, this is because the fees secure the grant of distribution rights that do not involve the use of copyright by GamesHeaven. That is, the fees are not paid for the right to do anything in relation to the games that is the exclusive right of the copyright owner.
Conclusion
Whether the income shall be classified as a royalty lies under whether the conditions of the supplied software have the characteristics of only simple use of the software. Careful judgement needed to correctly classify the royalty income.
This information has been prepared without taking into account your objectives, financial situation or needs. Because of this, you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.
Zoe Zhao, based in Melbourne, draws on Big 4 audit experience to assist small-to-medium businesses with precise financial management.
