ATO's big tech royalty ruling: 5 things directors must know

The net will stretch beyond software  

This ruling is focused on the technology and software sectors, where much of a company’s value is tied to intangible assets. But with tangible products and services across almost every industry increasingly reliant on embedded intellectual property (IP), the implications for Australian boards are likely to extend much more broadly.

“Everything is about intangibles, a lot of equipment and services have IP content today, and that’s where the ATO is going,” says Tadmore. “It’s saying, ‘The economy is changing and a lot of what was provided without IP content now has it embedded’. The ATO is looking to capture that value.”  

Tadmore believes the ATO’s agenda could expand into other sectors such as pharmaceuticals, cosmetics, motor vehicles and beyond. “I’m pretty confident the ATO has a broader scope in mind than software – the ruling is setting out a principal foundation for it to pursue.”  

The ATO has already chased embedded royalties in other sectors, such as the brand licensing and know-how around PepsiCo. In that case, the High Court held that payments made by the Australian bottler were paid solely for purchasing beverage concentrate, rather than embedding an unbundled royalty for the rights to use PepsiCo’s trademarks or IP. Despite that outcome, the ATO remains determined to scrutinise transactions where it believes embedded IP value is escaping taxation.  

“The ATO is looking at people exploiting overseas IP, irrespective of it being related to software,” says Byrne, previously a tax specialist with the ATO. He adds that as AI becomes more integrated into operations, the flow of software service fees overseas will increase.   

“If the ATO doesn’t get ahead of it now, the tax pool will shrink and profits continue shifting overseas,” he says. “This tax ruling has been in the works for quite a while and is specific to software, but the landscape in terms of royalty positions from the ATO is far greater – it is going heavy on royalties in general.”  

Even if your sector isn’t obviously in the sights of the new ATO ruling, boards need to be prepared for the scope to expand. 

Substance over form will be heavily scrutinised   

If a company’s contract explicitly states an arrangement is royalty-free, directors should not assume the business is automatically safe from regulatory action. The ATO intends to look past the wording of commercial agreements to examine the actual rights being granted. 

 “You can say something isn’t a royalty, but the ATO is more interested in looking at the substance,” says Byrne. He explains that if an Australian company is exploiting overseas software to enhance the value of a domestic product, the ATO may determine a taxable royalty is embedded in the transaction, regardless of the contract’s phrasing.  

For decades, global convention has dictated that if IP was a minor component of a broader service agreement, the payment did not need to be unbundled into a separate royalty.   

While TR 2026/2 acknowledges that Double Tax Agreements, such as the US-Australia tax treaty, take legal precedence over domestic law, the ATO’s expansive reading of domestic copyright law creates sharp friction with international consensus and treaty partners.  

“The ATO is basically saying, ‘We appreciate you disagree, and we’re willing to test that in the courts’,” says Byrne.  

“The convention and practice all over the world has been that if the IP was not the key component, you shouldn’t unbundle it and you wouldn’t declare a royalty,” says Tadmore.   

“The ATO is a bit of a pioneer among other tax offices around the world to say it wants to break it down now. But not everyone agrees with its position, including the US Treasury, which can lead to double taxation.”    

Navigating the ATO’s new ruling and complex international tax treaties will require highly specific legal and tax advice, which boards need to ensure is being sought proactively.

TR 2026/2 comes with retrospective risks   

The shift in the ATO’s interpretation means many companies may discover they have unwittingly failed to pay withholding tax on offshore royalties, creating a retrospective financial risk for boards to manage.  

“If a company has taken the view until now that it did not have to declare royalties, and now it changes the view, there is a risk of retrospective assessments of penalties and interest,” says Tadmore.  

If companies have historically relied on TR 93/12 to justify their tax positions, the ATO has communicated that this view will be applicable from 1 July 2021.   

But don’t rely on only four years. “Unlike ordinary tax assessments, RWT is not subject to statutory periods of review, potentially leaving historical arrangements exposed to ATO scrutiny well beyond the usual four years,” says Tadmore.    

Contracts need to be stress tested against the PCG  

While the ruling sets out the ATO’s enforcement position, directors should remember a Taxation Ruling represents administrative interpretation, not legislation. Taxpayers technically retain the right to adopt a contrary tax position and court challenges from multinationals are inevitable. However, because public rulings legally bind the ATO, taking a position against TR 2026/2 carries immediate risk.  

“It’s clear there’s not broad agreement that the ATO’s position is right, but you can’t bury your head in the sand and hope the issue goes away,” says Byrne. “This isn’t a draft ruling – it’s a finalised ruling and binding on the Commissioner.” 

Byrne advises boards to direct their legal and finance teams to review contracts and apply the ATO’s practical compliance guideline (PCG) framework for the ruling. It helps companies determine whether their arrangements fall into green, yellow, amber or red risk categories.  

Tadmore echoes this urgency: “Review your agreements to see what sort of IP content you’re actually receiving from overseas, test it against the ruling and see if you have an exposure.”   

“Your working assumption must be that you’re going to be reviewed. You want to do your self-assessment now, so when the ATO does approach you to review your arrangements, you’re ahead of that. Perhaps you have a confident position or perhaps you find some challenges – but you’re prepared to discuss them.”  

By acting proactively, boards can ensure they’re fully prepared to either defend their arrangements or negotiate. “If you find your position is not as strong, you might decide to approach the ATO and say, ‘We have a couple of weaknesses, can we sort it out in an amicable way’,” says Tadmore. “Don’t wait and be passive.”