Australia Treats Cloud Software Payments as Taxable Royalties

The Australian Taxation Office published Taxation Ruling TR 2026/2 on 4 September 2026, treating many cross-border software and cloud fees as royalties. Local companies that sell another group company’s programs, or that let customers run them online, may have to withhold tax on money sent overseas, including on some years after 1 July 2021.

The document is a public ruling on existing law and tax treaties, issued with a draft five-colour audit grid that sorts each outbound payment by how closely the ATO will look at it.

What the ATO Now Treats as a Software Royalty

A payment is a royalty when it is consideration for the use of copyright or similar rights, including the right to copy software, communicate it, or authorise a customer to use it in the cloud. Calling the fee a distribution payment, or marking the contract royalty-free, does not decide the tax result.

WHEN A SOFTWARE PAYMENT IS A ROYALTY

• The grant: Consideration for the grant of a right to use intellectual property is a royalty even if that right is never exercised.
• The use: Doing an act that Australian copyright law reserves to the owner, including authorising someone else to do it, counts as use of a copyright right.
• Know-how and help: Payments for know-how, or for help that lets the buyer enjoy those rights, can be royalties as well.
• Embedded code: A fee can still be a royalty where software is built into a physical product and the payment is for the right to use that code.
• Copies only: A payment is not a royalty if it is solely for the right to distribute copies the copyright owner already made, and not for any intellectual property right.
• Services only: A payment is not a royalty if it is wholly for services that have no link to those rights.

The Commissioner’s binding view on when software payments count as royalties applies to an Australian resident, or to an Australian branch of a foreign company, that pays a non-resident under what the ruling calls a software intermediation arrangement. The local entity earns money from software it does not own, and pays the owner or a licensee so that it can keep earning that money.

In the ruling’s first worked example, an Australian company branded OBA is the local distributor for programs whose intellectual property sits with a related Irish company, IEL. OBA’s contract lets it market the programs, allow downloads or online use, and deal with customers, while the papers still call the fee royalty-free. The ATO says performance of that contract requires copyright rights, so Australian royalty withholding applies to all of OBA’s payments at 10% under the Irish treaty. The word distributor does not save the deal, and neither does a royalty-free label.

Where a payment is for several things, the ruling says it can be split on a fair and reasonable basis. Where the copyright rights cannot be separated, from a practical and business point of view, from the rest of the bundle, the whole fee can be a royalty.

July 2021 Closed the Old Safe Harbour

TR 2026/2 applies both before and after 4 September 2026. The only surviving shelter from the old software ruling is the period when that ruling was still on the books and a taxpayer actually relied on it.

FROM THE 1993 SOFTWARE RULING TO TR 2026/2

1. 13 May 1993: The ATO issues TR 93/12 on computer software, written for a market that still shipped programs on disks.
2. 1 July 2021: The ATO withdraws TR 93/12, leaving no binding public ruling on software royalties.
3. 2021: Draft TR 2021/D4 puts the Commissioner’s new view into circulation and draws industry pushback.
4. 23 August 2022: Jose E. Murillo of the US Treasury writes to the Australian Treasury with objections to the draft.
5. 17 January 2024: The ATO withdraws the 2021 draft and issues TR 2024/D1 on the same core view, with more on treaties, copyright law, and software as a service.
6. 5 April 2024: Scott Levine of the US Treasury urges Australia to withdraw that draft or change it for the bilateral treaty.
7. 2025: The High Court decides Commissioner of Taxation v PepsiCo Inc, holding that certain bottler payments were not royalties.
8. 19 March 2026: The ATO publishes a Decision impact statement saying commercial facts around a deal can still reveal an unrecognised royalty.
9. 4 September 2026: TR 2026/2 is issued as a legally binding public ruling and draft PCG 2026/D4 sets out the audit grid.

Groups that kept paying on a 1993 shrink-wrap theory after TR 93/12 died were already outside a binding public ruling, even though the replacement stayed in draft for years. The High Court loss in PepsiCo did not stop the software project. The ATO said it had updated the guideline and the final ruling in line with that Decision impact statement, then published both on 4 September 2026.

Cloud Access Is Treated as a Copyright Act

The ruling’s appendix walks through the Copyright Act 1968 rights that sit inside a modern software deal: reproduction, communication to the public, adaptation, and authorisation. Software as a service is dealt with twice, once as communication and once as authorisation. A payment is a royalty, the ATO says, when it is consideration for the use of the right to authorise others, whether or not that right is written into the contract, or for the grant of that right, whether or not it is used.

That is the point at which a local seller of cloud access stops looking like a shop that moves boxes. If the Australian company cannot put the product in a customer’s hands without permission to exercise rights that belong to the copyright owner, the outbound fee is in royalty territory.

The OECD Commentary on Article 12, paragraph 14.4, describes a different deal. In that example a distributor pays only for copies it did not make, has no right to reproduce the program, and is treated as earning business profits rather than royalties, whether the copies arrive on a disk or as a file. The ATO quotes that passage in full, then confines it. The example, it says, cannot be relied on where the facts differ, including where a distributor can make software available to download without a further act by the software company. Australian copyright law, not the commentary standing alone, decides whether a payment leaving Australia is a royalty.

The Federal Court took a hard line on mixed bundles in International Business Machines Corporation v Commissioner of Taxation in 2011. Payments under a licence that granted the intellectual property rights needed to use, market, and distribute IBM programs were all royalties under the US treaty, so there was nothing left to split out as a plain distribution fee. TR 2026/2 uses that case as the model for when a bundle stays a royalty in full.

White, Green, Yellow, Amber and Red

The ruling says what the law is. Draft PCG 2026/D4, issued the same day, says who gets reviewed. It sorts software deals into white, green, yellow, amber and red, and it is still a draft. Comments are due by 2 October 2026, a four-week window, and when finalised the guideline is proposed to apply to deals entered into both before and after it issues. The current schedule covers software, including cloud access. Extra schedules may be added later; content streaming is not in this one.

THE FIVE ATO RISK ZONES

The green path for a related-party cloud deal is not a finding that the fee is not a royalty. It is a finding that the group has already booked one. In the guideline’s first example, AusCo contracts with Australian customers for downloadable and cloud-based products, takes the subscription money, and lets ForeignCo grant the customer a limited intellectual property licence and server access. The two companies treat part of AusCo’s outbound payment as a royalty, document a residual calculation, withhold on that royalty, and land in green because the royalty is more than 75% of the residual. The ATO says it will not prioritise that file.

The residual is the outbound payment minus the offshore supplier’s costs for making, distributing, or supporting the software sold to Australia, with a 5% mark-up on those costs. Labour, infrastructure, marketing, and third-party royalties can go into that cost pile. If the offshore owner has thin costs, the residual is close to the whole fee and 75% of it is a large royalty. If the owner has heavy costs, the same percentage is easier to hit. The grid is a pricing tool as much as a legal memo: book a royalty the ATO will accept, or sit in amber and wait for a review.

Who Has to Withhold on These Payments?

Section 128B taxes a non-resident on income that consists of a royalty. The duty to withhold sits on the Australian-resident payer. The ruling is explicit that the local company is the one that must deduct tax before the balance goes overseas, and that a treaty rate applies only to the extent the payment is a royalty under both the treaty and Australian law.

THE SIZE TESTS AND TREATY CAPS

• Related-party green: The booked royalty is at least 75% of the residual after offshore costs.
• Alternative green: The booked royalty is at least 50% of the whole outbound payment.
• Yellow exception: The Australian operating margin is above 10%, or within 10 percentage points of the global group’s margin, which can pull a deal out of amber.
• US treaty cap: Article 12 of the Australia-US tax treaty limits source-country tax to 5% of the gross royalty.

TR 93/12 can still apply, the ruling says, to the years before its withdrawal on 1 July 2021 where it was appropriately relied on. After that date there is no old public ruling to hide behind. The ATO has said it is willing to test its reading in court, so an assessment issued on this view can still be fought. Until a judge disagrees, the Commissioner’s published view is the one an Australian payer has to apply, including to older open years after the 2021 withdrawal.

A US Tax Credit May Not Follow

The United States has objected to this project since the first draft. The Federal Court recorded strong concerns about the 2021 draft in 2024 stay reasons in Oracle Corporation Australia Pty Ltd v Commissioner of Taxation, citing Murillo’s letter of 23 August 2022. On 5 April 2024, Scott Levine, then acting deputy assistant secretary for international tax affairs, wrote again. He said TR 2024/D1 still read the Australia-US treaty in a way that clashed with the treaty text and the OECD Commentaries, and he asked the ATO to withdraw the draft or revise it for the Australia-US tax treaty.

The United States does not agree with the analysis and conclusions of the two scenarios. In our view, these two examples involve solely the right to distribute copies of the software.

Scott Levine, Acting Deputy Assistant Secretary (International Tax Affairs), U.S. Treasury Department, 5 April 2024 letter

Levine’s other point is the one that hits the cash. Under the treaty as the United States applies it, income from similar distribution contracts would be business profits, not royalties, matching US Treasury regulations as well as the OECD Commentary. Australian withholding on a payment the United States still treats as business profits can leave the same income taxed twice if a US credit is refused. A February 2025 White House memorandum later told officials to look at tariffs and other measures against foreign digital taxes and rules aimed at US technology companies. The Australian ruling does not name US groups, and it presents itself as a definition of royalty rather than a digital services tax, but the credit gap is still a US-treaty problem.

TR 2026/2 itself flags that the United States treaty definition of royalties differs in material ways from the standard treaty text the ruling is built on, and that some of its principles may not apply to a given deal. The specific treaty text still has to be read. That is a litigation opening. It is not a licence to ignore the ruling while it stands.

Shifting the Contract Offshore Can Invite Part IVA

The draft guideline already treats a clean-up restructure as a reason to look, whatever colour the grid would otherwise assign. If agreements are changed so that Australian royalty withholding falls, the ATO says it may still apply compliance resources. A group that moves Australian customers onto a contract with an offshore company, while the Australian subsidiary keeps doing the selling work, is named as a possible scheme for Part IVA, including the multinational anti-avoidance rule in section 177DA, and for the transfer pricing rules in Divisions 815-B and 815-C.

The low-friction options inside the guideline are narrower than a re-papering exercise. A retailer that only buys finished copies on physical media, or that sells a one-off electronic copy at a fixed price without making extra copies or adapting the code, can argue for green without booking a royalty. A related-party cloud seller that wants the same colour has to recognise a royalty, withhold on it, and show the residual maths. Sitting silent, or stripping a royalty that used to be paid, is how a file moves toward amber and red.

Comments on the draft grid close on 2 October 2026 and should go to IntangiblesArrangements@ato.gov.au. The ATO has said it is willing to test the ruling in court, so the dollar cost of TR 2026/2 is still a figure a judge has to fix.

Disclaimer: This article is news reporting and analysis of an Australian Taxation Office public ruling and a draft practical compliance guideline. It is for information only and is not tax, legal, or financial advice, and it does not tell any company how to withhold, restructure, file, or dispute an assessment. Readers should consult a qualified Australian tax adviser, and where relevant US tax counsel, before acting on TR 2026/2 or draft PCG 2026/D4. Figures, zone tests, treaty rates, and the comment date reflect the ATO materials published on 4 September 2026 and may change when the guideline is finalised or if a court disagrees with the Commissioner.