The ATO has finalised its long-awaited software royalty ruling, Taxation Ruling TR 2026/2, and released draft compliance guidance, PCG 2026/D4. For many multinational groups, software distributors and businesses using overseas intellectual property, the key question is no longer whether software is involved, but whether the rights granted under the arrangement could give rise to royalty withholding tax obligations.
Why is this important?
The potential consequences can be significant.
If a payment is classified as a royalty:
- Australian royalty withholding tax may apply;
- historical payments may need to be reviewed;
- interest and penalties may arise where withholding obligations have not been met; and
- the arrangement may attract increased ATO scrutiny under the draft compliance framework.
Importantly, TR 2026/2 applies to payments made both before and after the ruling was issued, meaning businesses may need to consider historical exposures as well as future compliance obligations.
Has the law changed?
Not exactly.
The ATO’s position is that TR 2026/2 reflects the existing law rather than introducing a new rule. However, the ruling provides the ATO’s most comprehensive guidance to date on how software and intellectual property arrangements should be analysed for Australian royalty withholding tax purposes.
The practical impact is that many businesses may need to revisit arrangements that were established years ago and assess whether the ATO’s final views lead to a different outcome than previously assumed.
The previous ATO guidance on software royalties was issued in 1993, before the widespread use of electronic downloads, cloud computing and software-as-a-service (SaaS). As software distribution models evolved, questions emerged as to whether payments made under these arrangements were consideration for intellectual property rights and therefore royalties.
Following significant judicial developments, including the High Court’s decision in Commissioner of Taxation v PepsiCo Inc & Anor [2025] HCA 30, the ATO refined its guidance to focus on identifying what a payment is objectively made in consideration for. The ruling emphasises that a payment will only be a royalty to the extent there is a causal connection between the payment and a right, property or other matter falling within the royalty definition.
Am I affected?
You may be affected if your Australian business:
- distributes or resells software developed offshore;
- pays licence, subscription or access fees to an overseas related party;
- operates under a SaaS or cloud-based software model;
- controls customer access, activation or distribution of software;
- customises, modifies or localises software for customers; or
- is part of a multinational group that owns intellectual property outside Australia.
What is the ATO looking at?
The ATO’s central question is straightforward:
What is the payment actually for?
The analysis focuses on the rights granted under the arrangement rather than the label applied to the payment.
Simply describing a payment as a service fee, software fee, distribution fee or subscription fee will not determine its tax treatment. Businesses should understand:
- what rights are being granted;
- how the software operates in practice;
- what activities the Australian entity performs;
- whether the actual conduct aligns with the contractual documentation; and
- whether intellectual property rights are being exercised as part of the arrangement.
The ruling adopts an objective characterisation approach, focusing on what a payment is consideration for having regard to the arrangement’s terms, the parties’ conduct and the commercial purpose of the arrangement. Labels such as “distribution fee”, “service fee” or “resale margin” are not determinative.
Does this affect SaaS arrangements?
Potentially, yes.
A common misconception is that SaaS or software subscription payments cannot be royalties because customers do not receive ownership of the software. The ATO’s view is that the answer depends on the rights granted and exercised under the arrangement.
Under TR 2026/2, particular attention needs to be given to rights to reproduce, communicate, adapt or authorise the use of software. As a result, SaaS, cloud and software distribution arrangements should not automatically be regarded as service arrangements without further analysis.
What about tax treaties?
The position may also depend on the applicable Double Tax Agreement. TR 2026/2 notes that some Australian tax treaties contain material differences from the standard royalty definition, meaning the treaty outcome may differ depending on the jurisdiction involved.
How will the ATO assess risk?
Alongside the ruling, the ATO has released draft PCG 2026/D4, which proposes a five-zone risk framework.
The draft framework allows taxpayers to self-assess the likelihood of ATO review using white, green, yellow, amber and red risk zones. While TR 2026/2 determines whether a payment is a royalty, PCG 2026/D4 focuses on the ATO’s compliance approach.
Importantly, a higher risk rating does not automatically mean a taxpayer’s position is incorrect. Rather, it indicates the likelihood of ATO review. The draft PCG places significant emphasis on documentation, self-assessment and evidence supporting the position adopted.
What should businesses do now?
We recommend that businesses with cross-border software or intellectual property arrangements ask five key questions:
- What offshore software payments are we making?
Identify software, SaaS, licence, support and technology-related payments made to overseas entities.
- What rights are being granted?
Review agreements and determine whether any copyright, intellectual property or other rights are being granted or exercised.
- Does actual conduct match the contract?
The ATO is likely to look beyond labels and assess how the arrangement operates in practice.
- Have we considered royalty withholding tax before?
Many groups have historically viewed software payments as service or distribution payments without specifically documenting a royalty analysis.
- Could we support our position during an ATO review?
Businesses should ensure they have sufficient documentation to support their conclusions and demonstrate that an appropriate review has been undertaken.
How HLB can help
The businesses most likely to be affected are multinational groups, software distributors, SaaS providers and businesses making payments to offshore intellectual property owners.
Our International Tax team can assist with:
- reviewing software, SaaS and distribution arrangements;
- assessing royalty withholding tax exposure;
- evaluating treaty positions;
- undertaking PCG 2026/D4 risk assessments;
- reviewing historical payment arrangements; and
- preparing supporting documentation for ATO review purposes.
The key message is simple: if your business has cross-border software or intellectual property arrangements, now is an appropriate time to review whether royalty withholding tax obligations may arise and whether your position can be supported if reviewed by the ATO.