Cross-border software payments and royalties: implications of final taxation ruling and practical compliance guideline

The Australian Taxation Office (ATO) has published Taxation Ruling TR 2026/2 Income tax: royalties – character of payments in respect of software and intellectual property rights. This was accompanied by draft Practical Compliance Guideline PCG 2026/D4 Royalty characterisation of payments relating to intermediation or distribution arrangements – ATO compliance approach. 

Released on 4 September 2026, together these instruments represent the culmination of a five-year policy project that began with the withdrawal of Taxation Ruling TR 93/12 on 1 July 2021 and proceeded through two consultation rounds (TR 2021/D4 and TR 2024/D1). We now have a final, uncompromising position: namely, that many common cross-border software arrangements give rise to royalties attracting withholding tax under section 128B of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).

Key observations and takeaways 

• TR 2026/2 is retroactive and expansive – The ruling applies both before and after its date of issue (4 September 2026). Reliance on TR 93/12 is protected only to 1 July 2021. Software intermediation arrangements not re-examined since that date carry unprotected withholding tax exposure for the entire five-year period from July 2021 to September 2026.
   
• The ‘consideration for’ test is objective and purpose-focused – Following Commissioner of Taxation v PepsiCo Inc & Anor [2025] HCA 30, TR 2026/2 confirms that ‘consideration for’ a royalty requires a causal connection in the nature of the ‘purpose, basis, or condition’ of the payment. Contractual labels, including ‘royalty-free’ descriptions, are not determinative. The ATO will assess the whole arrangement and its commercial context, including the economic fundamentals of the arrangement.
   
• Terminology change is deliberate and broad – The shift from ‘software arrangement’/’distributor’ (TR 2024/D1) to ‘software intermediation arrangement’/’software intermediary’ (TR 2026/2) is capable of capturing resellers, platform operators, managed service providers, and intragroup supply chain entities – not only traditional distributors.
   
• Apportionment is theoretically available but practically constrained – The Compendium to TR 2026/2 confirms that Intellectual Property (IP) rights in software intermediation arrangements are ‘commonly’ neither separate nor severable from other rights granted, meaning the entire payment will typically be characterised as a royalty. The only worked apportionment example in TR 2024/D1 has been removed from TR 2026/2.
   
• Technological protection measures (TPMs) are now expressly within scope – TR 2026/2 at [138]–[146] treats TPMs, including licence keys, activation codes and DRM systems, as within the genus of IP for royalty purposes, extending the royalty analysis to the access-control mechanisms that characterise most modern software distribution.
   
• PCG 2026/D4 offers a structured but narrow safe harbour – The PCG, which replaces PCG 2025/D4 (which dealt with low-risk payments relating to software arrangements), establishes a five-zone risk framework (white, green, yellow, amber, and red). Only truly passive resellers of existing software copies, with no copyright rights granted or exercised, occupy the ‘green zone’. Cloud, SaaS, and hybrid arrangements require substantive analysis under the risk indicia and will commonly fall in the yellow, amber, or red zones. The PCG consultation period closes on 2 October 2026.
   
• International tensions remain unresolved – The ATO’s position diverges from the US Treasury’s view and is contested by reference to Organisation for Economic Co-operation and Development (OECD) Commentary Article 12 paragraph 14.4. Payments to residents of the exceptional treaty jurisdictions, specifically the United States, the Netherlands, Italy, Singapore, and Mexico, are not covered by TR 2026/2 and require separate treaty-specific analysis.
   
• Oracle and the Decision Impact Statement confirm that treaty-based dispute resolution remains available – The Full Federal Court’s stay of Oracle’s domestic proceedings confirms that MAP and binding arbitration under Australia’s DTA network are treaty-protected mechanisms for resolving royalty withholding tax disputes, recognised and upheld by Australian courts. This does not, however, stay the ATO’s compliance approach under TR 2026/2 and PCG 2026/D4 pending the MAP outcome.
   
• Key actions for multinationals – We recommend that impacted multinationals should review all cross-border software payment arrangements against TR 2026/2; engage with the PCG 2026/D4 consultation before 2 October 2026; and consider whether proactive ATO engagement is appropriate.

The ATO’s guidance on software royalties has evolved over three decades: from TR 93/12 in 1993, through draft rulings in 2021 and 2024, and culminating in the present Taxation Ruling and PCG. Each iteration has progressively broadened the scope of what constitutes a royalty, reflecting the ATO’s expanding view of the relationship between Australian copyright law and the taxation of cross-border software transactions. The landmark decision of the High Court in Commissioner of Taxation v PepsiCo Inc & Anor [2025] HCA 30, which, by a 4:3 majority, dismissed the Commissioner’s appeal and rejected his royalty characterisation of payments for beverage concentrate, provided authoritative guidance on the ‘consideration for’ enquiry, and TR 2026/2 reflects some of those principles in its final form. 

The Oracle litigation, in which the ATO has also released its Decision Impact Statement on the Full Federal Court’s decision, has simultaneously highlighted the systemic nature of the dispute. At least 15 multinational entities face analogous disputes with the ATO, and the controversy has generated significant friction with the United States Treasury.

This article critically examines the ruling, the accompanying draft PCG, and the Oracle Decision Impact Statement, and offers practical guidance for taxpayers and advisers.

Scope, class of entities, and the standard tax treaty definition

TR 2026/2 applies to cross-border payments made under a software intermediation arrangement by:

• an Australian resident; or 
   
• a non-resident, where a payment is related to or connected with a permanent establishment in Australia. 

The term ‘software intermediation arrangement’ is defined in TR 2026/2 as an agreement, arrangement or scheme under which an intermediary makes a payment or payments directly or indirectly to the owner or licensee (the ‘offshore supplier’) of software IP rights for the right to be in a position to earn income relating to the use of, or right to use, software IP rights. 

As such, TR 2026/2 does not apply to individual end-users who pay for direct personal access to software. An individual Australian consumer who pays a subscription fee directly to a software provider for their own personal or household use is not a ‘software intermediary’ within that definition: the payment is not made for the right to earn income from the software, and the subscriber acquires no copyright rights in the software at all. 

This definition encompasses payments made through multiple tiers of intermediaries, including sub-distributors, as well as direct intragroup payments between an Australian subsidiary and an offshore parent. The ruling addresses both the domestic law definition of ‘royalty’ in subsection 6(1) of the ITAA 1936 and the ‘standard tax treaty definition’ used in most of Australia’s double tax agreements.

Running parallel to the progression of TR 2026/2 is Taxation Ruling IT 2660 Income tax: definition of royalties (issued in 1991). It predates the software royalty debate and has never been withdrawn. TR 2026/2 at [5] expressly identifies IT 2660 as a companion instrument, noting that it ‘sets out our view on the meaning of royalties in subsection 6(1) and in the context of various tax treaties’. IT 2660 and TR 2026/2 operate together, with IT 2660 supplying the general definitional framework. This includes the authoritative guidance on the distinction between royalties and payments for services rendered, which TR 2026/2 at [54] expressly cross-references back to IT 2660, and TR 2026/2 providing the software-intermediation-specific overlay. IT 2660 remains the primary reference instrument for the general meaning of ‘royalty’ under subsection 6(1) across all industries and payment types.

The ruling focuses on jurisdictions whose tax treaty with Australia contains the ‘standard tax treaty definition’ of royalty (TR 2026/2 at [10]). That definition is used in most of Australia’s double tax agreements. The exceptions, which include the United States, Netherlands, Italy, Singapore, and Mexico, use non-standard royalty definitions. TR 2026/2 expressly acknowledges that it does not directly address payments to residents of those jurisdictions. 

The United States is, by value, the largest jurisdiction from which Australian businesses acquire software. The US Treasury has formally objected, in letters to the Australian Government in 2022 and 2024, to the ATO’s broad interpretation of royalties as inconsistent with the OECD Commentary on Article 12 and the Australia–United States Convention. Payments to US-resident payees requires a separate analysis under Article 12 of the Australia–United States Convention, which uses a materially narrower formulation. Equally, payments to residents of the Netherlands, Italy, Singapore, and Mexico require a treaty-specific enquiry. 

The standard tax treaty definition, which forms the foundation of TR 2026/2’s framework, specifies that a payment is a royalty to the extent it is consideration for:

• the use of, or the right to use, intellectual property, being copyright, patents, trademarks, designs, know-how, or other like property or right;
   
• the supply of technical or commercial knowledge; or 
   
• assistance ancillary to and enabling the enjoyment of those rights.

Drawing on this framework and applying it to modern software distribution models, TR 2026/2 at [16] concludes that a payment under a software intermediation arrangement is a royalty where it is consideration for:

• the grant of a right to use IP (including copyright), whether or not that right is exercised in practice;
   
• the use of any IP right, including the right to reproduce, communicate to the public, or adapt the software, or the supply of know-how;
   
• ancillary assistance enabling the enjoyment of those rights;
   
• rights in software embedded in tangible goods; or
   
• total or partial forbearance in respect of those rights. 

Conversely, under TR 2026/2 at [18], a payment is not a royalty where it is consideration solely for:

• the grant of a right to distribute copies of software made by the copyright holder, without any use of IP rights, or the assignment of all copyright in the software;
   
• the acquisition of tangible goods or physical media where no IP right is used or granted; or 
   
• services that are wholly unrelated to any IP right.

TR 2026/2 addresses embedded software (i.e. software incorporated into tangible goods such as consumer electronics, appliances, and industrial equipment). The general position is that where an Australian distributor acquires tangible goods with embedded software and neither uses nor is granted any copyright rights in respect of that software, the sale proceeds are generally not royalties (TR 2026/2 at [148]). The example given is the acquisition by a distributor of mobile handsets pre-installed with operating system software. However, where the distributor is granted rights to update, modify, or provide access to the embedded software, or where the embedded software has separable commercial value, a more nuanced analysis is required.  

The most significant technical development in TR 2026/2 relative to its predecessor drafts is the reframing of the ‘consideration for’ inquiry. TR 2026/2EC, the Compendium of ATO responses to issues raised in connection with the predecessor drafts, provides that previous reliance on GST authorities to define ‘consideration’ has been abandoned. In its place, the ruling adopts a causal test. This is consistent with the High Court’s analysis in PepsiCo and with the line of authority from significant Stamp Duty cases that were integral to a key component of the High Court’s decision in PepsiCo. Under this, ‘consideration for’ a royalty requires that the payment be made by reason of, or on account of, something within the royalty definition. That is, the royalty-characterised thing is the ‘purpose, basis, or condition’ of the payment. The test is objective: it asks what the payment is, in truth, made for, assessed by reference to the whole arrangement and commercial context, not by reference to the contractual label chosen by the parties. Corrs’ guide to the ongoing implications of the PepsiCo decision, published in August 2025, pre-empted this update to the ruling.

The High Court in PepsiCo found that the payments by the Australian bottler were not made as consideration for the use of IP because the ‘commercial and economic substance was that the relevant payments were for concentrate alone’. This was a conclusion driven by the arm’s-length nature of the dealings, the absence of a royalty clause, and the absence of evidence that pricing was disproportionate to the value of the goods alone. TR 2026/2 and PCG 2026/D4 draw on the PepsiCo Decision Impact Statement’s observation that the ‘economic fundamentals of an arrangement may be relevant to the identification of unrecognised royalties’. This signals that in related-party arrangements, which lack the arm’s-length pricing protection that was critical to PepsiCo’s success, the ATO will examine pricing evidence closely to determine whether royalties have been embedded in payments labelled as something else.

The abandonment of GST authorities and the adoption of a High Court-derived causal test provide a more principled and predictable framework. It has an important practical consequence: taxpayers whose arrangements have been structured to ensure that payments are for identifiable non-IP components, and who can demonstrate that substance with contemporaneous documentation, stand on stronger ground under the PepsiCo test than they might have been under the earlier GST-based analysis.

Copyright, exclusive rights, and the breadth of royalty characterisation

A distinctive feature of TR 2026/2 is its comprehensive reliance on Australian copyright law to determine whether a software intermediary is ‘using’ copyright for royalty characterisation purposes. The ruling integrates the framework of the Copyright Act 1968 (Cth) with the tax law definition of royalties in a manner that requires taxpayers to approach arrangements through both lenses simultaneously. The key proposition set out is that a royalty arises wherever the payment is consideration for the grant or exercise of any of the exclusive rights comprised in copyright in the software. This includes the right to authorise another person to exercise those rights, whether or not the right is in fact exercised in practice.

Under the Copyright Act, the owner of copyright in a computer program holds a suite of exclusive rights: 

• to reproduce the work in a material form (s 31(1)(a)(i));
   
• to communicate the work to the public (s 31(1)(a)(iv));
   
• to make an adaptation of the work (s 31(1)(a)(vi)); and
   
• to authorise another person to do any of these acts (s 13(2)).

TR 2026/2 takes the position that when a software intermediary exercises any of these exclusive rights, or is granted the right to exercise them, whether or not that right is in fact exercised, a royalty may arise. Critically, even a contractually granted but operationally unused right to reproduce or communicate software will bring the payment within the royalty definition, provided that the grant of that right was one of the things for which the payment was made.

The reproduction right (under s 31(1)(a)(i) of the Copyright Act) is central to most digital distribution models. The ATO takes the position that the download of software onto a customer’s device constitutes ‘reproduction in a material form’ (TR 2026/2 at [102]–[103]). An Australian distributor that authorises or facilitates such downloads – even where it does not itself hold or physically transmit a copy of the software, but simply grants the end user the right to download directly from the developer’s servers – is, in the ATO’s view, exercising an exclusive copyright right and therefore within the royalty definition. This analysis applies equally to software delivered by electronic means, app stores, and digital licence key distribution models.

For cloud-based and SaaS models, the communication right (s 31(1)(a)(iv) of the Copyright Act) assumes primacy. Where software is made available to Australian customers by online access, the ATO treats this as a ‘communication to the public’ (TR 2026/2 at [108]–[111]). An Australian entity that plays a role in determining which software or features are made available to customers – for example, by configuring access portals, managing user accounts, or acting as the contracting party vis-à-vis end users – may be treated as a person ‘responsible for determining the content of the communication’ within s 22(6) of the Copyright Act. On this analysis, many SaaS resellers, cloud aggregators, and technology intermediaries will be characterised as exercising a copyright right, rendering their upstream payments royalties.

The authorisation right is perhaps the most significant and most controversial of the three copyright pathways for Australian resellers and distribution channel partners. TR 2026/2 at [131]–[133] treats a distribution or channel partner agreement that permits the Australian entity to issue end-user licence agreements (EULAs) to customers as conferring an authorisation right, regardless of whether the Australian entity itself performs any technical copyright function. This means that even a purely administrative reseller (for example, one that merely passes through EULAs issued by the offshore supplier, takes orders, and invoices customers) may be regarded as exercising a copyright right, and its payments to the offshore supplier characterised as royalties. This position is at odds with the mainstream international approach, including the position of the US Treasury and the OECD Commentary on Article 12, which the ATO addresses directly in the Ruling but ultimately distinguishes on the grounds of Australian copyright law.

TR 2026/2 contains a dedicated discussion of the relevance of OECD Commentary at [78]–[86] of the Ruling. Consistently with its general position in TR 2001/13 Income tax: Interpreting Australia’s Double Tax Agreements, the ATO acknowledges that the OECD Commentaries are ‘an important guide on the interpretation and application of the OECD Model’. However, it affirms that ‘the text of a treaty has primacy in the interpretative process and the OECD Commentaries should not be considered to the exclusion of the words in the treaty’ (TR 2026/2 at [78]). 

Paragraph 14.4 of the OECD Commentary on Article 12 describes a distribution intermediary acquiring copies of a program ‘without the right to reproduce’ the software. It provides that in such circumstances, the distributor’s payments are business profits and not royalties. The ATO’s analysis at [84]–[86] is that the ATO accepts that the paragraph 14.4 example ‘may apply to many software intermediation arrangements in practice’, but holds that it ‘cannot be relied upon where the substance of an agreement or arrangement differs from the facts in the example’ – in particular, arrangements where ‘a distributor can independently make software available to download without further action by a software company’. The ATO further emphasises that the ‘relevance and application [of paragraph 14.4] depends upon the relevant domestic law of the country (particularly copyright law) from which the payment was made’ and that it must therefore be assessed by reference to how Australian copyright law operates. 

The implication is that the paragraph 14.4 example, which forms the basis of many taxpayers’ and advisers’ longstanding view that software distribution payments are not royalties, cannot simply be applied to Australian arrangements without first mapping those arrangements against Australian copyright law. This reasoning also directly addresses an argument pressed during the predecessor consultations and noted in the Compendium: namely, that Australia’s removal in 2000 of its earlier OECD observation to the relevant commentary signalled Australian acceptance of the OECD approach to software distribution. In the ATO’s view, the removal of the observation does not constrain its ability to apply Australian domestic copyright law to reach a different characterisation outcome.

Overall, the practical consequence of the ATO’s copyright analysis is that many arrangements previously understood as passive distribution (where an Australian entity marketed, sold, and invoiced customers for software without performing any technical copyright function) may now be characterised as involving copyright use, solely by reason of the grant of an authorisation right or the management of access controls. The TR 2026/2EC Compendium confirms that neither the absence of physical copying nor involvement within a corporate group alters this analysis, and that whether an arrangement constitutes a ‘software intermediation arrangement’ must be assessed on the specific facts of each case.

The extension of copyright protection to computer programs, effected by the Copyright Amendment Act 1984 (Cth), was motivated by the policy objective of protecting software developers against piracy and unlawful reproduction (not by any intention to expand the Australian tax base by imposing withholding tax obligations on arm’s-length commercial distribution arrangements). The Explanatory Memorandum to the Copyright Amendment Bill 1984 made this legislative purpose explicit: the Bill was introduced to ‘give to computer programs the protection now applied to literary works’. The Commissioner’s use of the copyright statutory framework as a mechanism for expanding the withholding tax base raises the question as to whether such application of the copyright provisions is aligned to the purpose for which the Copyright Amendment Act 1984 was enacted.

Technological protection measures: a new dimension in TR 2026/2

One of the notable additions in TR 2026/2 relative to TR 2024/D1 is the discrete treatment of technological protection measures (TPMs). TPMs are mechanisms that control access to copyright-protected works. In the software context, these include licence keys, activation codes, online access portals, digital rights management (DRM) systems, and other access-control technologies that govern whether and how a user may run, copy, or access software. TR 2026/2 at [144] takes the position that TPMs fall within the genus of IP for the purposes of the standard tax treaty definition of royalty, and accordingly that the ‘use of, or the right to use, TPMs’ falls within the royalty definition.

TR 2026/2 at [145] goes further. It provides that a distributor’s role in implementing TPM controls that restrict a customer’s access to software unless certain conditions are met (for example, requiring activation through the distributor’s own platform, or restricting access absent payment to the Australian entity) may be indicative of the distributor’s exercise of copyright rights. This could include the authorisation of acts comprised in copyright. On this analysis, most modern software distribution models, such as SaaS, cloud, digital download and subscription, rely on TPM-based access controls to enforce licence terms and manage customer access. An Australian distributor that implements or manages such controls is potentially exercising copyright rights through the TPM pathway, even if the analysis under the reproduction or communication rights would otherwise be contestable. Businesses whose distribution models involve platform-mediated access controls should specifically assess whether their role in operating those controls brings them within TR 2026/2.

What TR 2026/2 means: priority issues and practical risks

The ruling’s reach extends beyond the technology sector. Any Australian business that acquires software from an overseas supplier through an Australian subsidiary or third-party distributor, accesses cloud services supplied by an overseas group member, or acts as a distributor or reseller of foreign software will need to assess its position under TR 2026/2. The ruling is not limited to large multinationals: it applies to any cross-border software intermediation arrangement within its scope, regardless of the size of the Australian entity or the volume of the payments involved.

The shift in terminology from ‘software arrangement’ and ‘distributor’ (TR 2024/D1) to ‘software intermediation arrangement’ and ‘software intermediary’ (TR 2026/2) is deliberate and material. The term ‘intermediary’ (unlike ‘distributor’) does not carry the connotation of an entity that takes title to goods and resells them. It is capable of capturing resellers, platform operators, managed service providers, and any entity that sits between the software IP owner and the end user whose conduct involves the grant or exercise of IP rights. Businesses that formed a view on their royalties’ position under TR 2024/D1 on the basis that they were not ‘distributors’ in the traditional sense should reassess that position under the broader formulation. In particular, the ATO will seek to apply the ruling to periods both before and after its date of issue.

For businesses assessing their position under TR 2026/2, the following issues are most pressing.

Substance over form: the objective assessment of the arrangement

TR 2026/2 at [30] expressly provides that contractual characterisation is not determinative. An arrangement described as ‘royalty-free’, or an entity formally characterised as a ‘distributor’ with no express IP grant, is not thereby excluded from royalty characterisation. The ATO will conduct an objective assessment of the whole arrangement and the commercial context, asking what the payment is, in truth, consideration for.

This objective assessment takes into account not only the terms of written agreements but also the conduct of the parties and, critically, the economic fundamentals of the arrangement. This is a factor emphasised in the PepsiCo Decision Impact Statement (19 March 2026) and reflected in PCG 2026/D4. Taxpayers should review not only their formal contracts but also their operational practices: 

• how software is delivered;
   
• who issues end-user licences;
   
• who manages access controls; and
   
• how pricing is structured. 

If the intermediary in practice exercises rights consistent with copyright use, the absence of a formal royalty clause will not protect it.

Apportionment: available in theory, constrained in practice

TR 2026/2 at [17] acknowledges that where a payment is consideration for several things (at least one of which falls within the royalty definition), a fair and reasonable apportionment may be applied. This is provided sufficient evidence exists to establish the non-royalty portion (see also TR 2026/2 at [36], in the context of Example 2). However, two features of the ruling make apportionment practically constrained for the vast majority of taxpayers.

First, the ruling applies the principle derived from International Business Machines Corporation v Commissioner of Taxation [2011] FCA 335, that where IP rights granted are, from a practical and business perspective, inseparable from the other things for which the payment is made, the entire payment will be characterised as a royalty (TR 2026/2 at [34]–[35]). TR 2026/2 and TR 2026/2EC confirms that the ATO’s view is that ‘commonly’ in software intermediation arrangements, the IP rights (i.e. copyright, trademarks, know-how, ancillary services, and TPM access) are neither separate nor severable from the other rights granted. In practice, this means full royalty characterisation will be the default outcome for most arrangements, with apportionment a narrow exception reserved for arrangements with strong contemporaneous evidence of separable non-IP value.

Second, the only worked apportionment example in the previous draft ruling (Scenario 3 of TR 2024/D1, which dealt with a distributor granted rights to distribute both physical copies and online access) has been removed from TR 2026/2. Taxpayers are instead directed to PCG 2026/D4 for compliance guidance. The effect is that the final ruling is deprived of any illustration of how apportionment works in practice. Taxpayers whose arrangements involve a mixed payment should consider modelling their primary risk scenario in the first instance as one in which the entire payment is characterised as a royalty, not merely a portion of it.

Where apportionment is to be pursued, taxpayers must establish with contemporaneous documentation (created at the time the arrangement is entered into or renewed, not reconstructed after an ATO review has commenced) that the distribution or other non-IP rights had commercial value independent of the IP rights. The evidence required is likely to be substantial: contractual provisions pricing the non-IP rights separately, economic analysis of the relative value of IP and non-IP components, and ideally arm’s length comparables. Without such evidence, the default position under TR 2026/2 will be full royalty characterisation of the entire payment.

Temporal scope: unprotected exposure from 1 July 2021

TR 2026/2 applies both before and after its date of issue (4 September 2026). The protection afforded by TR 93/12 is expressly limited to periods before its withdrawal on 1 July 2021, and only where taxpayers have ‘appropriately relied upon’ it (TR 2026/2 at [38]). Any software intermediation arrangement entered into or renewed after 1 July 2021 that was not re-examined at the time of TR 93/12’s withdrawal therefore carries unprotected withholding tax exposure for the period from July 2021 to the present. For large multinational groups with material software distribution arrangements, the quantum of potential withholding tax, general interest charge and penalties accumulated over that five-year period may be very significant. Failure to withhold penalties may also apply to entities on the ‘other side’ of such arrangements.

PCG 2026/D4: a risk-based compliance framework

Recognising the compliance uncertainty created by TR 2026/2, the ATO simultaneously published draft PCG 2026/D4, which replaces draft PCG 2025/D4. PCG 2026/D4 is not legally binding but represents the Commissioner’s stated administrative approach. It is the principal instrument for managing compliance risk in the near term, pending the resolution of the underlying disputes, the finalisation of the PCG after its 2 October 2026 consultation close, and ultimately authoritative judicial determination of the royalty question. 

The risk zone framework in Schedule 1 to PCG 2026/D4 divides software intermediation arrangements into five zones (white, green, yellow, amber, and red) based on the nature of the intermediary’s role and its approach to royalty recognition.

• The white zone applies where no further risk assessment is required. For example, where the arrangement has been reviewed or audited by the ATO and given a ‘low risk’ or ‘high assurance’ rating, or where a court or tribunal has determined the royalty character of the payment. The white zone provides the highest level of certainty, but it depends on a prior ATO or judicial determination.
   
• The green zone applies to arrangements involving the straightforward resale of existing software copies (whether delivered electronically or on physical media) where the Australian intermediary does not acquire or exercise any copyright rights. This is a narrow category, broadly coextensive with the OECD Commentary Article 12 paragraph 14.4 example of a distributor paying ‘only for the acquisition of the software copies’. However, it must be read in light of the ATO’s own analysis of paragraph 14.4 in the Ruling (at [84]–[86]). The ATO’s own guidance acknowledges that contemporary software distribution models, involving cloud access, digital delivery, licence key distribution, or SaaS intermediation, will generally not satisfy this criterion.
   
• Yellow zone (low to medium risk) treatment is available where no royalty is recognised and the arrangement does not otherwise fall within the amber or red zones, including where taxpayers:
   
  • recognise a reasonable part of their outbound payments as royalties and withhold accordingly; or
     
  • maintain Australian taxable profit margins that are higher relative to the global group's profitability, suggesting that value has been retained in Australia (the ‘operating margin exception’). This also permits an amber-zone arrangement to qualify for yellow-zone treatment where the Australian operating margin exceeds 10% or is within 10 percentage points of the global group’s operating margin.
     
• At the amber zone (medium to high risk), arrangements will be prioritised for ATO review. This zone captures arrangements where the Australian intermediary sells products or services that substantially involve access to or use of software IP rights held by the offshore supplier, without adequate royalty recognition.
   
• The red zone (high risk) is the ATO’s highest priority for review. The principal concern is with cross-border arrangements structured to reduce or eliminate tax on profits connected with Australia, particularly where the Australian intermediary makes copies of the software or the offshore supplier is a tax resident of a ‘specified jurisdiction’. The red zone also captures arrangements involving unrelated-party structures with significant mischaracterisation indicators.

PCG 2026/D4 invites stakeholder comments until 2 October 2026, with specific questions posed about the risk zone criteria, the calculation of residual risk, practical application issues, and the utility of the examples provided. 

Practical implications for taxpayers 

Withholding tax obligations

Where TR 2026/2 applies and a payment is characterised as a royalty, the Australian payer is obliged to withhold royalty withholding tax under section 128B of the ITAA 1936 and the PAYG withholding provisions in Division 12 of Schedule 1 to the Taxation Administration Act 1953 (Cth). Where a double tax agreement reduces the applicable withholding tax rate (typically to 5% or 10% under the standard royalty article), the reduced rate may be claimed, provided the payment is a royalty within the applicable treaty definition. Taxpayers should review their current withholding positions against TR 2026/2.

Treaty positions and the exceptional jurisdictions

TR 2026/2 expressly applies only to jurisdictions using the ‘standard tax treaty definition’. For the exceptional treaty jurisdictions – the United States, the Netherlands, Italy, Singapore, and Mexico – a separate analysis under the applicable treaty definition is required, and TR 2026/2’s conclusions do not automatically apply. 

For US-resident payees, Australian entities should undertake a separate analysis under Article 12 of the Australia–United States Convention. The US Treasury’s formal position, communicated to the Australian Government in 2022 and 2024, is that payments by a distribution intermediary that does not hold a right to reproduce, adapt, or otherwise exploit copyright should constitute business profits under Article 7, not royalties under Article 12. This treaty-level argument provides a potentially significant basis for challenging any ATO characterisation in the US context and should be considered carefully in any arrangement review.

Where treaty-based disputes arise, the Oracle case confirms that MAP and binding arbitration under Australia’s DTA network are available as treaty-protected mechanisms recognised and enforced by Australian courts. Taxpayers facing significant, assessed withholding tax exposures should consider early engagement, and assess whether initiating MAP in the counterpart jurisdiction is appropriate. 

Transfer pricing considerations and the new SGE penalty

The royalty characterisation issue under TR 2026/2 intersects directly with the transfer pricing provisions in Division 815 of the Income Tax Assessment Act 1997 (Cth). Where a multinational group has structured its Australian software distribution arrangements without any recognised royalty between the Australian intermediary and the offshore IP owner, the ATO will assess whether the arm’s length price of the arrangement would have included a royalty component. (This is consistent with the PepsiCo Decision Impact Statement’s emphasis on testing the ‘economic fundamentals of arrangements that involve provision of IP with no royalty’). An adverse transfer pricing determination may interact with, and significantly compound, a withholding tax assessment. The transfer pricing adjustment increases the royalty base on which withholding tax is assessed and may attract separate transfer pricing penalties.

The Australian government had previously announced that it would introduce a new penalty for taxpayers with more than $1 billion in annual global turnover that have mischaracterised or undervalued royalty payments (to which withholding tax would normally apply). The ATO had previously indicated that the penalty would commence from 1 July 2026. This measure materially increases the financial risk for large multinationals with Australian software distribution arrangements. The interaction of the withholding tax, transfer pricing, and SGE penalty regimes means that the total financial exposure from a single mischaracterised arrangement (once withholding tax, general interest charge, transfer pricing adjustments, and the SGE penalty are aggregated) may be substantial.

Conclusions: certainty in form, complexity in substance

TR 2026/2 provides the ATO’s final interpretive position on software royalties. That position is retroactive in effect and diverges from the mainstream international approach. The ATO has held the line on the expansive characterisation position advanced in the earlier drafts. In several respects, it broadened it through the revised terminology, the new TPM provisions, and confirmation that apportionment will ‘commonly’ not be available in practice. 

The Oracle MAP and the at least 15 other live disputes noted by the Federal Court confirm that the underlying substantive question as to what constitutes a royalty for Australian tax purposes remains unresolved as a matter of authoritative judicial determination. TR 2026/2 is the ATO’s answer, but may not ultimately be the courts’ answer. 

In the meantime, multinationals should:

• review their software-related cross-border payment arrangements against TR 2026/2;
   
• assess their treaty position for payments to residents of exceptional jurisdictions;
   
• quantify any potential withholding tax exposure from 1 July 2021; and 
   
• consider engaging with the PCG 2026/D4 consultation process.

As noted, the Copyright Act was extended to computer programs in 1984 to protect software developers against piracy and unlawful copying, not to create withholding tax obligations on commercial distribution arrangements. The ATO’s approach raises a question about the proper limits of statutory interpretation in the context of tax law, and the extent to which a purposive reading of the Copyright Act may be invoked in future litigation. This argument may have particular force where the intermediary’s conduct falls at the outer margins of what constitutes ‘authorisation’ for copyright law purposes.

A further risk is that the framework set out in TR 2026/2 may not remain confined to software intermediation arrangements. The methodology on which the ruling applies (an objective, purpose-based inquiry into what a payment is ‘in truth’ made for, assessed by reference to the whole arrangement and its economic fundamentals rather than contractual labels) applies with equal force to cross-border payments involving other categories of IP. The ATO’s PepsiCo Decision Impact Statement makes clear that PepsiCo does not limit the Commissioner’s ability to challenge arrangements involving IP, including embedded royalty scenarios, and that the ATO will continue to ‘test the economic fundamentals of arrangements that involve the provision of IP but where no royalty is recognised’. 

The practical implication is that multinationals whose Australian operations pay cross-border amounts involving, directly or indirectly, trademarks, patents, know-how, or other IP without expressly recognising a royalty component should not assume that TR 2026/2’s software focus excludes them from this broader compliance risk. The ATO’s stated compliance posture following PepsiCo, creates a material risk that the same approach will be applied to non-software IP arrangements, in particular those involving related parties.

Impacted multinationals should examine the commercial substance and purpose of their arrangements, consider whether they have detailed contemporaneous documentation in place, and draw on both IP law and tax law expertise. This will help ensure that they are best placed to navigate what remains a complex and contested area of Australian international tax law.