Intangibles: Key tax risks for multinational groups

19 February 2025

Recent developments and government announcements have highlighted the need for multinational groups to consider their arrangements with intangibles in order to prepare for and manage revenue authority scrutiny.

The success of many large multinational organisations comes from the value derived from the intellectual property rights subsisting in their ‘intangibles’. These include well-known brands, trade secrets, know-how, copyright protected works, inventions, patents, software and goodwill. All companies own some type of intangible. The Australian Taxation Office (ATO) views intangibles as the main driver of value creation.

A consequence of these assets’ intangible nature is that they may provide value to an entity across multiple jurisdictions, whilst simultaneously defying a simplistic evaluation of their performance within any one of those jurisdictions. If the owners, residing in Country A, of a trademark registered in Country B, profit as a result of their ownership from sales in Country C, which state or states may seek to tax those profits? To what degree may they do so? And how may they do so without raising concerns that they are seeking the extraterritorial enforcement of their taxation laws? These questions are difficult, and in a world in which intangible assets are increasingly the main drivers of multinationals’ value creation, domestic legislatures and taxation authorities are acutely interested in taxing such assets. The Australian government and the ATO are no exception, and their recent actions directed towards the taxing of intangibles ought to be followed closely by multinationals with a presence or operations in Australia.

Tax and intangibles

It is necessary first to set out what is meant by the phrase ‘intangible assets’ or ‘intangibles’ in the present context. Intangibles are valuable assets with no physical substance. They include registrable forms of intellectual property, such as trademarks, designs, patents and plant breeders’ rights. Other examples of intangibles include non-registrable forms of intellectual property such as copyright, trade-secrets, confidential know-how, customer relationships and business goodwill. Often, organisations have not fully identified or do not have an enterprise wide understanding of the existence of, and corresponding value that may reside in, their portfolio of intangible assets (whether registrable or not).

The definition that is used by the ATO in its recent publications is the following:

“… property, assets and rights that are not physical or financial assets, which are capable of being controlled for use in commercial activities, and are not restricted by any accounting or legal concepts or definitions – see paragraphs 6.6 to 6.8 of Chapter VI of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as approved by the Council of the Organisation for Economic Co-operation and Development (OECD Transfer Pricing Guidelines) and last amended on 20 January 2022.”^[1]

The ATO’s definition directs attention to the OECD Transfer Pricing Guidelines, which focus on the concept of intangibles in the context of transfer pricing. Those guidelines state:

“6.6. … the word ‘intangible’ is intended to address something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances…

6.7. Intangibles that are important to consider for transfer pricing purposes are not always recognised as intangible assets for accounting purposes… Furthermore, the determination that an item should be regarded as an intangible for transfer pricing purposes does not determine or follow from its characterisation for general tax purposes, as, for example, an expense or an amortisable asset.

6.8. The availability and extent of legal, contractual, or other forms of protection may affect the value of an item and the returns that should be attributed to it. The existence of such protection is not, however, a necessary condition for an item to be characterised as an intangible for transfer pricing purposes. Similarly, while some intangibles may be identified separately and transferred on a segregated basis, other intangibles may be transferred only in combination with other business assets. Therefore, separate transferability is not a necessary condition for an item to be characterised as an intangible for transfer pricing purposes.”

Australia has adopted a targeted approach by taxing certain types of payments made with respect to certain types of intangible assets. However, these forms of taxation ought not to be considered in isolation as there are sufficient commonalities and recurring issues.

In general, some of the key areas in which tax is imposed with respect to intangibles include:

deductibility of costs in the development of intangibles
taxes on royalty payments for the use of intangibles
arm’s length pricing of payments between related parties relating to intangibles
anti-avoidance considerations relating to the movement of intangibles to low-tax jurisdictions

ATO assurance and audit activity

The ATO continues to receive significant funding from the government to conduct its assurance and audit activities. This means that most taxpayers will be reviewed by the ATO.

The ATO’s Annual Report, released on 31 October 2024, reveals that multinationals are a ‘key focus area’.^[2] The ATO will prioritise Tax Avoidance Taskforce funding and resources to large audits and litigation in the large corporate and multinational markets. Significant audits and litigation will be used to clarify the law and test legal principles, as well as send a message to these groups (and the broader public) to ensure compliance. With several recent multinational disputes being taken to court (as outlined below), the ATO has demonstrated its willingness to litigate tax disputes.

More specifically, the ATO is targeting a number of taxpayers, including in the telecommunications, information technology, pharmaceutical, financial services and consumer goods sectors on the tax and legal risks associated with the embedded royalties and transfer pricing aspects of cross-border commercial and intra-group contractual arrangements. This extends to the potential application of Australia’s anti-avoidance provisions to such arrangements.

In such cases, it is important for taxpayers to proactively prepare for ATO reviews and audits, as well as seek assistance during the early structuring phase. This includes consideration of the evidentiary requirements to support the substance of development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets across jurisdictions.

The PepsiCo Case

In June 2024, the Full Court of the Federal Court handed judgment in PepsiCo, Inc v Commissioner of Taxation [2024] FCAFC 86. The Full Court allowed PepsiCo’s appeal, holding that it was not liable to pay royalty withholding tax in respect of its exclusive bottling agreements with the Australian bottler and distributor of its soft drinks. In summary, the Full Court favoured a literal and legalistic approach to the question of whether consideration was paid ‘as consideration for’ the use of the relevant IP, focusing on the express terms of the relevant agreements. Not satisfied that any consideration was provided for the use of IP rights, the majority held that no royalty had been paid, such that no royalty withholding tax was payable.^[3] The Full Court also found in favour of the taxpayer in respect of the application of Australia’s diverted profits tax (DPT), which is the first time that DPT was considered by an Australian court. The High Court has granted special leave for the Commissioner to appeal the Full Court’s decision of the Full Court, with many taxpayers eagerly awaiting the outcome of the High Court appeal. On 9 January 2025, the Commissioner filed its submissions to the High Court and Pepsico filed its submissions on 30 January 2025.

The Pepsico case is covered in detail in our previous articles:

The Pepsico case signals the ATO’s focus on taxpayers granting rights in, or otherwise dealing with, intellectual and intangible property. Taxpayers should consider reviewing any comparable arrangements (including cross border supply and service agreements) as well as the valuation and cross-border licensing of brands, inventions, copyright protected works and other intellectual property.

The Oracle case

The Federal Court is also currently considering how royalty withholding tax applies to Oracle Australia in relation to sublicence fees paid to Oracle Ireland under intercompany licensing arrangements. Oracle Australia purchased software and hardware from Oracle Ireland and distributed these products in Australia.^[4] The ATO contends that Oracle Australia should have paid royalty withholding tax of approximately $253m. As such, Oracle Ireland enlivened mutual agreement procedure (MAP) under the Ireland-Australia tax treaty.^[5]

Oracle Australia recently appealed to the Federal Court in order to preserve its right, and satisfy certain timeframes, to appeal in Australia. However, Oracle concurrently applied for a temporary stay of the Australian proceedings to permit the MAP to reach its conclusion.

On 31 October 2024, the Federal Court rejected Oracle’s application to stay the Australian proceedings, meaning that the MAP process that had already commenced under the Ireland-Australia tax treaty would be suspended. The Federal Court noted that the public interest in having certainty on the technical tax question in dispute (i.e. whether software sublicence fees are ‘royalties’ for withholding tax purposes) was significant, because:

the ATO presented evidence of approximately 15 other taxpayers whose distributions arrangements required consideration of what constitutes a ‘royalty’;^[6] and
the ATO’s approach to the characterisation of royalties outlined in its draft ruling (see below) has created ‘strong concerns’ for the United States.^[7]

Further details in respect of the Oracle case can be found in PepsiCo and Oracle cases: reassessing royalties in Australian tax.

Oracle has since appealed the decision of the Federal Court in respect of the stay application. Whilst the ATO has provided its view on the royalties issue (namely, TR 2024/D1), we will need to wait for judicial guidance on the issue which may not occur for some time.

Draft Taxation Ruling TR 2024/D1

In January 2024, the ATO released draft taxation ruling 2024/D1, which is targeted at ‘software arrangements’. In this context, a ‘software agreement’ is said to be an ‘agreement, arrangement or scheme under which a distributor makes payment or payments directly or indirectly to the owner or licensee (as the case may be) of the copyright (or other IP) for the right to be in a position to earn income relating to the use of, or right to use, software’.^[8] The ruling provides the ATO’s updated view on when payments under a software arrangement constitutes royalties for the purposes of royalty withholding tax.

Based on the ATO’s view, the circumstances under which a software distribution arrangement will give rise to royalty withholding tax are wide-ranging. Whilst this area of the law is largely untested, the draft ruling demonstrates the ATO’s continued focus on intangible arrangements and heightened compliance activity.

The ATO have advised that they will continue to review and audit taxpayers who enter into such arrangements. The ATO has previously announced that the finalisation of the draft ruling would be deferred, pending the outcome of the PepsiCo High Court proceedings.

Practical compliance guideline 2024/1

PCG 2024/1 sets out the ATO’s compliance approach to arrangements involving intangible migration arrangements. The guideline provides taxpayer risk ratings in order for the ATO to direct resources to review a taxpayer with respect to:

Migration of intangible assets; and
Mischaracterisation and non-recognition of Australian activities connected with intangible assets.

The ATO has set out onerous evidentiary expectations in relation to taxpayers having contemporaneous documents evidencing commercial decision making, DEMPE functions and the tax / profit outcomes of intangible arrangements. The Guideline applies to most taxpayers with related-party offshore intangible arrangements. Taxpayers should appropriately seek to gather and assess the evidence in order to meet the ATO’s expectations.

Anti avoidance – DPT and Part IVA

The ATO has increasingly focused on applying Part IVA and DPT to scrutinise intangible arrangements. Part IVA, being a general anti-avoidance provision, allows the ATO to cancel tax benefits derived from arrangements made with the primary purpose of avoiding tax, while DPT targets large multinational companies that shift profits artificially out of Australia to low-tax jurisdictions. In order for multinational taxpayers to be able to defend against Part IVA and DPT, it is important that any transactions involving intangibles are supported by sound commercial objectives. Taxpayers need to gather and assess the commercial rationale and substance of transactions to ensure that they are aligned with genuine business purposes and to ensure that taxpayers have contemporaneous evidence to support the positions adopted.

Notably, there have been a significant number of Part IVA and DPT cases before the Australian Courts as the ATO seeks to apply Part IVA and DPT more broadly.^[9] Businesses need to ensure that their arrangements are robust in both commercial substance and compliance to mitigate the risk of falling foul of Part IVA and DPT provisions, which could result in costly disputes and penalties.

Other government measures

In the 2024–25 Budget, the government announced that from 1 July 2026 it will introduce a new penalty for taxpayers with more than $1 billion in global turnover annually who have mischaracterised or undervalued royalty payments to which withholding tax would normally apply. This measure is not yet law.

The government had previously announced rules to deny deductions for payments relating to intangibles connected with low corporate tax jurisdictions. This measure was discontinued as part of the 2024–25 Budget. The discontinuation was appropriate given the government’s implementation of the ‘Pillar Two’ 15% global minimum tax and domestic minimum tax in Australia, which broadly achieves the same objective of combatting tax avoidance using cross-border intangible payments to low tax jurisdictions. Needless to say, it demonstrates the Australian Government and ATO’s commitment to scrutinising cross-border intangible arrangements.

Uncertainty in intangibles

Based on recent developments in Australian case law and the ATO’s compliance activity it is evident that the ATO is increasingly focused on scrutinising intangible arrangements. It is also apparent that the positions of the courts and the ATO on these issues are not always aligned. The ATO has found itself having to provide prospective guidance on the increasingly complex legislation seeking to impose tax on intangible assets, while also having to react to judicial decisions that challenge the bases upon which it issues such guidance. The result leaves taxpayers, and in particular multinationals, with additional uncertainty in an ever changing tax landscape.

^{[1] PCG 2024/1 [3]. See also, for example, TA 2018/2, fn 1; TA 2020/1 fn 1.}

^{[2] ATO Annual Report 2023-24, page 16.}

^{[3] PepsiCo, Inc v Commissioner of Taxation [2024] FCAFC 86 at [9].}

^{[4] Oracle Corporation Australia Pty Ltd v Commissioner of Taxation (Stay Application) [2024] FCA 1262 at [3].}

^{[5] Oracle Corporation Australia Pty Ltd v Commissioner of Taxation (Stay Application) [2024] FCA 1262 at [11]-[12].}

^{[6] Oracle Corporation Australia Pty Ltd v Commissioner of Taxation (Stay Application) [2024] FCA 1262 at [65].}

^{[7] Oracle Corporation Australia Pty Ltd v Commissioner of Taxation (Stay Application) [2024] FCA 1262 at [63].}

^{[8] Draft Taxation Ruling TR 2024/D1 – Income Tax: royalties – character of payments in respect of software and intellectual property rights, paragraph 9.}

^{[9] Minerva Financial Group Pty Ltd v FC of T [2024] FCAFC28; Mylan Australia Holding Pty Ltd v FC of T (No 2) [2024] FCA 253; Merchant v FC of T [2024] FCA 498; Ierna v FC of T [2024] FCA 592; PepsiCo, Inc v FC of T [2024] FCAFC 86.}

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