The Australian Taxation Office (ATO) has released draft guidance that could significantly impact Australian businesses making payments to overseas software providers.
The Draft Practical Compliance Guideline PCG 2025/D4 outlines the ATO’s compliance approach to identifying when cross-border software payments may be treated as royalties – and therefore be subject to withholding tax. This reflects the ATO’s broader focus on IP and the tax treatment of payments made under software arrangements.
While the guidance offers a welcome framework to help businesses self-assess their risk, it also flags areas that may require review – even for those who consider themselves low risk. If your organisation is making payments to offshore software providers, it’s important to understand where you sit on the ATO’s risk spectrum and whether your arrangements may attract scrutiny.
Key takeaways for Australian businesses
- Royalty risk is a compliance focus: Cross-border payments for software may be considered royalties under Australian tax law and therefore subject to withholding tax. Businesses should ensure payment structures are well-documented to avoid compliance risks and scrutiny. This is particularly relevant for undissected payments made to non-residents who own or control intellectual property (IP).
- Self-assess using the ATO’s risk zones: The ATO’s framework allows businesses to determine whether their arrangements are in the white or green zone – both are considered low risk.
- The ‘white zone’ applies where the arrangement has already been reviewed or agreed (e.g. Advance Pricing Arrangements or court decisions).
- The ‘green zone’ applies to standard software use cases – such as off-the-shelf software used internally, or software that is inherent or practically inseparable to enable tangible goods to perform their intended function.
If you cannot confidently self-assess, or your arrangements fall outside these zones, you may face closer scrutiny and compliance activity – particularly where it's unclear how much of the payment relates to IP.
- Reassess existing structures: The ATO has signalled that restructures – especially those resulting in less or avoid royalty withholding tax – may still attract compliance attention, even if they fall within a low-risk zone. This includes restructures shifting contracts offshore while key activities remain in Australia.
Why this matters
Incorrectly identifying your royalty withholding tax obligations can result in interest, penalties, and reputational damage. The ATO has made it clear that it won’t hesitate to apply general anti-avoidance provisions where appropriate, particularly in cases involving restructures or aggressive arrangements. This guidance also reinforces the ATO’s focus on undissected payments, where the nature of the payment is not clearly documented.
The ATO is currently accepting feedback on the draft until 17 September 2025 – details are available here. The ATO will also review their position when the High Court hands down their decision on the PepsiCo appeal.
Next steps
We recommend reviewing your existing and future software arrangements involving offshore parties, particularly if you’re making lump-sum or bundled payments for access, use, or rights relating to software IP. Consider whether you can confidently self-assess as low risk under the ATO’s framework, or whether a more detailed review is required.
If you’d like help understanding your risk profile, ensuring compliance, and what this means for your business, please reach out.
