The Australian Taxation Office has finalised its position on the treatment of cross-border software payments, issuing Taxation Ruling TR 2026/2 alongside a revised draft compliance framework, PCG 2026/D4.
The developments are particularly relevant for multinational technology groups using Australian distributors, resellers or other intermediaries to provide software and cloud-based products to Australian customers.
The central question is whether payments made offshore are simply payments for software distribution or services — or whether some or all of the payment should instead be characterised as a royalty subject to Australian royalty withholding tax.
The final ruling sets out the ATO’s interpretation of the law, while the draft PCG introduces a five-zone framework showing how the ATO proposes to allocate compliance resources to software arrangements.
TR 2026/2: The ATO’s Final Position
TR 2026/2, released in September 2026, finalises the ATO’s position on when payments made under software arrangements may constitute royalties for Australian income tax purposes.
It addresses cross-border payments connected with software and intellectual property rights, including arrangements involving Australian intermediaries and offshore software or IP owners.
Importantly, the ATO’s analysis focuses on the rights and obligations involved in an arrangement rather than simply the contractual label attached to the transaction.
Calling an entity a “distributor”, for example, or describing particular rights as “royalty-free”, does not by itself determine the tax characterisation of the payment. The legal rights, surrounding circumstances and actual operation of the arrangement remain relevant.
PepsiCo Forms an Important Part of the Background
The finalisation of the software royalty guidance also needs to be viewed in the context of the High Court’s decision in Commissioner of Taxation v PepsiCo Inc & Anor [2025] HCA 30.
Following that judgment, the ATO published its Decision Impact Statement on 19 March 2026.
The ATO’s subsequent guidance reflects its updated position following PepsiCo, including its view that the economic fundamentals of an arrangement may assist in identifying royalties that have not been separately recognised or expressly identified in the contractual payment structure.
This is particularly relevant to software arrangements where a single payment may economically compensate the offshore supplier for several elements, including software, distribution activities and intellectual property rights.
The issue is therefore not limited to agreements containing an expressly identified royalty.
When Could a Software Payment Be a Royalty?
Under the ATO’s final position, payments can potentially constitute royalties where consideration is provided for matters including:
- the grant of a right to use intellectual property;
- the actual use of an intellectual property right;
- copyright rights, including rights connected with reproduction or communication;
- the supply of know-how;
- assistance connected with the application or enjoyment of intellectual property or know-how;
- rights relating to intellectual property embedded in tangible products; and
- certain forms of forbearance concerning intellectual property rights.
This makes the precise role performed by the Australian entity critical.
For example, circumstances where a software intermediary authorises downloads, authorises reproduction, provides access to SaaS products or facilitates customer access can be relevant to determining whether intellectual property rights are being used.
Technological access controls such as licence keys, activation codes and other mechanisms controlling access to software can also be relevant to the analysis.
Not Every Software Payment Is a Royalty
The ATO’s position does not mean that every cross-border software payment constitutes a royalty.
Payments can remain outside royalty treatment where an arrangement involves, for example, the straightforward acquisition or resale of software without the Australian entity acquiring or exercising relevant copyright or other intellectual property rights.
Similarly, the acquisition of tangible products containing embedded software does not necessarily involve a royalty merely because software is present in the product.
The distinction depends heavily on what rights the Australian entity actually receives and exercises and what the offshore payment is economically and legally for.
SaaS and Modern Distribution Models Require Closer Analysis
One of the important practical aspects of the ruling is its application to modern software distribution structures.
Traditional software distribution often involved physical copies of software being purchased and resold. Modern models can involve cloud access, subscriptions, downloads, activation credentials and local intermediaries facilitating customer access.
These features can affect the analysis.
A distributor that appears commercially to be performing a routine sales function may still need to determine whether its role involves rights belonging to the copyright or other IP owner.
The analysis therefore requires businesses to understand not only their intercompany agreements but also how software is technically delivered, accessed and activated by customers.
Apportionment Could Become a Major Practical Issue
Payments under software arrangements may compensate an offshore supplier for several different elements.
Some could potentially constitute royalties while others may represent distribution rights, services or other commercial activities.
Where a payment relates to multiple components, an allocation or apportionment may therefore become necessary.
This creates an important documentation issue for multinational groups seeking to support a division between royalty and non-royalty components.
The question becomes particularly significant where the contractual documentation does not separately identify the value attributed to relevant IP rights.
The Applicable Tax Treaty Still Matters
Where a payment is made to a resident of a treaty jurisdiction, the relevant Australian double tax agreement must also be considered.
Royalty definitions are not necessarily identical across Australia’s treaty network.
Accordingly, the analysis should not stop with the domestic Australian tax treatment. Businesses should examine the wording of the royalty article in the specific treaty applicable to the offshore recipient.
PCG 2026/D4 Introduces Five Risk Zones
Alongside the final ruling, the ATO released draft Practical Compliance Guideline PCG 2026/D4.
The distinction between the two documents is important.
TR 2026/2 sets out the Commissioner’s interpretation of the law. PCG 2026/D4 instead describes how the ATO proposes to allocate its compliance resources.
A higher PCG risk rating therefore does not itself mean that the taxpayer’s legal position is incorrect.
The draft framework contains five categories:
| Risk Zone | ATO Risk Classification |
| White | Further risk assessment not required |
| Green | Low risk |
| Yellow | Low to medium risk |
| Amber | Medium to high risk |
| Red | High risk |
The framework provides taxpayers with a structured mechanism for assessing the compliance risk attached to their software arrangements.
Schedule 1 Focuses Specifically on Software
An important structural feature of the draft PCG is that the software framework appears in Schedule 1.
In other words, the Guideline itself provides the overarching compliance approach, while Schedule 1 applies that framework specifically to payments relating to software arrangements.
The use of a schedule-based structure also allows additional schedules to potentially be introduced for other types of arrangements in the future.
The current software risk framework should therefore be understood as the first specific application of a potentially broader compliance framework.
Green Zone: Lower-Risk Arrangements
The draft PCG identifies circumstances capable of receiving green-zone treatment.
These include certain straightforward acquisitions of software for private or internal business use, software embedded in tangible products and simple distribution arrangements where the Australian entity does not receive broader rights to copy, adapt or otherwise exploit the software.
Lower-risk treatment can also potentially be available where a royalty is recognised, appropriately documented, reported and subject to withholding tax and the arrangement satisfies the quantitative criteria contained in the draft PCG.
For related-party arrangements, the draft framework introduces a residual risk assessment calculation.
One of the thresholds currently contemplated in the draft compares the recognised royalty with 75% of the calculated residual amount.
However, this percentage should not yet be regarded as final.
The draft PCG expressly states that the threshold percentage used in the residual risk assessment calculation will be confirmed after feedback received during the consultation process has been considered.
Accordingly, the 75% threshold is part of the current draft framework and remains open to change before the PCG is finalised.
A New Residual Risk Assessment Calculation
The residual risk assessment calculation is one of the most significant features of the draft PCG.
Broadly, the methodology seeks to assess the residual amount associated with the offshore supplier after taking specified costs connected with the arrangement into account, together with the relevant mark-up contemplated by the draft framework.
The resulting amount is then used as part of the risk assessment of the recognised royalty.
For multinational groups, this could create a significant information requirement because the Australian taxpayer may need access to detailed financial and cost information held by an offshore related party.
The methodology therefore brings together royalty characterisation, withholding tax and economic information that may also interact with the group’s transfer pricing analysis.
Amber Zone Includes an Important Operating-Margin Carve-Out
The amber zone is intended to identify arrangements that the ATO regards as presenting a medium to high compliance risk.
However, the draft framework includes an important profitability qualification.
An arrangement that would otherwise fall within the amber-zone criteria is excluded from that zone where the Australian entity’s operating margin:
- exceeds 10%; or
- is within 10 percentage points of the operating margin of the global group.
This is an important practical qualifier because the ATO is not assessing software arrangements solely by reference to the existence of access rights, passwords, licence keys or similar features.
The profitability of the Australian operation relative to the broader group can materially affect its classification under the draft risk framework.
Red Zone Signals the Highest ATO Compliance Attention
The red zone represents the highest level of compliance risk under the draft framework.
The relevant indicators focus on arrangements displaying characteristics that the ATO considers more likely to involve unrecognised or insufficiently recognised royalty payments.
A red-zone classification can therefore be expected to attract greater ATO attention.
However, the same distinction remains important: risk classification under the PCG does not itself determine whether a payment is legally a royalty.
That question must still be determined under the applicable Australian tax law and, where relevant, the applicable tax treaty.
Restructuring May Not Eliminate the Risk
The draft PCG also signals ATO attention toward restructurings that reduce or eliminate Australian royalty withholding tax.
Changes to legal agreements or payment flows therefore need to be considered in the context of the broader commercial and economic arrangement.
Depending on the circumstances, restructuring may also raise issues under other Australian tax provisions, including transfer pricing and anti-avoidance rules.
Groups considering changes to software distribution structures should therefore assess the overall arrangement rather than focusing exclusively on the prospective withholding tax outcome.
Historical Positions May Also Need Review
The final ruling is relevant not only to new software arrangements.
Multinational groups may also need to consider whether their historical treatment of cross-border software payments remains consistent with the ATO’s final position, taking into account the applicable law, previous ATO guidance and the particular facts of their arrangements.
This potentially turns the exercise into both a prospective and historical review.
What Multinational Groups Should Review
Businesses with Australian software distribution, reseller, SaaS or technology arrangements should consider mapping their existing structures against both TR 2026/2 and draft PCG 2026/D4.
Particular attention should be given to:
- cross-border payments connected with software and intellectual property;
- distribution, reseller, SaaS and licensing agreements;
- the copyright and other IP rights actually granted to Australian entities;
- how software is technically delivered, activated and made available to customers;
- the economic fundamentals of the arrangement following the ATO’s response to PepsiCo;
- applicable tax treaty provisions;
- existing royalty withholding tax positions;
- methodologies used to allocate or apportion mixed payments;
- transfer pricing policies associated with the relevant arrangements;
- Australian and global operating margins;
- the appropriate PCG 2026/D4 risk zone; and
- historical restructurings involving software or intellectual property.
The analysis increasingly requires tax, transfer pricing, contractual and intellectual property considerations to be examined together rather than separately.
Four-Week Consultation on the Draft PCG
While TR 2026/2 is final, PCG 2026/D4 remains draft guidance.
The ATO has opened a four-week consultation period on the revised compliance framework.
This distinction is particularly important because elements of the quantitative methodology remain subject to consultation.
That includes the percentage threshold used in the residual risk assessment calculation. The draft itself makes clear that the final percentage will be confirmed following feedback received through the consultation process.
Businesses assessing their position against the PCG should therefore treat the current quantitative thresholds as draft parameters rather than settled final ATO guidance.
Why This Matters
The significance of the ATO’s software royalty guidance extends beyond traditional software licensing.
The analysis focuses on what is actually happening within modern software distribution arrangements — who controls customer access, what rights are granted or exercised, how the software is delivered and what the offshore payment economically represents.
The PepsiCo decision and the ATO’s subsequent Decision Impact Statement add another important dimension, with the ATO emphasising the economic fundamentals of an arrangement when considering whether an unrecognised royalty may exist.
At the same time, PCG 2026/D4 introduces a much more structured compliance lens.
Australian profitability, group profitability, recognised royalties, residual returns and the characteristics of the software arrangement can all influence where an arrangement sits within the ATO’s risk framework.
For multinational technology groups, the question is therefore no longer simply whether an agreement contains an explicit royalty clause.
The broader question is whether the legal rights, technical operation and economic substance of the software distribution model indicate that part of an outbound payment represents consideration for intellectual property rights — and, separately, how the resulting position will be viewed under the ATO’s compliance framework.
FAQ
What is TR 2026/2?
TR 2026/2 is the ATO’s final taxation ruling setting out the Commissioner’s view on when payments connected with software and intellectual property rights may constitute royalties.
Why is PepsiCo relevant?
The High Court decision in Commissioner of Taxation v PepsiCo Inc & Anor [2025] HCA 30 and the ATO’s subsequent Decision Impact Statement form important context for the updated guidance. The ATO considers that the economic fundamentals of an arrangement can be relevant when identifying royalties that have not been separately recognised.
Are all payments by Australian software distributors royalties?
No. Characterisation depends on the rights involved and the particular arrangement. Straightforward acquisition or resale arrangements can fall outside royalty treatment where the Australian entity does not acquire or exercise relevant IP rights.
Can SaaS arrangements be affected?
Potentially. Modern software arrangements involving cloud access, subscriptions, customer-access mechanisms and intermediaries can require analysis of the underlying rights and functions.
What is PCG 2026/D4?
PCG 2026/D4 is the ATO’s draft practical compliance guideline accompanying its software royalty position. It establishes a five-zone compliance framework — white, green, yellow, amber and red.
Is the 75% residual risk threshold final?
No. The 75% threshold appears in the current draft framework, but the PCG expressly states that the percentage to be used in the residual risk assessment calculation will be confirmed following feedback received through the consultation process.
Does the amber zone contain a profitability exception?
Yes. Under the draft framework, an arrangement is excluded from the amber zone where the Australian operating margin exceeds 10% or is within 10 percentage points of the global group’s operating margin.
Does an amber or red rating mean the taxpayer’s position is legally incorrect?
No. The PCG determines the ATO’s compliance approach and allocation of compliance resources. It does not itself determine the legal characterisation of the payment.
Is the PCG limited to software?
Schedule 1 currently provides the specific risk framework for software arrangements. The schedule-based structure means further schedules could potentially address other types of arrangements.
Is PCG 2026/D4 final?
No. It remains draft guidance and is subject to a four-week consultation process.
What should businesses do now?
Businesses should review cross-border software and SaaS arrangements, identify the rights granted to Australian entities, assess how the arrangements operate in practice, reconsider royalty withholding tax and treaty positions, review Australian and global profitability, and determine how existing arrangements would be classified under the draft PCG framework.