INTM630330 - Royalty Withholding: Definition of a royalty: Royalty payments included in the payment for other goods and services

The payment for use of the intellectual property may be included in a payment made for a range of goods or services. The Commentary on Article 12 of the OECD Model Tax Convention emphasises the nature of the payment is integral in determining whether there is any element in relation to IP. For a payment to be a royalty, it must be made for use of intellectual property. The principles outlined in the Commentary should be followed in determining whether in substance a payment is a royalty, regardless of any contractual provisions that may label a payment otherwise.

The Commentary also recognises that contracts can cover both the provision of services and the use of intellectual property. It prescribes that the contract should be distilled into its constituent parts by means of a reasonable apportionment or the information in the contract. The appropriate tax treatment is then applied to each constituent part of the payment, depending on the character of those constituent parts. If one part of the payment constitutes by far the principal purpose of the contract and the other parts are ancillary, the treatment applicable to the principal part should generally be applied to the whole amount of the consideration. Such an approach is appropriate in determining whether a payment includes an element for use of intellectual property.

Where a payment includes an element for use of intellectual property, that element will need to be quantified. Transfer pricing principles will be of assistance in pricing the element related to royalties. Ultimately, the approach is dependent upon the facts and circumstances of the arrangement.