A Full Court of the Federal Court of Australia held recently that a fairly typical software distribution agreement did not confer on the distributor a right to use source code. One may ask why would the parties need to know? The answer lies in the application of royalty withholding tax to payments made by Australian taxpayers to Canadian software licensors.

As we reported in February 2014, the Federal Court of Australia held that that certain payments made by an Australian software distributor to a Canadian licensor were royalties for the purposes of the Australia/Canada double tax agreement, and were therefore subject to the 30% royalty withholding tax regime. The trouble for the Australian taxpayer is that they had not been making payments on account of the royalty withholding tax to the Australian Tax Office.

The Canadian licensor never provided the source code, nor granted remote access to that code, to the Australian distributor. Despite this, the distributor argued that they had acquired a right to use the source code. The Full Court gave this argument short shrift in light of the language of the distribution agreement, under which the distributor was (relevantly) granted the rights to:

  • market End User Licences and Application Template Licences;
  • make Copies of Licensed Software and Documentation;
  • supply Copies of Licensed Software to End Users pursuant to End User Licences and Application Template Licences;
  • develop Application Templates for use by End Users;
  • supply Application Templates developed by Distributor to End Users pursuant to Application Template Licences.

The software in issue was for use by accountants – it was intended to assist the accountants to create and record their working papers.

The Application Templates were defined in the distribution agreement to consist of content and mathematical instructions used in conjunction with software to increase the ease and efficiency of use of the software. Presumably they were templates that could be quickly adapted by an end-user to meet their needs for a particular type of engagement – for example to prepare a tax return for a self-managed superannuation fund. It is not apparent from the decisions of the Full Court or the trial judge how the distributor created these Application Templates (save that it must have been possible to do so without the need to modify the underlying source code for the software, since the distributor did not have that source code).

The Full Court took a different approach from the trial judge, but with the same result. The Full Court held that it was clear from the language of the distribution agreement that the distributor was not granted the right to use the source code of the licensed software.

The Australian taxpayer went so far as to contend that the right to use a computer program includes the right to use the source code for that program. That claim was, unsurprisingly, rejected. If it was correct, users who are reliant for business continuity on particular software would never need to enter into separate source code licences or software escrow agreements to cater for the possibility that the software licensor may go out of business or cease to support the licensed software.

As we explained in our original report on this case, it has relevance only to royalty withholding tax to which the Australia-Canada Double Tax Agreement applies.