Royalty or Profit-Shifting: Australia's Risk-Zone Test and Its Implications for Indian TP Characterisation Disputes

Cross-border payments for software, brand use, or know-how raise a recurring transfer pricing question: how much of the payment compensates the foreign parent for genuine IP use, and how much constitutes profit shifted out of the local entity. India has addressed this question primarily through tribunal litigation. Samsung, Sony, Vodafone Idea and other taxpayers have contested the same AMP/royalty issue across multiple assessment years, with outcomes turning on functional characterisation: whether the Indian entity operated as a full-risk licensed manufacturer or a disguised contract manufacturer, and whether the royalty comparable used by the TPO was genuinely similar. In its August 2026 ruling on Samsung India, the Delhi ITAT found that the TPO had benchmarked a consumer electronics brand licence against royalty agreements from the agricultural and biotech sectors, a comparison the tribunal rejected along with roughly ₹7,800 crore in other adjustments.

Australia has taken a structurally different approach. On 4 September 2026, the ATO finalised Taxation Ruling TR 2026/2, addressing when cross-border software and IP payments constitute royalties, and released draft Practical Compliance Guideline PCG 2026/D4 alongside it. The PCG sets out a five-zone, colour-coded risk framework, from white to red, that software distributors use to self-assess their royalty withholding exposure.

The zones rest substantially on a quantitative trigger: an Australian distributor's operating margin relative to its global group's margin, with a 10-percentage-point band used as a proxy for whether an embedded royalty sits inside an otherwise 'royalty-free' distribution arrangement. Consultation on the draft PCG closed on 2 October 2026. The same package included a Decision Impact Statement on the Oracle case, confirming that MAP and treaty arbitration remain available even where domestic litigation on the same royalty question is still running in parallel.

The two approaches differ in method and cost. India's approach is precedent-driven and functionally granular: each case requires its own FAR analysis, its own comparable search, and its own tribunal hearing, sometimes across a decade of appeals before the characterisation question is settled for that taxpayer and that year. Australia's approach is administrative and mechanical: a margin threshold either trips a risk flag or it does not, without relitigating functional characterisation in every case.

Each method has a cost. India's approach protects taxpayers from being classified on crude proxies, but generates litigation overhead that both the department and taxpayers have raised concerns about for years. Australia's approach is more scalable and predictable, but practitioners have already flagged that a single margin band applied uniformly across SaaS, cloud and subscription models may catch arrangements unrelated to embedded royalties.

The comparison is relevant to Indian practice independent of the Australian context. CBDT has, over the last two budget cycles, moved India's TP regime toward more systemised and less discretionary processes: block assessments that carry a TPO's margin determination forward two years, a rationalised safe harbour regime with fixed bands by transaction category, and a stated intent to limit automated-analytics flags from triggering full scrutiny unless paired with other evidence of evasion. This is consistent with a shift toward rules-based risk-zoning, though the department has not framed it in those terms.

If CBDT, or an AI-assisted TPO, were to adopt a quantitative first pass for royalty and FTS characterisation along the ATO's lines, drawing on CbCR and segmental data the government already collects, such a system could replace inconsistent manual judgment with predictable, published zones. It could equally reproduce the same reliance on a mismatched comparable that the Samsung tribunal had to correct, embedded instead in a model that taxpayers outside the department cannot audit.

The ATO's framework was put out for public comment; an Indian equivalent, if one emerges, may not follow the same consultative process. For TP practitioners, that difference in process, more than the underlying royalty question, is worth tracking as India's own risk-assessment tools develop.

TR 2026/2: Australia's Software Royalty Ruling and Its Implications for Groups with Indian Operations

On 4 September 2026, the Australian Taxation Office finalised Taxation Ruling TR 2026/2, along with a draft Practical Compliance Guideline, setting out its position on when cross-border payments for software, SaaS access, and related IP arrangements amount to 'royalties' subject to withholding tax. The ruling took five years to finalise, replacing a position that traces back to the withdrawal of an older ruling in 2021. It follows the Australian High Court's decision in PepsiCo, which the ATO has relied on to justify a substance-over-form, purpose-focused test for what counts as a royalty.

The fact pattern is close to one India's Supreme Court resolved in 2021, in Engineering Analysis Centre of Excellence v CIT. That decision ended nearly two decades of litigation by holding that payments to non-resident software suppliers for resale or use under distribution agreements and end-user licences are not royalty payments, because what is transferred is a copyrighted article, not an interest in the copyright itself. India adopted the narrow, taxpayer-favourable reading. TR 2026/2 goes the other way, and further: it takes the position that where IP rights are practically inseparable from the other commercial rights in a software intermediation arrangement, which the ATO treats as the common case, the entire payment is characterised as a royalty, with no workable apportionment pathway in the final text. The draft compliance guideline layered on top classifies most royalty-free distribution structures as medium-to-high risk unless the local margin clears a threshold meaningfully higher than the ATO's own prior benchmark for low-risk distributor margins.

The commercial reality of how software gets distributed cross-border has not changed. What has changed is the doctrinal lens two major tax administrations apply to that reality, and the two now point in opposite directions. This matters because many multinational software distribution structures are built on a common template rolled out across several jurisdictions at once. A group that priced its Indian and Australian distribution entities on the same functional analysis and the same intercompany agreement now faces two different downstream outcomes. In India, the royalty question was settled years ago, so the TP analysis stands on its own. In Australia, the royalty characterisation question sits ahead of the TP question and can override it: if the whole payment is a royalty, the arm's length distribution margin analysis becomes secondary to a withholding tax exposure that was never priced into the original structure. MinterEllison's analysis of the final ruling described this as a 'full-royalty rather than apportioned outcome' as the default assumption, a marked hardening from where the draft guidance started.

Whether this is an Australian idiosyncrasy or an early sign of a broader trend is not yet clear. Some revenue authorities, facing fiscal pressure, have shown greater willingness to use substance-based, purpose-focused tests to recharacterise payments, an interpretive approach not unlike the one behind India's GAAR and its expanded commercial substance doctrines. If more jurisdictions begin reading embedded software royalties this expansively, Indian multinationals licensing software into distribution networks abroad, and Indian subsidiaries of global software groups receiving payments from Indian customers, may need a characterisation review ahead of every TP benchmarking exercise, rather than a periodic refresh of comparables alone. For now, groups with common distribution documentation across India and Australia should map where the two jurisdictions' positions on the same contract diverge, rather than assume that a settled Indian royalty position carries over wherever the same paperwork is used.