27 August 2012 External T.I. 2011-0416181E5 - US internet publisher - CDN resident advertiser

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Is the fee paid by a resident of Canada to a US publisher to advertise on its website subject to withholding tax pursuant to either of subparagraphs 212(1)(d)(i) or (iii) Act and, if so, would the Treaty apply to reduce or eliminate such withholding tax?

Position: Yes, 212(1)(d)(iii) would apply and yes, Treaty relief would be available to the extent the US Publisher had no PE in Canada.

Reasons: In our view, there would be a sufficient link between the fee and the benefit to be derived from the services to be performed by the US Publisher and those services would not be in connection with the sale of property or the negotiation of contracts. The Fee would fall under Article VII (Business Profits) of the Treaty and the business profits of a resident of the United States shall be taxable only in United States unless the resident carries on business in Canada through a PE situated in Canada.

XXXXXXXXXX
						2011-041618
						L. Carruthers, CA

August 27, 2012

Dear XXXXXXXXXX:

Re: Advertising on the internet and Part XIII

This is in reply to your email dated August 4, 2011, in which you inquired whether a particular hypothetical payment from a person resident in Canada to a corporation resident in the US would be subject to withholding tax pursuant to either of subparagraphs 212(1)(d)(i) or (iii) of the Income Tax Act (the “Act”) and, if so, if the Canada-US Income Tax Convention (the "Treaty") would apply to reduce or eliminate such withholding tax.

Our understanding of the hypothetical situation you described in your email is as follows:

• US Publisher, a corporation resident in the US, operates a website that is hosted on one or more servers which are physically located in the US (the “Website”). US Publisher is eligible for the benefits of the Treaty.
• The Website is managed and maintained by employees of US Publisher who perform these duties while being physically located in the US (the “US Employees”). US Publisher has no servers physically located in Canada. US Publisher has no permanent establishment (“PE”) in Canada.
• US Publisher is considering entering into an agreement with a promoter resident in Canada (the "Promoter") where Promoter would sell advertising space on the Website by soliciting advertising clients resident in Canada (the "Advertisers"). Promoter is not a dependent agent of the US Publisher.
• Advertisers buy advertising space on the Website for an agreed fee (the “Fee”). US Employees update the Website to reflect the Advertisers’ ads.
• Persons resident in Canada viewing the Website (the "Customers") could "click" on an Advertiser’s ad to view more information.
• Advertisers pay Promoter the Fee which is based on the number of "clicks" on their ads by Customers. For example, an Advertiser would pay Promoter $100 for every 1000 “clicks” on the Advertiser’s ad (regardless of whether any purchases were completed by the Customers).
• Promoter retains, for its services, part of the Fee (say $20) and remits the remaining amount to US Publisher (say $80 as the "Remitted Amount").

You indicated in your email that it is your view that subparagraph 212(1)(d)(i) of the Act should not apply to the Remitted Amount because it should not be considered as a payment for a property located in Canada. We would note at this time that subparagraph 212(1)(d)(i) of the Act refers to payments for the use of in Canada any property as opposed to a payment for a property located in Canada. In other words, it is not whether a property is located in Canada but rather if the payment is for the use in Canada of any property. You further stated that the fact that the Advertisers’ ads would appear on a computer screen in Canada should not result in a property being in Canada. In particular, you submitted that since the website would not be managed or maintained in Canada but, rather, would be managed outside of Canada by the US Employees, the more appropriate view should be that the ad placed on the website is not a property located in Canada.

You also indicated that it is your view that subparagraph 212(1)(d)(iii) of the Act should not apply to the Remitted Amount because the link between the number of "clicks" on an Advertiser’s ad and that Advertiser’s profits would be too weak to fall within the wording of the provision. You stated that, in your view, the wording "dependent on profits or benefit to be derived" should require a strong correlation such as fees based on sales or profits and not merely the potential for increased sales. You further noted that, in your view, the analysis of the hypothetical scenario should be similar to that of the traditional arrangement of a publisher being remunerated for ads placed in paper magazines where the publisher’s fee is dependent on the number of magazines in circulation. In such a case, it is your view that a correlation between the Advertisers’ profits and the number of magazines sold (i.e., circulated) would be too weak to fall within subparagraph 212(1)(d)(iii) of the Act.

Our Comments

As stated in paragraph 22 of Information Circular 70-6R5 (which can be accessed on the internet at http://www.cra-arc.gc.ca.), written opinions are not advance tax rulings and, accordingly, are not binding on the Canada Revenue Agency (the "CRA"). The following comments are, therefore, of a general nature only and nothing in this letter should be construed as implying that the CRA has agreed to, reviewed, or made any determination in respect of any of the hypothetical facts set out above.

Although your specific inquiry was whether the Remitted Amount would be subject to withholding tax pursuant to either of subparagraphs 212(1)(d)(i) or (iii) of Act and, if so, if the Treaty would apply to reduce or eliminate such withholding tax, it is the Fee that is the subject of our letter not the Remitted Amount. Notwithstanding the assumption that Promoter would not be a dependent agent of US Publisher, in our view, Promoter would be receiving the Fee from Advertisers as an agent of US Publisher such that the Fee would be an amount that a person resident in Canada (Advertisers) pays or credits to a non-resident (US Publisher).

An actual determination of whether a particular amount (e.g., the Fee) is subject to tax under Part XIII of the Act is a question of fact that can only be determined after a thorough review of all the relevant facts of the particular situation including but not limited to all relevant agreements. For example, it is unclear from the hypothetical situation you described whether the Website would have content other than the ads such that the ads would be in the nature of traditional advertisements which offer information about the products and/or services offered by the Advertisers or if the Website would exist solely to provide a marketplace for transactions between Advertisers and Customers. The following comments are based on our assumption that the Website would not exist solely to provide a marketplace but, rather, its existence would have a purpose independent of placing the ads for Advertisers.

Subparagraphs 212(1)(d)(i) and (iii) of the Act read as follows:

212(1) Every non-resident person shall pay an income tax of 25% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to the non-resident person as, on account or in lieu of payment of, or in satisfaction of,
…
(d) …, any payment

(i) for the use of or for the right to use in Canada any property, invention, trade-name, patent, trade-mark, design or model, plan, secret formula, process or other thing, whatever,
…
(iii) for services of an industrial, commercial or scientific character performed by a non-resident person where the total amount payable as consideration for those services is dependent in whole or in part on

(A) the use to be made of, or the benefit to be derived from, those services,

(B) production or sales of goods or services, or

(C) profits,

but not including a payment made for services performed in connection with the sale of property or the negotiation of a contract,

Given our understanding that the ads would be uploaded to the Website by the US Employees who would also be carrying out all other management and maintenance functions in respect of the Website, in our view, the Advertisers would be paying for services provided by US Publisher such that the Fee would not be considered as the payment for the use of or the right to use in Canada any property. If our understanding is correct, subparagraph 212(1)(d)(i) of the Act would not apply to the hypothetical situation you described.

Given our understanding of the nature of the services to be provided by US Publisher to Advertisers, it should be uncontroversial that those services would be of a commercial character as that term is used in subparagraph 212(1)(d)(iii) of the Act. In this regard, in Hasbro Canada Inc. v. Her Majesty the Queen, 98 DTC 2129 (T.C.C.) Dussault, T.C.C.J. stated that:

“… it is difficult to interpret that provision as applying only to payments for a particular category of services when the words used have definitely a wide import and are not qualified in any manner.” (Page 2138)

It is also provided in paragraph 23 of Interpretation Bulletin IT-303 (which can be accessed on the internet at http://www.cra-arc.gc.ca) that “charges for product development and marketing know-how or research which vary in accordance with production or sales” may fall within subparagraph 212(1)(d)(iii) of the Act. In our view, both the Hasbro decision and IT-303 warrant a conclusion that the services provided by US Publisher would constitute services of a commercial character. The next issue is whether the “total amount payable as consideration for those services is dependent in whole or in part on” any of the criteria listed in clauses 212(1)(d)(iii)(A) to (C) of Act.

Based on our understanding of the hypothetical situation you described, the Fee would not be dependent in whole or in part on the sales of products or the profits of the Advertisers because the Fee would be determined irrespective of any sales made by Advertisers and, therefore, neither of clauses 212(1)(d)(iii)(B) or (C) would apply to the hypothetical situation. However, in our view, there would be a sufficient link between the Fee, which is based on the number of Customer “clicks” on an ad, and the benefit to be derived from the services to be performed by US Publishers such that clause 212(1)(d)(iii)(A) of the Act would apply to the hypothetical situation you described. The benefit to be derived from the services to be performed by US Publishers would, in our view, be the opportunity for interested Customers to view information about the Advertisers which could lead to sales.

The post amble of subparagraph 212(1)(d)(iii) of the Act states that the provision does not apply to a payment made for services performed in connection with the sale of property or the negotiation of a contract. Based on our understanding of the hypothetical situation, however, the Fee would not be a payment in connection with the sale of property or the negotiation of contracts because, in our view, the exemption provided by the post amble of subparagraph 212(1)(d)(iii) of the Act only applies when the payee (US Publisher) is directly involved in the sales activity or in the negotiation of a contract which may or may not result in a sale, and this is not case in the hypothetical situation you described.

In summary, it is our view that pursuant to subparagraph 212(1)(d)(iii) of the Act, the Fee would be subject to 25% withholding tax in Canada unless the amount is reduced or eliminated by the terms of the Treaty.

Treaty Relief

The Fee would generally fall under Article VII (Business Profits) of the Treaty, however, paragraph 6 of Article VII clarifies that where business profits include items of income which are dealt with separately in other Articles of the Treaty, the provisions of those other Articles shall not be affected by Article VII. As a result, if Article XII (Royalties) applies to the Fee, then the provisions of that Article would apply to the Fee and would not be affected by Article VII.

Paragraph 4 of Article XII of the Treaty defines royalties for the purposes of Article XII quite broadly as follows:

The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic, or scientific work (including motion pictures and works on film, video tape or means of reproduction for use in connection with television) any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, tangible personal property or for information concerning industrial, commercial or scientific experience, and notwithstanding the provisions of Article XIII (Gains), including gains from the alienation of any intangible property or rights described in this paragraph to the extent that such gains are contingent on the productivity, use or subsequent disposition of such rights.

Based on our understanding of the hypothetical scenario you described, it is our view that the Fee would not meet the definition of “royalties” in paragraph 4 of Article XII of the Tax Treaty and, therefore, the provisions of that Article would not apply to the Fee. We are of this view because, as discussed above, the Fee would be paid for services to be provided by US Publisher rather than for the use of or the right to use any of the items noted in paragraph 4 of Article XII of the Treaty.

Pursuant to paragraph 1 of Article VII of the Treaty, the business profits of a resident of the United States shall be taxable only in United States unless the resident carries on business in Canada through a PE situated in Canada. Where a Canadian PE exists, the US resident may be taxed in Canada on the business profits attributable to that PE. An actual determination of the existence of a PE in Canada is always a question of fact, and could only be made after a thorough review of all the relevant facts.

We trust these comments are of assistance.

Olli Laurikainen, CA
for Director
International Section II
International Division
Income Tax Rulings Directorate