The Queen v. St. John Shipbuilding & Dry Dock Co. Ltd., 80 DTC 6272, [1980] CTC 352 (FCA)

The Chief Justice:—The issue in this appeal is whether lump sum payments of $25,375, $75,000 and $81,875 made by the respondent in 1971, 1972 and 1973 respectively to Com/Code Corporation, a non-resident United States corporation, were amounts in respect of which the respondent was required by the applicable provisions of the Income Tax Act* [1] to deduct and remit to the Receiver General of Canada non-resident income tax payable by Com/Code.

The amounts in question were paid by the respondent pursuant to a contract under which Com/Code supplied to a Canadian computer service company for the respondent (it might alternatively have been for the respondent’s own computer had it had one of the kind required) tapes containing technical data or material referred to as the Autokon-I System which, when combined with input data on a specific ship’s hull, produced technical data for use in the construction of the hull. The items supplied by Com/Code included, as well, users manuals and programmers manuals.

The information so obtainable by the use of the system was not secret. It was information that could have been worked out by competent technical personnel, as had formerly been necessary, by more laborious efforts and with the expenditure of much more time. Com/Code also made the system available to other shipbuilders at a price. The respondent was, however, bound by the contract to keep the information obtained by use of the system confidential and to use it only for the respondent’s purposes. Subject to that, there was no contractual restriction on the respondent as to how many times or over what period of time information might be obtained or preserved or used and the amounts of the payments were in no way related to the extent of such use, or to revenues or profits attributable thereto or to the period of such use. Under the contract it was open to the respondent to continue indefinitely obtaining information from the computer and to keep the information as long and to use it as often as the respondent wished.

The contract does not purport to evidence a sale of the tapes and manuals to the respondent. Instead, it purports to be a grant of a nonexclusive licence to use the system in connection with the design and construction of the respondent’s ships, the forming of sections of ships and for other industrial applications for which the system may be suitable. There is in the contract no reference to the ownership of the tapes or manuals so supplied nor is there any provision which gives Com/Code any right in any circumstances to require that they be returned.

The statutory provision under which tax is claimed on the amount paid in the year 1971 was section 106 of the Income Tax Act, RSC 1952, c 148, and on the amounts paid in 1972 and 1973 was section 212 of the Income Tax Act as amended by Statutes of Canada 1970-71-72, c 63. The relevant portions of section 106 read as follows:

(1) Every non-resident person shall pay an income tax of 15% on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of,

(d) rent, royalty or a similar payment, including, but not so as to restrict the generality of the foregoing, 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,

(ii) for information concerning industrial, commercial or scientific experience where the total amount payable as consideration for such information is dependent in whole or in part upon

(A) the use to be made thereof or the benefit to be derived therefrom,

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

(C) profits,

(iii) for services of an industrial, commercial or scientific character performed by a non-resident person where the total amount payable as consideration in whole or in part upon

(A) the use to be made thereof or the benefit to be derived therefrom,

(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,

(iv) made pursuant to an agreement between a person resident in Canada and a non-resident person under which the non-resident person agrees not to use or not to permit any other person to use any thing referred to in subparagraph (i) or any information referred to in subparagraph (ii), or

(v) that was dependent upon the use of or production from property in Canada whether or not it was an instalment on the sale price of the property, but not including an instalment on the sale price of agricultural land,

but not including

(vi) a royalty or similar payment on or in respect of a copyright,

(vii) a payment in respect of the use by a railway company of railway rolling

stock as defined in paragraph (25) of section 2 of the Railway Act,

viii) a payment made under a bona fide cost-sharing arrangement under which the person making the payment shares on a reasonable basis with one or more non-resident persons research and development expenses in exchange for an interest in any or all property or other things of value that may result therefrom, or

(ix) a rental payment for the use of or the right to use outside of Canada any corporeal property;

The only material difference in the relevant wording of section 212 is that under it the tax is fixed at 25%. However, under the Convention referred to later in these reasons it is not to exceed 15% in situations to which the Convention applies.

It will be observed that the net cast by subparagraph 106(1)(d)(i) is very broad. It includes not only “rent, royalty or a similar payment’’ but “any payment” for “the use of or for the right to use in Canada” any “property” (a word which is defined in the broadest of terms in paragraph 139(1)(ag) (now a part of subsection 248(1)) or any of the items enumerated in the wording that follows it, or “other thing whatsoever”. This very broad wording came into effect in 1968. Prior to that the wording had been much narrower. Western Electric Co v MNR, [1969] 2 Ex CR 175; [1969] CTC 274; 69 DTC 5204, 5212; Affirmed [1971] SCR (vi); [1971] CTC 96; 71 DTC 5068 was decided on it.

With respect to payments to residents of the United States, however, the provisions of the Income Tax Act are, and have been since 1944, subject to the provisions of the Canada-US Reciprocal Tax Convention and Protocol thereto signed in March 1942.* [2]

Articles I and Il of the Convention provide:

ARTICLE I

An enterprise of one of the contracting States is not subject to taxation by the other contracting State in respect of its industrial and commercial profits except in respect of such profits allocable in accordance with the Articles of this Convention to its permanent establishment in the latter State.

No account shall be taken in determining the tax in one of the contracting States, of the mere purchase of merchandise effected therein by an enterprise of the other State.

ARTICLE II

For the purposes of this Convention, the term “industrial and commercial profits’’ shall not include income in the form of rentals and royalties, interest, dividends, management charges, or gains derived from the sale or exchange of capital assets.

Subject to the provisions of this Convention such items of income shall be taxed separately or together with industrial and commercial profits in accordance with the laws of the contracting states.

Paragraph 6(a) of the Protocol, as renumbered in 1956, defines “rentals and royalties” as follows:

6.(a) The term “rentals and royalties” referred to in Article II of this Convention shall include rentals or royalties arising from leasing real or immovable, or personal or movable property or from any interest in such property, including rentals or royalties for the use of, or for the privilege of using, patents, copyrights, secret processes and formulae, good will, trade marks, trade brands, franchises and other like property:

Both the Tax Review Board and the Trial Division of this Court held that the amounts here in question did not fall within the wording of section 106 or 212 of the Income Tax Act. The Trial Division also held that the amounts did not fall within the meaning of “rentals and royalties” as defined in the Protocol to the Convention and were exempt under its provisions.

Assuming that the wording of subparagraph (1)(d)(i) of sections 106 and 212 is to have its full scope and is not to be restricted because of the presence of the subparagraphs which follow it, I am not satisfied that the provision is not broad enough to include the payments in question. It is not easy for a payment of the kind described to escape the definition of “any payment . . . for the use of or for the right to use in Canada any property . . . or other thing whatever.” But I do not think it is necessary to reach a definite conclusion on the point since the Convention must prevail and, if because of its provisions, Com/Code was not liable for Canadian income tax in respect of the amounts, that is the end of the matter.

As the amounts in question were plainly industrial and commercial profits of Com/Code they were exempted under the broad language of Article I of the Convention and could only be made subject to the Canadian nonresident tax if they fell within the exception from industrial and commercial profits provided in Article II with respect to “income in the form of rentals and royalties”. Moreover, the amounts could only be “income in the form of rentals and royalties” if they fell within the definition of “rentals and royalties” in the Protocol.

That definition appears to be intended to expand the scope of what would be covered by the ordinary meaning of rentals and royalties but it seems to me that the expansion is not in the meaning of the words but is by reference to the sorts of things in respect of which the rentals and royalties are paid. The expression is to include “rentals or royalties” from leasing both real or immovable and personal or movable property (all apparently of a corporeal nature) and is to include as well “rentals or royalties” for the use of or for the privilege of using a list of items of incorporeal property. Nowhere, however, is there any wording which could have the effect of expanding the definition by including payments that do not have the characteristics ordinarily associated with rentals or royalties. It was submitted for the appellant that the use of the words “or for the privilege of using” expanded the meaning but I do not think that is so. The wording is apt with respect to rentals* [3] while the wording “for the use of” is apt with respect to royalties. There is therefore no justification for interpreting the definition so as to distort the ordinary meaning of either word.

In my opinion what Com/Code gave and the respondent received under the contract cannot be regarded as the use of or the privilege of using “patents, copyrights, secret processes and formulae, goodwill, trade marks, trade brands (or) franchises’’ within the meaning of the definition but it seems to me to be conceivable that it might fall within the meaning of “other like property”.* [4] However, assuming that it does, I do not think that the payments made by the respondent can be regarded as “rentals or royalties” for its use or for the privilege of using it.

The payments have none of the characteristics of rentals or royalties. The word “rental” is not a familiar one to use in connection with property rights of the kinds enumerated but I see no reason to think that when used in reference thereto it would connote characteristics different from those it has in its more familiar use in relation to tangible property. A rental can, of course, be paid in a lump sum but in my opinion the word is inseparable from the connotation of a payment for a term, whether fixed in time or determinable on the happening of an event or in a manner provided for, after which the right of the grantee to the property and to its use reverts to the grantor. “Royalties”, though a broad term, when used in the sense of a payment for the use of property, connotes a payment calculated by reference to the use or to the production or revenue or profits from the use of the rights granted. In Jowitt’s Dictionary of English Law the term is defined thus:

Royalty, a payment reserved by the grantor of a patent, lease of a mine or similar right, and payable proportionately to the use made of the right by the grantee. It is usually a payment of money, but may be a payment in kind, that is, of part of the produce of the exercise of the right. See RENT.

Royalty also sometimes means a payment which is made to an author or composer by an assignee or licensee in respect of each copy of his work which is sold, or to an inventor in respect of each article sold under the patent.! [5]

Neither “rentals” nor “royalties”, in the ordinary connotation, in my opinion, includes a lump sum payment for the use of or for the privilege of using property indefinitely.

It seems to me as well that the repetition of the expression “rentals or royalties” in the definition, which, with deference, appears to me to have an unusual grammatical construction, indicates that the authors had in mind that what was being dealt with was the taxation of income, as opposed to capital, and that the expression “rentals or royalties” is used, rather than “any payment”, in order to ensure that no payment that would not have the characteristics of “rentals or royalties” would be included.

Here there was no limit as to time with respect to use or the right to use. Nor were the payments proportionate to or in any way related to use or extent of use or to revenues or profits therefrom or to a period of use. The right to use the information and to keep the physical objects supplied by Com/Code, as well as what was produced by using them in the computer, continued in the respondent indefinitely. It follows, in my view, that the payments were not rentals or royalties within the meaning of the Conven tion and Protocol and that Com/Code was not liable to non-resident tax in respect of them.

The appeal therefore fails and it should be dismissed with costs.