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Citation: 2003TCC498
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Date: 20030715
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Docket: 2002-3112(IT)G
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BETWEEN:
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SYSPRO SOFTWARE LTD.,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR DETERMINATION OF A QUESTION
GARON, C.J.
[1] This
is a case where the Appellant and the Minister of National Revenue have agreed
in writing that a question of law in respect of proposed reassessments for the
1996, 1997, 1998, 1999 and 2000 taxation years should be determined by this
Court in accordance with the provisions of section 173 of the Income Tax Act
(the "Act"). The proposed reassessments involve the
application of Part XIII of the Act, which levies a 25% withholding tax
on certain payments made by Canadian residents to non-residents. In the present
case, the payments were made by the Appellant to a non-resident corporation in
the name of Encore Software Systems Limited ("Encore") in respect of
a certain computer software known as "Impact Encore". The question of
law for determination is framed in the Reference in the following terms:
Are royalties paid by the Appellant
to Encore in accordance with the Agreement royalties or similar payments in
respect of a copyright in respect of the reproduction of a literary work
within the meaning of [sub]paragraph 212(1)(d)(vi) of the Act?
[2] The
material facts are outlined in the Reference:
MATERIAL FACTS AGREED TO
BY THE PARTIES
3. Encore
Software Systems Limited ("Encore") is a corporation not resident in Canada and the owner of the
copyright in certain computer software known as "IMPACT Encore".
4. The IMPACT
Encore software (the "Software") is a literary work as that term is
used in subparagraph 212(1)(d)(vi) of the Act.
5. On June 1,
1996 a predecessor of the Appellant and Encore entered into an agreement
relating to the exploitation of the Software (the "Agreement").
6. The relevant
terms of the Agreement for the purposes of this reference are as follows:
(a) Encore
granted to the Appellant a license to reproduce and distribute the
Software in accordance with the terms and conditions set out in the Agreement
(clause 4.1);
(b) the
Appellant agreed not to deliver possession of any copies of the Software to any
third party unless that person first executed a software license agreement
(clause 4.4);
(c) Encore
agreed to cause to be provided to the Appellant a master copy of the Software
suitable for reproduction of multiple copies by the Appellant (clause 4.5);
(d) the
Appellant agreed to reproduce the Software only in the same form as the master
copies provided and only to make such number of copies as necessary to satisfy
the Appellant's obligations (and a reasonable number of copies for
demonstration, support and training purposes) (clause 4.6);
(e) Encore
granted to the Appellant the right to use Encore's trade marks and trade names
in connection with the distribution and sub-licensing of the Software, such use
to cease upon termination of the Agreement (clauses 8.1.14, 18.1.2 and 18.1.6);
(f) Encore
agreed not to approach the Appellant's licensees, potential licensees or
sub-distributors without first consulting the Appellant, and agreed not to
grant to any other person, entity or distributor the right to trade or install
the Software in the territory assigned to the Appellant in the Agreement (clauses
9.11 and 9.12); and
(g) The
Appellant agreed to pay Encore royalties in respect of each software license
agreement entered into by the Appellant or its sub-distributors. The royalty is
calculated as 17.5% of the sale price (less any discounts and upgrade
trade-ins), increased to 20% from January 1, 1998 forward. The percentage is
renegotiable at two year intervals, but is not to exceed 20%. In addition, an
annual license fee is payable by the Appellant to Encore (clauses 11.2, 11.3
and 11.4).
7. The Respondent
conducted a review of the Appellant's 1996 to 2000 taxation years and proposes
to reassess on the basis that the royalties paid by the Appellant to Encore
under the Agreement were taxable under Part XIII of the Act, and the Appellant
failed to deduct and remit in the following amounts.
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TAX YEAR
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PART XIII TAX
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1996
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$ 6,197.00
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1997
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109,960.00
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1998
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106,714.00
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1999
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177,182.00
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2000
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$ 184,821.00
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Appellant's Argument
[3] The
Appellant's position is that subparagraph 212(1)(d)(vi) of the Act exempts
from tax royalties paid under the Agreement because the royalties relate to and
are connected with the reproduction of the Software.
[4] The
Appellant contends that the right to reproduce includes the attendant right to
distribute. He asserted that no business would pay for the right to reproduce
without the right to distribute or for the right to distribute without the
ability to access copies.
[5] In
the Appellant's written argument, it was contended that royalties are payable
on each sub-license entered into by the Appellant and that for each sub‑license,
the Appellant is authorized to reproduce for distribution one copy of the
Software. In these circumstances, the royalties clearly relate to and are
connected with the right to reproduce the Software, such that the exemption in
subparagraph 212(1)(d)(vi) of the Act is applicable.
[6] It
was also submitted by the Appellant, that the exemption set out in
subparagraph 212(1)(d)(vi) of the Act applies here by virtue
of the relationship or connection between the royalties and the right to make
copies of the software. In support of this conclusion, the Appellant relied on
the decision of the Supreme Court of Canada in Nowegijick v. The Queen et
al., 83 DTC 5041, which considered the meaning of the words "in
respect of", which are found in the exemption in subparagraph 212(1)(d)(vi).
[7] Counsel
for the Appellant also referred to the decision of Bowman, A.C.J. of this Court
in Angoss International Limited v. The Queen, 99 DTC 567, where the
taxpayer had paid $150,000 (U.S.) to a non-resident under a source code
license agreement. He pointed out in that case that the learned judge concluded
that the exemption applied to the full amount of a royalty even though it was
related to or in connection with both the right to use and the right to
reproduce software.
The
Respondent's argument
[8] The
Respondent submits that a broad reading of the revised exemption from Part XIII
tax would be contrary to the expressed intention of Parliament to restrict the
ambit of the exemption set out in subparagraph 212(1)(d)(vi) of the Act.
In support of this proposition, counsel for the Respondent relied on an excerpt
from the book of Ruth Sullivan, Driedger on the Construction of Statutes,
Third Edition, page 369, which reads as follows:
In keeping with the
current emphasis on purposive analysis, modern courts are particularly
concerned that exceptions and exemptions be interpreted in light of their
underlying rationale and not be used to undermine the broad purpose of the
legislation.
[9] The
Respondent submits that when the Appellant paid the royalties in respect of
each software license entered into by the Appellant, the royalties are paid in
respect of the use of the Software and not royalties in respect of the
reproduction of the Software.
[10] The Respondent further suggests that the royalties that were paid by
the Appellant was not based on either the right to reproduce the Software or on
the number of reproductions made or used by the Appellant.
[11] The Respondent went on to propound that the broad scope of the phrase
"in respect of" only extends to expanding what constitutes a
"production or reproduction" as these are the words which the phrase
modifies. In the Respondent's view, it does not encompass payment for the use
and distribution of the Software.
Analysis
[12] Since it is agreed by the parties that the Software 'Impact Encore' is
a literary work, the precise question in issue is whether the royalty payments
made by the Appellant to Encore during the years in question are in respect of
a copyright in respect of the reproduction of a literary work.
[13] Part XIII of the Act imposes a tax of 25% on a wide range of
payments made by Canadian residents to non-residents. In the long list of
classes of payments set out in subsection 212(1) of the Act, royalties
are included. There is, however, an exemption from that tax for a royalty paid
to a non-resident in circumstances specified in subparagraph 212(1)(d)(vi).
The relevant portion of subsection 212(1) reads:
(1) Tax. 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) Rents, royalties, etc. –
rent, royalty or similar payment, including, but not so as to restrict the
generality of the foregoing, any payment
. . .
but not including
(vi) a royalty or similar payment on or
in respect of a copyright in respect of the production or reproduction of any
literary, dramatic, musical or artistic work,
[14] It is therefore necessary to ascertain the nature of the rights and
obligations set out in the Agreement between a predecessor of the Appellant and
Encore. These rights and obligations referred to in paragraph 6 of the
Reference are in broad outline as follows:
a) The Appellant was
granted a license to reproduce and distribute the Software in accordance with
the terms and conditions specified in the Agreement.
b) The Appellant was
entitled to be provided by Encore a master copy of the Software suitable for
reproduction of multiple copies.
c) The Appellant
agreed not to deliver possession of any copies of the Software to any third
party unless that person first executed a Software License Agreement.
d) The Appellant also
agreed to reproduce the Software only in the same form as the master copies
provided and only to make such number of copies as detailed in the Agreement.
e) Finally, the
Appellant agreed to pay Encore, as appears from paragraph 6(g) of the
Reference, royalties calculated on the basis of specified percentages of the
sale price in respect of each Software License Agreement entered into by the
Appellant or its sub‑distributors.
[15] From the above clauses of the Agreement, it is apparent that the
Appellant is given the right to reproduce the Software and make copies thereof
subject to certain limitations set out therein. The Appellant is also given the
right to distribute the Software. Royalties are paid by the Appellant in
respect of each Software license Agreement.
[16] In my view, the fundamental feature of the Agreement is that the
royalties are paid for every Software License Agreement entered into by the Appellant
or its sub-distributors. Execution of such an Agreement is a condition
precedent to the acquisition of a copy of the software. It is the Software
License Agreement that permits the Appellant to reproduce the Software. I do
not agree with the Respondent that the royalties are not based on the number of
reproductions made by the Appellant. Quite the contrary, each time there is a
Software License Agreement, there is a reproduction of the Software and a
royalty is paid.
[17] In my view, the language used in subparagraph 212(1)(d)(vi)
clearly comprehends or includes the right to reproduce the software that was
granted to the Appellant by the Agreement binding the Appellant and Encore. It
is precisely for this right that royalties were paid by the Appellant to
Encore. I am referring more particularly to the following portion of this
enactment "a royalty in respect of a copyright in respect of the . . . or
reproduction of any literary . . . work".
[18] It may not be amiss to refer to the historical background regarding
subparagraph 212(1)(d)(vi) of the Act. Prior to its repeal by
section 92 of c.1 of the Statutes of Canada, 1977-78, this subparagraph
simply read:
(vi) a royalty or
similar payment on or in respect of a copyright,
The present wording of subparagraph 212(1)(d)(vi) was substituted
therefor, which I reproduce again for sake of convenience:
(vi) a royalty or
similar payment on or in respect of a copyright in respect of the production or
reproduction of any literary, dramatic, musical or artistic work.
[19] Despite the provisions of subsection 45(2) of the Interpretation
Act which lays down that an amendment of an enactment does not necessarily
imply a change in the law, it would appear that Parliament intended by the
amendment introduced in 1977 to narrow the ambit of this exemption.
[20] In my view, prior to 1977 royalties in respect of a copyright were
completely exempt from Part XIII tax while since 1977, not only has the
exemption been restricted to literary, dramatic, musical and artistic works,
but also to the right to produce or reproduce such works.
[21] What is the ambit of the present exemption?
[22] The import of the phrase "in respect of" used twice in the
present enactment has been explained in the case of Nowegijic v. The Queen,
[1983] 1 S.C.R. 29, by the Supreme Court of Canada as it appears from the
following passage at page 39:
The words "in respect
of" are, in my opinion, words of the widest possible scope. They import
such meanings as "in relation to", "with reference to" or
"in connection with". The phrase "in respect of" is
probably the widest of any expression intended to convey some connection
between two related subject matters.
[23] The words "a copyright in respect of the production or
reproduction of any . . . work" must therefore be given a broad meaning
and would, in my view, encompass any other right connected with the right to
produce or reproduce the work, including the right to distribute the work. The
broad scope of the phrase "in respect of" expands what constitutes a
"production or reproduction".
[24] Also, from section 3 of the Copyright Act, it appears that the
major right granted by a copyright is the right to produce or reproduce a work.
That right is formulated thus in the opening portion of subsection 3(1) of the
that Act:
For the purposes of this Act,
"copyright" in relation to a work, means the sole right to produce or
reproduce the work or any substantial part thereof in any material form
whatever . . .
There is no reference in this subsection to the right to distribute copies
of a work. This right to distribute may be viewed as a component of the right
to reproduce or is ancillary to such a right.
[25] This conclusion seems to be in accord with the views expressed by
Associate Chief Justice Bowman, in the case of Angoss International Limited,
supra.
[26] In that case, the parties had two separate agreements, a Source Code
License Agreement and a Value Added Reseller License Agreement. The Agreements
were to allow the taxpayer to examine the source code of SmartWare for 60 days.
One purpose of the Agreement, if it decided to pay $150,000 (U.S.), was to grant it the use of the source code in the
manufacture of Software, which it intended to sell. One of the issues that the
Court had to determine in that case was whether the payment was exempt under
subparagraph 212(1)(d)(vi) of the Act. Associate Chief Justice
Bowman made the following observations:
It follows therefore
that a computer source code is a literary work in respect of which copyright subsists.
It is equally clear that the payment was for the right to use or reproduce the
source code and was therefore "on or in respect of a copyright in respect
of the production or reproduction of any literary . . . work."
[27] In that case, the Court therefore exempted the whole $150,000 (U.S.) without any regard to the fact that a portion
thereof was for the right to distribute copies of a work.
[28] The matter could be viewed from another angle. In effect, it could be
said that subparagraph 212(1)(d)(vi) of the Act exempts from Part
XIII tax payments relating to the right to produce or reproduce among other
matters, a literary work but it does not embrace the right "to use"
for instance, the literary work by the payer for its own internal purposes and not
with a view of selling the Software to third parties. In this connection, it is
of interest to contrast the wording of subparagraph 212(1)(d)(vi)
with subparagraphs 212(1)(d)(i) and 212(1)(d)(vii) of the Act
where the right "to use" property described in these respective
subparagraphs is clearly spelled out. To put it in another way, if the
Appellant had used the literary work in the course of its own in-house
operations, it would most probably be taxable pursuant to subparagraph 212(1)(d)(i)
of the Act which provides clearly that the "use" or the right
"to use" any property is subject to Part XIII tax. Although in
some sense "use" takes place in the production or reproduction of any
work, to give meaning to subparagraph 212(1)(d)(vi) of the Act requires
that the exemption provision prevail over for instance
subparagraph 212(1)(d)(i) or else the exemption would never apply.
[29] In view of the above observations, I am of the opinion that the
subject royalties paid to Encore by the Appellant are exempt from Part XIII of
the Act.
[30] For these reasons, I determine that the royalties paid by the
Appellant to Encore are royalties or similar payments in respect of the
reproduction of a literary work within the meaning of subparagraph 212(1)(d)(vi)
of the Act and as such they are exempt from tax pursuant to this
subparagraph.
Signed at Ottawa, Canada, this 15th day of July 2003.
Garon,
C.J.
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