CRA finds a lump sum paid to a non-resident for granting an exclusive right to distribute its product in Canada was subject to s. 212(1)(i) (“restrictive covenant”) withholding
In consideration for a lump sum, a non-resident in a Treaty country (NRco) granted an arm’s length Canadian company (Canco) the exclusive right to distribute its product in Canada, with Canco agreeing not to acquire or sell competitive products. The Directorate found that the lump sum was not a royalty on general principles and, in light of Farmparts (which stated that an exclusive right to buy and sell could, “under no circumstances, be said to constitute the use or the right to use” the product) likely also was not caught by s. 212(1)(d)(i), nor did the Directorate recommend challenging the characterization under the agreement of the licence of a trademark as being gratuitous (as the “Distribution Agreement does not contemplate an extensive use of the trade-mark, but only limited use in connection with the distribution, promotion and advertising of the product.”) However, the exclusivity of the distributorship right granted by NRco was a “restrictive covenant,” so that the lump sum would be subject to Part XIII tax under ss. 56.4(2) and 212(1)(i).
But there was the Treaty, whose Royalty Article was similar to the OECD Model, the Commentary on which stated that that payments made in consideration for obtaining the exclusive distribution rights of a product in a given territory do not constitute royalties within the meaning of the Model Tax Convention as they are not made in consideration for the use of, or the right to use, an element of property included in the Royalty definition. Hence, the lump sum was withholding-tax exempt.