Her Majesty the Queen v. Saint John Shipbuilding & Dry Dock Co LTD, [1979] CTC 380, 79 DTC 5297

Walsh, J.:—This is an appeal by plaintiff from a decision of October 22, 1976 of the Tax Review Board to the effect that the amounts of $25,375, $50,000 and $81,875 were not amounts in respect of which non-resident tax was payable for the 1971, 1972 and 1973 taxation years respectively.

These sums arose from payments made by defendant in the respective years to Com/Code Corporation, a United States company.

During the hearing in this Court the amount of $50,000 on which nonresident tax is claimed for the 1972 taxation year was corrected to read $75,000 by amendment granted by consent, this figure being the correct amount. These payments resulted from the acquisition by defendant from Com/Code by agreement entered into on or about April 8, 1971, of the right to use in Canada that company’s Autokon-I System of computerized information in connection with defendant’s shipbuilding operation.

Plaintiff relies inter alia for the 1971 year on the provisions of paragraph 106(1)(d) of the Income Tax Act, RSC 1952, c 148, as amended and for the 1972 and 1973 taxation years upon paragraph 212(1)(d) and subsection 215(6) of the new Income Tax Act, SC 1970-71-71, c 63, as amended. In addition to disputing liability under the aforementioned sections of the Statute defendant relies on Articles I and II of the Canada-US Tax Convention and Clause 6(a) of the Protocol thereto and the Canada-United States of America Tax Convention Act, 1943-44 S of C c 21. As the provisions of the sections in question which are relied on are identical in both taxation Acts it will be convenient in these reasons for judgment to merely refer to the sections of the new Act. Subparagraphs 212(1)(d)(i) and (ii) read as follows:

(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 1 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,

The amount of 25% is reduced to 15% with respect to payments made to residents of the United States by virtue of the provisions of the Canada-US Tax Conventions. Subsection 215(6) reads:

(6) Where a person has failed to deduct or withhold any amount as required by this section from an amount paid or credited or deemed to have been paid or credited to a non-resident person, that person is liable to pay as tax under this Part on behalf of the non-resident person the whole of the amount that should have been deducted or withheld, and is entitled to deduct or withhold from any amount paid or credited by him to the non-resident person or otherwise recover from the non-resident person any amount paid by him as tax under this Part on behalf thereof.

Plaintiff contends that the payments were made for the use of or right to use in Canada Com/Code Corporation’s property, invention, trade name, patent, trade mark, design or model, plan, secret formula, process or other thing whatsoever, within the meaning of subparagraph 212(1 )(d)(i). Plaintiff claims that alternatively rents, royalties, or similar payments were paid by defendant for its acquisition of rights to Com/Code Corporation’s Autokon-I System within the meaning of paragraph 212(1)(d) of the Act and that it is therefore liable to pay the 15% tax pursuant to subsection 215(6) because it failed to deduct or withhold such tax from a non-resident.

Defendant for its part contends that the agreement was to provide defendant with information concerning industrial, commercial or scientific experience and the total amount payable as consideration for such information was not dependent in whole or in part upon the use to be made thereof or the benefit to be derived therefrom, production or sales of goods or services, or profits, within the meaning of subparagraph 212(1 )(d)(ii), and furthermore that the payments were industrial and commercial profits within the meaning of Articles I and Il of the Convention and clause 6(a) of the Protocol thereto since Com/Code Corporation had no permanent establishment in Canada within the meaning of Article I and clause 3(f) of the Protocol. The aforementioned Articles I and II read respectively as follows:

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.

and clause 6(a) of the Protocol defines the term “rental and royalties’’ referred to in Article Il of the Convention in the following manner:

The term “rental 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, goodwill, trade marks, trade brands, franchises and other like property.

Defendant further states that the amounts paid were not rents, royalties or similar payments within the provisions of paragraph 212(1)(d) of the Act nor payments for the use of said property within the provisions of subparagraph 212(1)(d)(i) and that while they were payments for information concerning industrial, commercial or scientific experience within the meaning of subparagraph 212(1 )(d)(ii) they were not the type of payments subject to income tax within the meaning of the said paragraph since they were not dependent in whole or in part upon the use to be made thereof, the benefit to be derived therefrom, the production or sales of goods or services or profits. In the alternative defendant pleads that they were industrial and commercial profits payable to an enterprise of the United States of America which had no permanent establishment in Canada and therefore not subject to taxation in Canada under the provisions of the Tax Convention and Protocol thereto.

Evidence of witnesses confirmed by the agreement between defendant and Com/Code dated April 8, 1971 indicates that what defendant acquired was the right to use a computerized system which might perhaps be considered as a bank of information relating to shipbuilding established by Com/Code. The use of this system eliminates a great many mathematical computations and calculations required in the construction of a ship. Before this system was adopted it was necessary in converting the plans of the naval architect or designer into construction drawings to construct each plate of the hull from the drawings reduced to one-tenth in size laid out on the loft floor. These drawings would then be photographed to 1-100 hundred size and from the negative the cutting tools could be guided to cut the steel plates. The plates of course had different shapes and curvatures and the process was a laborious one. The computer bank contains information based on the collection of shipbuilding designs from all over the world enabling, as one witness stated, detailed information to be obtained by feeding proper input data to the computer for the construction of anything from a rowboat to a warship. Moreover information can be obtained not only with respect to the hull plates but also cross girders and other steel required and the optimum pattern for cutting the hull plates from steel sheets on the loft floor so as to minimize wastage of steel by inaccurate layout of the plans on it. When the cutting tool is directed by the computerized information received the plates are also cut more accurately than under the old system. By using this information the time for this phase of the construction of a ship may be reduced from say two months to two or three weeks.

It is merely necessary to take the co-ordinates in three dimensions off the line plans of the ship and code them on a punch card which is then fed into the computer as input. The output data can be obtained in two forms, first a print-out giving in great technical detail the measurement and fairing of each plate and secondly on a punched tape which can be fed into the cutting machines.

The bank of information is furnished confidentially by Com/Code to whatever computer system is designated by the customer—in this case Computel. The system was not furnished exclusively by Com/Code to defendant, of course, but was also available to other shipyards in the United States and Canada who acquired the system. I have expressly avoided the use of the word “bought” or “leased” in connection with the acquisition of the right to use the system by defendant and others who obtained it from Com/Code since it is the key to the whole problem. On the one hand defendant cannot be considered as the purchaser of the system since the contract specifically provides that the information in it is solely for the use of defendant and cannot be passed on by it to any third party. Defendant therefore cannot be considered as having rights of ownership which would imply the right to dispose of or use the information in any legal manner it might choose. On the other hand, having paid a lump sum for the use of the system with options and revisions of the system as provided in the agreement, over a period of three years, defendant cannot be considered merely as the lessee of the system, or as having acquired it on a royalty payment basis, since the amount paid remains the same whether defendant makes extensive use or no use whatsoever of the system and there is no fixed period of time at which the right to use the system terminates. Presumably defendant can continue to use it as long as the information in it is usable and has not become obsolete. It was conceded that although Com/Code has undoubtedly gone to the great expense of assembling and computerizing all this information and by doing so provides an extremely useful service to shipbuilding, the information itself is not protected by patent or copyright and any shipbuilder could if its operations were extensive enough to justify the expense, assemble and computerize its own bank of similar information. The issue is not whether the payments made by defendant to Com/Code were of a capital or income nature so far as defendant is concerned, but merely whether 15% should have been deducted from them and remitted to the Minister of National Revenue from Com/Code pursuant to subsection 215(6) of the new Act. Jurisprudence relating to the distinction between income and capital expenses is not directly pertinent. The agreement between defendant and Computel called for the granting of “a non-exclusive licence” and the payment is referred to as being “for licence to use the system”. Plaintiff contends that what was acquired was property within the meaning of subparagraph 212(1 )(d)(i) and in this connection refers to the case of Rapistan Canada Limited v MNR, [1974] CTC 495; 74 DTC 6426, which was however a case dealing with whether a deed of gift whereby a US company granted appellant company its “know-how, techniques, skills and experience” in order to enable it to carry on in Canada the particular manufacturing operation that was carried on in the US by the US company was capital in nature subject to deduction of capital cost allowance. In rendering judgment Chief Justice Jackett stated at 498 [6427-8]:

While the “Deed of Gift” purports to be a gift, grant and assignment of “knowhow, techniques, skills and experience”, as far as I know, under no system of law in Canada, does knowledge, skill or experience constitute “property” that can be the subject matter of a gift, grant or assignment except to the extent, if any, that it can be aright or a part of a right in respect of which there is property of the kind classified as industrial property. Therefore, as I understand the “gift” in this case in the light of the evidence, it must be construed as a promise by the donor that the appellant will be informed and instructed by the “donor” as to how to commence and carry on a certain manufacturing operation. Clearly, it is not based on any of the industrial property rights such as patents for inventions, copyright, trade marks and industrial designs. As I understand the law, knowledge or ideas, as such, do not constitute property.

Defendant contends however that the words in subparagraph (i) must be read in the light of the preamble to paragraph (d) “rent, royalties or a similar payment, including but not so as to restrict the generality of the foregoing, any payment” and by applying the ejusdem generis rule, that all payments referred to specifically must have characteristics similar to rents or royalties. According to this argument the word “including” is not used in its extensory sense for the purpose of enlarging the meaning of the preceding words but rather for the purpose of defining the types of rents, royalties or Similar payments to be taxed by the subparagraph. Reference was made to the case of Commissioners of Customs and Excise v Savoy Hotel Ltd, [1966] 2 All ER 299 in which, in reviewing the words “manufactured beverages, including fruit juices” in Schedule 1 to the Purchase Tax Act 1963, Sach, J stated at 302:

... there is nothing here in the use of the word “included’’ that compels the court to say that “fruit juices” must be construed without reference to the two words with which the sentence begins and which should, where practicable, be given some effect in relation to the words that follow.

In contending that the payments made were in the nature of rent plaintiff referred to the case of United Geophysical Co of Canada v MNR, [1961] CTC 134; 61 DTC 1099 at 145 [1104-5] where Thurlow, J (as he then was) dealt with the question under paragraph 106(1 )(d) of the old Act of whether payments not having characteristics of rent, in view of there being no certainty in the agreement as to the amount to be paid or as to the time when the payment must be made, nevertheless came within the section. He stated:

It is, I think, apparent from the use in the section of the wording which follows the words “rent” and “royalty” that Parliament did not intend to limit the type of income referred to in the subsection to either what could strictly be called “rent” or “royalty” or to payments which had all of the strict legal characteristics of “rent” or “royalty”. Nor does the scope of the section appear to be restricted to payments of that nature in respect of real property for the word “property” appears in the section and that word is defined in very broad terms in s 139(1 )(ag) as including both real and personal property. It seems to me, therefore, that s 106(1 )(d) includes any payment which is similar to rent but which is payable in respect of personal property.

He was however dealing with the argument that rent must be limited to profits arising from real property, and in summing up his reasoning he also Stated at p 1105:

Without attempting to determine just how wide the net of s 106(1)(d) may be, I am of the opinion that the subsection does refer to and include a fixed amount paid as rental for the use of personal property for a certain time, (emphasis mine).

Certainly in the present case there is no limitation as to time. This distinction was referred to with approval by Cattanach, J in C I Borland Properties Limited v MNR, [1967] CTC 432; 67 DTC 5289 where he stated at 437 [5292]:

From my brother Thurlow’s remarks, I conclude that in his opinion (assuming the amount was paid for the use of property) there must be two attributes present to constitute a payment similar to rent, although without all other strict legal requirements thereof, (1) that it is a fixed amount and (2) that it is paid for a certain time. I would add that the amount is fixed if it is stated so that it can be ascertained with certainty.

With respect of the word “royalties”, Cameron, J stated in the case of May McDougall Ross v MNR, [1950] CTC 169; 50 DTC 775 at 176 [778]:

.. . Royalties, in reference to mines or wells in all the definitions, are periodical payments either in kind or money which depend upon and vary in amount according to the production or use of the mine or well, and are payable for the right to explore for, bring into production and dispose of the oils or minerals yielded up.

In MNR v Paris Canada Films Limited, [1962] CTC 538; 62 DTC 1338 Dumoulin, J stated at 543 [1341]:

Proceeding by elimination, I incline to believe that a lump payment for rights irrevocably ceded, tantamount to an assignment in perpetuity, as in exhibit 11, can hardly be reconciled with the customarily accepted notions attaching to “rents or royalties”, id est: limit of time, retention of “jus in re" by the lessor and periodical rentals by the lessee, either for fixed sums or an apportionment of receipts.

In the case of Vauban Productions v Her Majesty The Queen, [1975] CTC 511; 75 CTC 5371 Addy, J stated at 513 [5372]:

The term “royalties” normally refers to a share in the profits or a share or percentage of a profit based on user or on the number of units, copies or articles sold, rented or used. When referring to a right, the amount of the royalty is related in some way to the degree of use of that right. This is evident from the various dictionary definitions of the word “royalty” when used in connection with a sum payable. Royalties, which are akin to rental payments, have invariably been considered as income since they are either based on the degree of use of the right or on the duration of the use, while a lump sum payment for the absolute transfer of a right, without regard to the use to be made of it, is of its nature considered a capital payment, although it may of course be taxable as income in the hands of the recipient if it is part of that taxpayer’s regular business . ..

Plaintiff contends however, that the word “royalties” has not been restricted to payment for the use of the information since subparagraph 212(1 )(d)(i) in referring to payment “for the use of” also adds the words “or for the right to use” and that what defendant acquired was “the right to use”. In support of this argument plaintiff refers inter alia to the British case of Rustproof Metal Window Co Ltd, v Commissioners of Inland Revenue 29 TC 243 where Lord Greene, MR stated at 267:

Returning to the argument of Counsel, I cannot understand why it should be Said, as the proposition implies and was specifically argued, that a sum received in respect of the right to use a patent which is payable whether or not the patent is in fact used and without reference to any question of user must necessarily be a capital receipt. A sum received in consideration of the grant of the right to use a patent, whether user does or does not take place, is surely just as capable of being an income receipt as a sum received in consideration of the grant of the right to use any other kind of property, for example, a motor-car. Whether or not it is an income or a capital receipt must, I should have thought, be ascertained by reference to all the relevant circumstances and not by some fixed rule of law such as is suggested.

Reference was also made to the case of Murray (Inspector of Taxes) v Imperial Chemical Industries, Ltd, [1967] 2 All ER 980 in which at 983 Lord Denning, MR stated:

Applying these criteria, in the persent case it is quite clear that the royalties for the master CPA patent and the royalties for the ancillary patents of the taxpayer company were revenue receipts. That is admitted. So far as the lump sum is concerned, I regard it as a capital receipt, even though it is payable by instalments. I am influenced by the facts: (i) that it is part payment for an exclusive licence, which is a capital asset; (ii) that it is payable in any event irrespective of whether there is any user under the licence; even if the licensees were not to use the patents at all, this sum would still be payable; (iii) that it is agreed to be a capital sum payable by instalments and not as an annuity or a series of annual payments. In these circumstances I am quite satisfied that the lump sum was a capital receipt and the taxpayer company are (sic) not taxable on it.

In the case of Jeffrey (H M Inspector of Taxes) v Rolls-Royce Ltd, 40 TC 444 which dealt with an agreement between Rolls-Royce and the Republic of China to license the Chinese to manufacture a Rolls-Royce jet aero engine and supply the necessary information and drawings, to advise them from time to time as to improvements and modifications in manufacture and design, and to instruct Chinese personnel of their works and to release one or two members of their own staff to assist in China with the manufacture of the engine in consideration of the payment of ‘‘a capital sum of fifty thousand pounds” plus royalties, it was held that the fifty thousand pounds was a revenue receipt despite being designated as capital payment. As previously indicated however these cases dealt with the distinction between capital and revenue receipts and the Court is not called upon to decide in the present case whether the payments made by defendant to Com/Code were revenue receipts for Com/Code or whether they were capital or revenue payments by defendant in order to interpret paragraph 212(1 )(d) of the Act. In the case of Farmparts Distributing Ltd v Her Majesty the Queen, [1979] CTC 263: 79 DTC 5193 (which I am informed is now under appeal) my brother Gibson, J decided that this distinction was necessary for the proper interpretation of paragraph 212(1)(d). He stated at 268 [5196-7]:

The words “rent, royalty or other similar payment” used in section 212(1)(d) of the Income Tax Act require a determination categorizing the payments made in every case. This is so because the basic scheme and concept of the present Income Tax Act is that all categories of specific factual situations are provided for in its charging provisions. In other words, everything is considered to be covered.

This is a fundamental change from the basic scheme and concept of the previous Act which employed general language in its charging provisions. It dealt with principles and standards. It left for judicial decision whether a particular factual situation fell within or without such general language in the charging provisions.

(Type of payments)

Therefore, in considering the categorization of the payments made in this case, it appears that in all of the subsections of section 212(1)(d) of the Income Tax Act (except section 212(1)(d)(v) what is contemplated is payments on income account. It appears also that section 212(1 )(d)(i) only may be applicable in these appeals. It appears also that the subject payments were lump sum payments, made once and for all, but that feature in the subject cases is not of material assistance in determining the categorization of such payments.

While the question is not an easy one I am inclined to the view in the light of all the above jurisprudence that, even though the payments made by defendant to Com/Code may have been and probably were, income receipts for that company, they certainly were not rental payments and that it stretches the word “royalties” to conclude that the lump sum payment (the fact that it was in three instalments does not alter this) even if it is considered as merely for the “right to use” the information should be considered as a royalty payment, although [it] is in no way attached to the extent of use, or to the profits made by the defendant as a result of such use, and hence there is no basis on which a royalty payment could be calculated.

I am strengthened in tnis conclusion by the wording of subparagraph (il) of paragraph 212(1)(d). It appears to me that what was acquired by defendant can properly be classified under this subparagraph as “information concerning industrial, commercial or scientific experience”. If this is the case then it clearly is not taxable under subparagraph (ii) since it is neither dependent on use to be made thereof, the benefit to be derived therefrom, the production or sales of goods or services, or profits within (A), (B) or (C) thereof. If it comes within one of the subparagraphs under which it would not be taxable it is not justifiable to attempt to classify under another subparagraph, by virtue of which it might be taxable. Having concluded that the tax is not required by virtue of paragraph 212(1 )(d) of the Income Tax Act, nor paragraph 106(1)(d) of the former Act, this disposes of the matter and it is not really necessary to deal with defendant’s argument based on the Canada-US Tax Convention. This second argument of defendant was also thoroughly dealt with however by counsel for both parties and I will therefore also deal with it. This argument again raises the question of whether the payments made to Com/Code were “income in the form of rents and royalties” or “industrial and commercial profits” in Canada. The latter are not taxable in Canada but rentals and royalties from the sale or exchange of capital assets are excepted and therefore not exempt.

The words “rentals and royalties” in the Protocol apply to “the use of, or for the privilege of using” which plaintiff points out differs from the words in subparagraph 212(1 )(d)(i) which reads “use of or for the right to use”. I do not find any significant difference in the wording. However, I find the examples in the Protocol which refers to “patents, copyrights, secret processes or formulae, goodwill, trademarks, trade brands, franchises and other like property (emphasis mine) to be, if anything, somewhat more restrictive than subparagraph 212(1)(d)(i) which uses the words “any property, invention, trade name, patent, trademark, design or model, plan, secret formulae, process or other thing whatever (emphasis mine) if one is to apply the ejusdem generis rule since what was acquired does not come within any of the items of property specified in Clause 6(a) of the Protocol nor is it “other like property”.

Plaintiff relies on the case of Western Electric Company Incorporated v MNR, [1969] CTC 274; 69 DTC 5204, affirmed in the Supreme Court, [1971] CTC 96; 71 DTC 5068, under paragraph 106(1)(d) of the former Income Tax Act which held that confidential technical information supplied by an American company to a company in Canada constituted trade secrets which bore a close analogy to ‘‘secret processes and other like property” within the meaning of paragraph 6(a) of the Protocol. The present case can be distinguished however in that the information is in no way secret, but merely a compilation in useful form of information otherwise available. Furthermore in the Western Electric case royalty payments were definitely made, based on sales of goods manufactured by use of the information received. I also conclude therefore that under the provisions of the Canada- US Tax Convention the payments made were not subject to the deduction of withholding tax as required by subsection 215(6) of the Act.

Plaintiff’s action is therefore dismissed with costs.