Saint John Shipbuilding & Dry Dock Co LTD v. Minister of National Revenue, [1976] CTC 2370, 76 DTC 1283

Delmer E Taylor:—This is an appeal from income tax assessments for the years 1971, 1972 and 1973. There are two matters at issue.

The first is the taxability of payments totalling $10,925 made by the appellant in the year 1971 to a company called Kongsberg Systems Incorporated for the use of certain equipment. Kongsberg Systems Incorporated (hereinafter referred to as “Kongsberg”) being a nonresident corporation, the Department of National Revenue has assessed against the appellant a 15% tax of $1,638.75, and has added $299 as interest, since the appellant failed to withhold the appropriate amounts from its remittances to Kqngsberg. The appellant contends that the payments were made in conjunction with a capital expenditure for new equipment purchased from Kongsberg and therefore were not subject to the said tax. The respondent claims these were ordinary rental payments under a lease, and relies on paragraph 106(1)(d) and subsection 109(1) of the Income Tax Act, RSC 1952, c 148, as amended.

The second issue is the taxability of payments made by the appellant in amounts of $25,375, $75,000 and $81,875 in the years 1971, 1972 and 1973 respectively and totalling $182,250, to a non-resident corporation, Com/Code Corporation (hereinafter referred to as Com/Code), pursuant to an agreement signed between the appellant and Com/Code on April 8, 1971 involving the acquisition by the appellant of certain rights and the obtaining of certain technical information pertaining to a system known as Autokon-I. Since the appellant failed to deduct the appropriate amounts from its remittances to Com/Code under this agreement, the Department of National Revenue has assessed against the appellant a 15% tax for each year in the following amounts: 1971— $3,806.25 plus interest of $762.46; 1972—$11,250 plus interest of $1,500; 1973—$12,281.25 plus interest of $987.60. The appellant contends these were not payments subject to Canadian income tax under any existing taxing provisions. The respondent relies on paragraph 106(1)(d) and subsection 109(5) of the Income Tax Act, RSC 1952, c 148 as amended (the old Act), and paragraph 212(1)(d) and subsection 215(6) of the Income Tax Act, SC 1970-71-72, c 63 as amended (the new Act). It should be noted that, due to the transitional provisions between the “old” Act and the “new” Act, the withholding tax continued at 15% rather than at the 25% rate called for under section 212 of the “new” Act.

The appellant (hereinafter referred to as the company) is, and at all material times was, a company incorporated under the laws of the Province of New Brunswick and having its head office in Saint John, New Brunswick. It is engaged in the business of repairing and constructing ships, boats and other vessels. In addition to evidence introduced directly by the appellant through witnesses, there were two main documents provided at the hearing. One is the agreement between the company and Com/Code, and the other the agreement between the company and Kongsberg. These are, respectively, Exhibits A-1 and A-2, and shall be designated as such in this decision.

Dealing first with the Kongsberg matter as evidenced through witnesses, and the document filed as Exhibit A-2, the Board notes the point brought forward by counsel for the appellant that Exhibit A-2 represents only an interim arrangement between the company and Kongsberg, awaiting the availability of the equipment purchased by the company and delivered at a later date by Kongsberg. The Board also accepts the fact that, if the purchased equipment had been available for delivery by Kongsberg, the company might not have been required to enter into this interim arrangement. Nevertheless, the company chose this method of maintaining operations when the equipment to be purchased was not available, presumably after weighing. up the advantages and disadvantages of other alternatives, and there is nothing in the evidence which would detract from a conclusion that this arrangement was simply the result of a lease, subject to the tax imposed. The major document, Exhibit A-2, utilizes the understood terms, and has the accepted characteristics of a lease, including references to “rent”, “initial six-month period”, “may be renewed from month to month”, etc. It is the view of the Board that this part of the appeal is not supported by the facts, and must be dismissed.

Turning now to the second part of the appeal, counsel for the appellant and counsel for the respondent both presented considerable information in connection with the characteristics of these payments to Com/Code and the definitions which should be attached thereto, as well as outlining the meanings and interpretations which in their opinion should be placed on both the words and the context of the applicable provisions in both Income Tax Acts. Counsel for both parties agreeed that the wording of section 106 of the “old” Act and of section 212 of the “new” Act were identical to the extent that they were relevant in this appeal. Counsel for the appellant made two main points: first, that the payments to Com/Code were “industrial and commercial profits” and not “rents or royalties” as described in the Tax Convention and Protocol between Canada and the United States and were not taxable because Com/Code did not have a permanent establishment in Canada; and second, that if the payments were “rents, royalties, etc”, these payments were for “information” under the applicable sections of the Income Tax Acts, and since none of the conditions therein for taxability of information appeared to have been met, the payments were exempt from such taxation.

Before proceeding to examine these points in detail, it would be of advantage to make some determination of just what type of asset was received from Com/Code. The following are quotations from Exhibit A-1:

AUTOKON LICENSE AGREEMENT

THIS AGREEMENT made this 8th day of April, 1971,

BY AND BETWEEN:

SAINT JOHN SHIPBUILDING & DRY DOCK CO, LTD, with head office in Saint John, New Brunswick, Canada, hereinafter called “the Subscriber”, of the one part,

— and —

COM/CODE CORPORATION, with executive offices locate dat 1812 K Street, NW, Washington, DC, USA, hereinafter called “the Company”, of the other part .

WHEREAS the Company has valuable technical information known as the Autokon-I System;

AND WHEREAS the Subscriber is desirous of acquiring rights with respect to said Autokon-I System and of obtaining the technical information pertaining to the said Autokon-I System;

NOW, THEREFORE the parties hereto agree as follows:

l. DEFINITION OF TERMS:

(A.) The Company refers to COM/CODE Corporation of Washington, DC, who has exclusive rights to sell and service the said Autokon-! System in North America; these rights being granted by Shipping Research Services of Oslo, Norway, the owners of the Said Autokon-I System.

(B.) The Autokon-I System (the System)—refers to all technical information as presently developed and/or controlled by the Company consisting of the following five integrated computer programs which are the up-to-date version of the System and which has been already adopted to some certain computer hardware system and is currently operational thereon (all as more specifically defined in Schedule “A” attached hereto):—

1. Hull Definition

2. Plane Plate Contour Generation

3. Plate Nesting

4. Shell Expansion

5. Longitudinal Fairing

(C.) Use—In return for the obligations assumed under this agreement, the Subscriber is hereby granted a non-exclusive license (italics mine) to use the System, as defined in Section B, above, in connection with the design and construction of the Subscriber’s ships, the forming of sections of ships, and for other industrial applications for which the System may be Suitable. Such use of the System is to be confined to the Subscriber and associated Irving companies. This license may be exercised by the Subscriber by having the Company install an operating version of the System on the Subscriber’s own computer or on such other computer of suitable capacity as may be selected by the Subscriber provided a non-disclosure and confidence agreement is first entered into between the owner of such other computer and the Company similar to the terms set out in Section VI! hereof.

ll. TECHNICAL INFORMATION:

The technical information on the System consists of user’s manuals, programmers’ manuals and computer Programs. In accordance with the terms of this agreement, the Company shall furnish and disclose technical information to the Subscriber as follows:

(A.) User’s manuals, containing rules for the Preparation of input data and recommended operating practices. Five (5) registered copies of said user’s manuals will be provided in the English language.

(B.) Programmers’ manuals, including flow charts of Sub-routines contained therein. Two (2) registered copies of said programmers’ manuals will be provided in the English language.

IBM 360-40*

*(The words “IBM 360-40" were inserted in writing and appropriately initialled, apparently at the time of signing the document.)

(C.) Computer programs of the System supplied in source code form on magnetic tape and/or card deck.

it becomes obvious that in some sections the agreement is, at the very least, unclear with regard to its purposes, and may indeed be contradictory. “Acquiring rights . . . and obtaining the technical information . . (preamble) must be viewed as referring to the same transaction as “the Subscriber is hereby granted a non-exclusive license” (I. (C.)). The “rights” to the Autokon-I System, and obtaining the “technical information” pertaining thereto, are indicated in the preamble as separate and distinct, whereas the “Autokon-I System” mentioned in paragraph (A.) of Clause I is referred to as “the System”, and in paragraph (B.) thereof is stated in rather specific terms to refer to five integrated computer programs. If there is any doubt left about the use of the word “refers” in this section, it is cleared up by the definition under section II—^Technical Information. In the view of the Board, that which the company received was an integrated set of computer programs together with the attendant “User’s and Programmers’ Manuals”. The “System” which the company obtained is simply that, no more and no less.

Turning to the question of the use of these programs by the company, one is confronted with some additional lack of clarity. Com/Code under I. (A.) had “exclusive rights to sell and service the said Autokon-I System in North America”. The company was “desirous of obtaining rights with respect to the said Autokon-I System” (preamble). There is no indication that the desire of the company with regard to such “rights” was ever specifically satisfied, or indeed that Com/Code had any authorization to grant rights of any description. However, the company was “granted a non-exclusive license to use the System”. So, the company obtained the technical information, described as “the System”, which was further identified as five integrated computer programs with supporting manuals, and the company was granted a non-exclusive licence to use the computer programs. There is no indication of the penalties or liabilities which the company would incur in the event of violation of the mutual agreement on use restriction of the System contained in other clauses of the agreement. The very nature of computer programs is that, once made available, they can be readily copied, or the necessary data can be readily extracted and stored. The original computer program itself might become virtually worthless as a specific and individual item once it has been made available to a user.

The following clause from the agreement deals with the payment, and the Board includes paragraph (A.) thereof in its original form and repeats it as it appears after the addition of clearly legible handwritten changes apparently inserted and initialled at the time of the signing of the agreement and indicated by asterisks:

V. COMPENSATION:

(Original)

(A.) For license to use the System, as defined in Section I, (C) hereof, a license fee of $175,000.00 (US funds) is to be paid as follows: $90,000 upon the signing of this agreement and $85,000 upon acceptance of the System by the Subscriber.

(As altered and initialled)

(A.) For license to use the System, as defined in Section 1, (C) hereof, a license fee of $175,000 (US funds) is to be paid as follows: (*$25,000) upon the signing of this agreement, (*$20,000 upon the acceptance of each of the said five programs,) and (*$50,000) upon acceptance of the System by the Subscriber.

(B.) Labour cost of installation of the System is for the account of the Subscriber and will be covered by a separate purchase order.

(C.) Additional registered copies of the said user’s manuals are available at a price of $70.00 (US funds) per copy. Copies of the said programmers’ manuals are available at $150.00 (US funds) per copy. Such prices shall apply until 1 April, 1976.

(D.) All invoices will be paid by the Subscriber within fifteen (15) days after receipt.

At this stage it should be pointed out that, whereas the agreement calls for payments of $175,000, the company actually paid Com/Code a total of $182,250. No specific evidence was brought forward at the hearing regarding this difference in price but a reading of the agreement in the context of the evidence supports the view that the difference of $7,250 was for labour, installation, and service.

As already stated, the parts above marked with asterisks and shown in brackets are the changes made in handwriting and appropriately initialled. Therefore the agreement was changed to call for the payment of $25,000 upon signing, $100,000 paid in instalments of $20,000 as each of the five programs was accepted, plus a final payment of $50,000, thus maintaining the total of $175,000. It is clear that the company was to pay $175,000 for a licence fee, and there does not appear to be any term or period of time associated with the said fee. There is no mention made that any of this payment was to defray the cost of the computer programs themselves. It is this point which is significant to the Board. No matter whether the nature of that which was received by the company was a property consisting of a series of computer programs, as held by the respondent, or merely information on the computer programs, as held by the appellant, the payments made to Com/Code related to a licence fee for the use of that which was received, and there was no payment made for the physical property which was acquired.

The Board appreciates the efforts of both counsel to provide enlightenment on some of the words used both in the agreement and in the Income Tax Acts, but it should prove helpful to set out here the definitions which the Board will use in dealing with this matter. These are taken from The Living Webster Encyclopedic Dictionary of the English Language, 1973-74 edition, published by North American Educational Guild, Ltd, Winnipeg, Manitoba:

license: formal permission or authorization to do or forbear some act;

fee: a sum paid for a privilege;

rent: compensation paid at intervals to the owner of a property;

royalty: a compensation or portion of proceeds paid to the owner of a right, as an oil right or a patent, for the use of it; . . .; the payment made for such a right.

In reviewing whether or not the payment of $175,000 for this licence fee should be characterized as either a rent or a royalty, the Board has been particularly aware of the reasons for judgment of what was then the Exchequer Court of Canada in United Geophysical Company of Canada v MNR, [1961] CTC 134; 61 DTC 1099, and of this Board and the Trial Division of the Federal Court in Vauban Productions v MNR, [1973] CTC 2230; 73 DTC 184; [1975] CTC 511; 75 DTC 5371. In the first matter, the learned judge provides as a summary definition of rent: . there are but two characteristics of the sum, namely it is for the use of machinery, etc, and it is paid for that use for a certain time.” When the second matter was before the Tax Review Board, Mr Prociuk commented: "In my humble opinion the agreement is a lease of motion picture films and not a sale. It contains all the elements of a lease. The fact that consideration thereof is one lump-sum payment does not alter its character in any way.” In the same matter, before Addy, J in the Federal Court—Trial Division, the following explanation was provided by the learned judge at page 513 [5372]:

The term “royalties” normally refers to a share in the profits or a share or percentage of a profit based on user [sic] 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. This concept of the basic difference between “royalties” and “lump sum payments” for the transfer of rights has been recognized in the following cases: CIR v Rustproof Metal Window Co, Ltd, 29 TC 243 at 254 and 255; CIR v British Salmson Aero Engines, Ltd, 22 TC 29 at 36; Desoutter Bros Limited v J E Hanger & Co, Limited et al, [1936] 1 All ER 535 at 536; Strick (H M Inspector of Taxes) v Regent Oil Co Ltd, 43 TC 1 at 18, 44, 50 and 59; Withers (H M Inspector of Taxes) v Nethersole, [1948] 1 All ER 400 at 403 and 405; and Technical Tape Corporation v MNR (1964), 35 Tax ABC 389; 64 DTC 428.

Later, in the same judgment, he went on to say at page 515 [5374]:

. . . It is therefore quite clear that the CBC did not receive all of the rights which the distributor Vauban had received. In other words, the rights of the latter were distributor and user’s rights while those of the former were solely user’s rights.

To this argument, however, counsel for the Plaintiff replies that, although the CBC might not have received exactly the same rights which the distributor Vauban had originally acquired, the latter in effect had divested itself [of] any remaining rights whatsoever by granting the Canadian Broad- casting Corporation the exclusive right to show the films for the whole of the period for which Vauban had any title to the films.

It is not necessary to decide whether this state of affairs is Sufficient. io constitute an absolute transfer as opposed to a leasing, for, when one compares paragraph (3)(f) of the contract which is quoted above with paragraph

(2) of Exhibit l (page 4 of the Agreed Statement of Facts), it appears quite evident that, in fact, Vauban did not transfer all that it had received.

And, in summation, the following comment is made with reference to certain quotations used in the judgment:

The three above-quoted clauses from the contract are completely consistent with the concept of a leasing of a right or the temporary assignment of part of the right to the plaintiff and are inconsistent with an absolute Sale. The fact that the consideration was. paid in a lump sum and not by instalments does not alter the nature of the transaction.

The Board therefore finds that the payments in question in this matter, totalling $175,000, cannot be Classified as “rent” since, at the minimum, there is no element of “use for a certain time”. With respect to whether or not they are “royalties”, the Board finds that although there are references to “use” in the agreement, they are not ones which the Board reads as relating to “degree of use”, or “duration of the use”. Such references to various instalments in the Original contract, the changes made at the date of signing with respect to the points in time when instalments would be due, and even the fact that the required instalments were not made as required but in fact occurred over a period of some two years, relate only to the basis for payment of the total agreed amount, and do not indicate any period or passage of time in connection with use. The payments, therefore, are not regarded as royalties.

Under the relevant section of the Act, 212(1)(d), it remains to determine if the payment falls within “. . . or a similar payment”. The one apparent common denominator between “rent” and “royalty” appears to me to be the reference to time, and without this characteristic one would certainly have serious reservations about classifying any amount as “a similar payment”, whether it was made in a lump sum payment or by instalments. This view is not diminished, in my opinion, by the inclusion in the descriptive phrase in paragraph 212(1)(d) of the words “. . . , any payment”, since this phrase cannot be read to mean an enlargement of the basic term “rent, royalty, or a Similar payment . . .”, but must be read as relating only to the types of payment to which the clause later refers. The Board rejects the position that it can be classified as a “similar payment”.

In argument, counsel for the appellant stated that

the Dry Dock did acquire ownership of the information that it obtained from Com/Code, and even though it was restricted in its right to use the ownership, had the right to use the information at all times for its own purposes, and could therefore be considered, l suggest, as an owner of that information. Perhaps not the only owner, because Com/Code itself would still have the information, and indeed the other customers of Com/Code would have the same information possibly, but once the information was transferred to the Dry Dock pursuant to the License Agreement (Exhibit A-1), then that information fell permanently into the possession of the Dry Dock and it could be used for any purpose authorized by the contract itself.

The agreement itself, however, in section VII. (C.) points out, and I quote: “The Subscriber is not granted any copyright or any other literary or property rights on the technical information supplied by the Company.” It is suggested that, to whatever degree the appellant company became an owner, it was as owner of the property or the right granted in the licence itself, not of the technical information supplied to the appellant. Further, the responsibility of Com/Code according to section II. of the agreement seems to be to “furnish and disclose technical information”. However, the Board accepts the argument made by counsel for the appellant to the degree that the right of the appellant to that which was granted was of an enduring and not of a temporary or of a periodic nature.

The Board finds that the payments in question made by the appellant to Com/Code which amounted to $175,000 were for a licence fee, transferring to the company certain user’s rights. Together with other amounts of $7,250 for installation and service, making a total of $182,250, they do not constitute payments made for rent, royalty or a similar payment under paragraph 106(1)(d) of the Income Tax Act, RSC 1952, c 148 as amended, or under paragraph 212(1)(d) of the Income Tax Act, SC 1970-71-72, c 63 as amended.

The appeal is therefore allowed in part, with the portion of the appeal dealing with Com/Code Corporation in the amount of $182,250 being allowed, and the portion of the appeal dealing with Kongsberg Systems Incorporated in the amount of $10,925 being dismissed.

Appeal allowed in part.