6 June 1994 GST/HST Interpretation 1994-06-06 - Application of the GST to Royalty Payments

XXXXX

Attention: XXXXX

June 6, 1994

Dear XXXXX

Thank you for your letters dated October 26, 1993, and March 31, 1994, requesting clarification of the application of the GST to royalty payments collected by the XXXXX. We regret the delay in our response.

This interpretation is based upon our current understanding of the Excise Tax Act (ETA) and regulations thereunder in their present form and does not take into account the effects of any proposed or future amendments thereto or future changes in interpretation.

While we trust that these comments will be of assistance to you, they do not constitute a GST ruling and are therefore not binding upon the Department in respect of any particular fact situation.

Statement of Facts

From the information provided in your letters and in your telephone conversations with Elaine Bonnah of this office, our understanding of the facts is as follows:

•   XXXXX is a non-profit organization and GST registrant that supplies taxable memberships to its XXXXX and XXXXX under separate agreements.

•   XXXXX provides XXXXX and XXXXX with publications, newsletters, reports and promotional materials in addition to the operation and supervision of an administrative and royalty collection system for the purpose of assisting the funding of new plant development.

•   XXXXX collects fees from XXXXX in return for registering new plants. GST has been collected in respect of this service.

•   XXXXX is not involved in the supply, distribution or sale of the plants themselves.

•   The XXXXX develop the plants and supply them to distributors (wholesalers) who bulk up the plants and then sell them to the XXXXX[.]

•   The XXXXX are required to pay a royalty fee to the XXXXX who develop the plants. The royalty payments represent consideration for the right to propagate certain cultivars.

•   The distributors provide a list of persons who purchase plants to XXXXX then sends the purchasers a membership kit. Once purchasers become XXXXX will collect the royalty fees from them on behalf of the XXXXX[.] There is no legislation compelling the purchasers to pay the royalty fees; however, if they do not become members of XXXXX they may not be able to purchase plants from the distributors.

•   Royalty fees are also collected by XXXXX from resident and non-resident XXXXX and are paid to XXXXX and to agents acting on behalf of XXXXX both inside and outside Canada. In the case of roses bred by XXXXX royalties are collected, but most may be retained by XXXXX[.]

•   XXXXX sends its XXXXX a "royalty report" which lists the plant cultivars (varieties) and the royalty rates per bud, cutting, division or scion. The XXXXX report the plants they propagated and send a cheque payable to XXXXX in the amount of the royalties they owe.

•   The royalty report provides the name of some, but not all, of the XXXXX[.] In addition, the royalty report does not provide the full name and registration number of the XXXXX that are GST registrants and does not identify those XXXXX that are not registered for GST purposes.

•   Under the terms of the XXXXX, XXXXX retains 10% from the royalties collected as an administrative fee. This amount represents consideration for the administrative services provided by XXXXX and therefore is subject to GST.

•   The preamble to the XXXXX explains that XXXXX of XXXXX have agreed to supply plant materials to the XXXXX and that pursuant to the XXXXX, the XXXXX have constituted and appointed XXXXX as their exclusive royalty administrator and royalty collection agent regarding the commercial use or exploitation of XXXXX supplied to the XXXXX[.]

•   Under subsection 3.1 of the XXXXX, the XXXXX must certify that he or she is the owner or authorized agent of all the plants that have, or will be registered.

•   Subsection 5.1 states that the XXXXX constitutes and appoints XXXXX as the exclusive royalty administration and receiving agent for all royalty administration and accounting and royalty amounts due or owing the XXXXX as a result of the supply or sale by the XXXXX of propagation material to XXXXX who are members in good standing of XXXXX[.] This subsection further indicates that XXXXX is not liable for any uncollected royalties from existing or former XXXXX[.]

•   According to subsection 5.3, no rights, as agent or otherwise are conferred on XXXXX in respect of any breeder rights included in the XXXXX, and it shall be the XXXXX sole responsibility to enforce such rights against any third person, including XXXXX who have not paid royalty payments as required.

•   Subsection 6.3 states that at the time of distribution, supply or sale of propagation material by the XXXXX or an authorized representative to a XXXXX the XXXXX agrees to advise the XXXXX that XXXXX will be responsible for the administration of, and the receiving of royalties applicable thereto (except for certain exceptions described elsewhere in the Agreement).

•   Per subsection 8.4, in the event of non-payment of royalties by a XXXXX of XXXXX only the XXXXX shall be responsible for instituting any legal proceedings in order to recover royalty amounts due and owing, or to restrain any continued unauthorized use of the XXXXX. However XXXXX will render reasonable assistance required by the XXXXX in order to obtain recovery of the royalty amounts due and payable. To the extent necessary, XXXXX will assign such rights its has with a XXXXX under the XXXXX in order that the XXXXX may enforce royalty collection.

•   Under subsection 8.5, the XXXXX has the right to make available to third parties plant propagation material at rates more favourable than that set out in schedule "A" of the Agreement.

•   Subsection 9.1 provides that the XXXXX agrees to indemnify and save XXXXX harmless against any and all third party claims made respecting XXXXX administration and royalty receiving agency activities performed by it on behalf of the XXXXX.

•   While XXXXX has charged and remitted GST in respect of the administrative services it provides to the XXXXX (i.e., 10%), no GST has been collected or remitted in respect of the royalty payments themselves (i.e., 90%).

Interpretation Requested

You have requested whether XXXXX is required to charge GST in respect of the amount of the royalty payments which is subsequently transferred to the XXXXX[.]

Analysis

While it is the responsibility of the parties involved in any transaction to determine whether an agency relationship is in existence, it appears that XXXXX is acting as an agent of the XXXXX in collecting and remitting royalty payments from the XXXXX. That is, while it is a legal question as to whether there is an agency relationship between these parties, the following criteria would suggest that an agency relationship exists:

1. The Nature of a Principal/Agent Relationship

Essentially, an agent becomes an extension of the principal and the activities carried on by the agent are those of the principal. The principal acquires any legal rights and is subject to the obligations in relation to third parties that may arise as a result of actions taken on the principal's behalf by its agent. It is important to note that the law does not require a person who is an agent to disclose this fact to a third party. An agency relationship may exist despite the fact that the third party is not aware of the identity of the principal or even that there is a principal.

2. Authority to Act as an Agent

There must be some indication that the agent is authorized to enter into a contractual arrangement on behalf of the principal. The grant of authority by the principal may be express (i.e., a written agency agreement) or implied. In other words, an agency relationship may be created simply by the principal consenting to have an agent act on its behalf.

3. Ability to Bind the Principal

This refers to the ability of the agent to affect the legal position of the principal (e.g., to enter into contracts on behalf of the principal or to discharge the obligations of the principal).

4. Fiduciary Duty

An agent must act in the best interest of the principal and may not put its own personal interest before those of the principal. An agent is not permitted to receive any financial advantage in excess of that to which it is entitled as remuneration. The ultimate liability with respect to the transaction undertaken rests with the principal.

Based on the foregoing, it appears that XXXXX is acting as an agent of its XXXXX when it collects royalties on their behalf from the XXXXX.

1) GST Treatment of Royalties Collected by XXXXX on behalf of XXXXX that are GST Registrants:

As XXXXX does not disclose in writing to the XXXXX the names and GST registration numbers of those XXXXX that are themselves registered for GST purposes, XXXXX must collect GST in accordance with the methods set out in section 177 of the ETA.

This works as follows:

XXXXX must charge and remit 7% GST on 100% of the royalty fee it collects from the XXXXX.

When XXXXX passes the royalty fee less the amount charged for the administrative services (i.e., 100% of the royalty fee net of the 10% administration fee) to the registrant XXXXX, this amount is considered to be payment by XXXXX for the rights supplied by the XXXXX to propagate certain cultivars.

Generally, the registrant XXXXX must charge GST to COPF on the amount of the royalty payment.

Note:

Special rules apply to public service bodies, such as charities and non-profit organizations under the GST. If a XXXXX is a public service body, it should ensure that exempting provisions available to these organizations do not apply before charging XXXXX the GST on this transaction.

XXXXX will be entitled to claim an offsetting input tax credit equal to the GST it pays to the registrant XXXXX.

The following example shows how XXXXX should calculate its GST remittance in respect of royalties collected on behalf of its registrant XXXXX

Example:

Amount collected by XXXXX from theXXXXX:

Royalty fee collected by XXXXX	$100
GST payable on the royalty fee	7
Total	$107

GST to be remitted by XXXXX in respect of this payment - $7.00

Amount passed to registrant XXXXX:

Royalty fee	$100
Less the 10% administration fee	10
Net proceeds to registrant Breeder Member	$  90

As mentioned above, the amount XXXXX gives to the registrant XXXXX is regarded as consideration paid by XXXXX for the rights it resupplied to the XXXXX. The registrant XXXXX will be responsible for collecting the GST from XXXXX on this amount (i.e., 7% of $90 = $6.30). XXXXX will be entitled to claim an input tax credit equal to this amount.

Summary:

GST collected by XXXXX on $100 royalty fee	$7.00
Input tax credit to be claimed by XXXXX	$6.30
Net tax remittance	$0.70

(which represents the GST that would otherwise be payable on the taxable 10% administration fee)

The treatment of these royalty payments will be somewhat different when they are collected on behalf of XXXXX that are not GST registrants.

2) GST Treatment of Royalties Collected by XXXXX on behalf of XXXXX that are not required to charge GST

Note: This treatment applies to non-registrant XXXXX and to non-resident XXXXX, unless the non-resident XXXXX are carrying on a business in Canada and are themselves GST registrants, in which case the royalty payments paid to these organizations will be subject to the treatment described above.

XXXXX must charge and remit 7% GST on 100% of the royalty fee it collects from the XXXXX[.]

When XXXXX passes the royalty fee less the amount charged for the administrative services to the non-registrant XXXXX this amount is considered to be payment by XXXXX for the right supplied by that XXXXX to propagate certain cultivars. As the XXXXX is a non-registrant, it will not be required to charge XXXXX GST on the net royalty fees it receives from that organization.

Example:

Amount collected by XXXXX from the XXXXX:

Royalty fee collected by COPF	$100
GST payable on the royalty fee	7
Total	$107

GST to be remitted by XXXXX in respect of this payment - $7.00

Amount passed to XXXXX that are not required to charge GST:

Royalty fee	$100.00
Less the 10% administration fee	10.00
Net proceeds to the XXXXX	90.00

Subsection 177(1.1)

Note: There are special rules available under subsection 177(1.1) of the ETA that would entitle XXXXX to claim a notional input tax credit equal to 7/107th of the amount it passes to the non-registrant XXXXX[.] However, to be entitled to this treatment, XXXXX must also pass along to the non-registrant XXXXX an amount equivalent to the GST. This would require that XXXXX differentiate between registrant and non-registrant XXXXX and may result in increased bookkeeping requirements.

If XXXXX chooses to use this method, it would treat the royalty payments collected on behalf of its non-registrant XXXXX as follows:

Example:

Amount collected by XXXXX from the XXXXX

Royalty fee collected by XXXXX	$100
GST payable on the royalty fee	7
Total	$107

GST to be remitted by XXXXX in respect of this payment - $7.00

Amount passed to XXXXX that are not required to charge GST:

Royalty fee	$100.00
PLUS GST payable on the royalty fee	7.00
Subtotal	$107.00
LESS 10% administration fee	10.00
LESS GST	.70
Total proceeds to the XXXXX	$  96.30

XXXXX will be entitled to claim a notional input tax credit equal to the GST collected on the royalties (i.e., 7/107th of $96.30 or $6.30).

Summary:

GST collected by XXXXX	$7.00
Notional Input tax credit to be claimed by XXXXX	$6.30
Net tax remittance	$0.70

(which represents the GST that would otherwise be payable on the taxable 10% administration fee).

I hope that this will be of assistance. If you have any questions on the information provided in this letter, please contact Joanne Houlahan at (613) 954-7945 or Elaine Bonnah at (613) 952-6761. For further assistance in this regard and to resolve any issues concerning the remittance of GST on these royalty payments, you should contact XXXXX[.]

Yours truly,

J.A. Venne
Director
Tax Policy - Special Sectors
Policy and Legislation