3 December 2002 External T.I. 2002-0173855 - Removal computer software OECD abservation

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: TEI Question - Withdrawal of observation on computer software in OECD Commentary on March 28, 2002 by Finance - timing.

Position: See response - no change in assessing for payments made before March 28, 2002.

Reasons: change in Finance Policy

TEI - December 3, 2002

Question 19

Paragraph 14 of the Commentary on Article 12 of the OECD Model Tax Convention on Income and Capital concerning the taxation of royalties provides that payments made for the rights acquired in relation to software copyrights should be treated as commercial income in accordance with Article 7 (Business Profits). Paragraph 27 of the Commentary states that Canada "has an observation" on the comments in paragraph 14 that such payments should not be taxed as business profits but as Royalties under Article 12. CCRA's Technical News No. 23 (June 2002) indicates that the Department of Finance has informed the OECD that Canada is withdrawing its "observation" in paragraph 27 and that the CCRA will consider such payments to be taxed as business profits under Article 7. CCRA also stated in the Technical News that it views payments as a "royalty" where such "payments [are] . . . for the use of, or the right to use . . . other intangible property."

In light of the announcement in Technical News No. 23 that Finance has withdrawn its observation, has CCRA determined whether any interpretation bulletins, assessing positions, or procedures should be modified? If so, we would appreciate an update on the anticipated changes.

CCRA Response

We first wish to point out that Canada's former observation was in fact on paragraphs 14 to 14.3 of the Commentary to Article 12 of the OECD Model Convention. In addition, in those paragraphs the OECD discusses different rights in relation to the copyright of computer programs, and we encourage you to read those paragraphs in conjunction with this response. Please note that payments for the use of some computer software may still be subject to the Royalty Article as described in paragraph 14.3 of the OECD Commentary.

Canada's former observation on this commentary stated:

Canada does not adhere to paragraph 14 through 14.3. In Canada, payments by a user of computer software pursuant to a contract that requires that the source code or program be kept confidential, are payments for the use of a secret formula or process and thus are royalties within the meaning of paragraph 2 of the Article.

We repeat what we said both in Technical News No.23 and at the May 2002 IFA Conference for clarity. The Department of Finance wrote to the OECD on March 28, 2002 to inform them that Canada is removing its observation on Article 12 of the Commentary. Accordingly, as of March 28, 2002, for the purposes of Canada's Income Tax Conventions, subject to the exceptional cases described in paragraph 14.3 of the Commentary on Article 12, the CCRA will no longer view such a payment as described in our observation as a payment for a "secret formula". This new position is applicable to Conventions in force as of March 28, 2002 and subsequent Conventions that come into force after that date.

However, those responses also noted that, for the purposes of Canada's Income Tax Conventions, any payment for computer software will still be a royalty and subject to Article 12 where the definition of "royalty" in a particular Convention refers to "other intangible property". Also Part XIII tax applies to payments for computer software pursuant to paragraph 212(1)(d) of the Income Tax Act, unless the payment is in respect of "shrinkwrap" software or the exception in subparagraph 212(1)(d)(vi) applies.

Accordingly, payments made prior to March 28, 2002, for the use of custom computer software are royalties for the purposes of Canada's Income Tax Conventions and Canada retains its right to tax, subject to a specific exemption provision for computer software, such as that found in the Canada-U.S. Convention. After March 27, 2002 a payment for the use of custom computer software will only be subject to the Royalty Article of a particular Convention if there is a reference to other intangible property in the royalty definition and there is no specific exclusion in the Royalty Article for computer software.

Our assessing position follows this position; in other words, there is no change in assessing for payments made before March 28, 2002. Interpretation Bulletin IT-303 is currently being revised and will discuss rents, royalties and other payments, including payments for computer software.

Jane Stalker
November 18, 2002
2002-017385