28 January 2004 Internal T.I. 2003-0043517 - Intellectual Property as TCP

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.

Principal Issues:

1. Is intellectual property owned by a non-resident TCP?

2. Confirm computation of deemed dividend and shareholder benefit.

Position:

1. No
2. Confirmed

Reasons:

1. The property was not used or held in, nor eligible capital property in respect of, a business carried on in Canada by the non-resident.

2. Similar to example in paragraph 7 of IT-432R2.

			January 28, 2004

	COMPLIANCE BRANCH	HEADQUARTERS
	International Tax Directorate	Income Tax Rulings
			  Directorate
S. E. Thomson
	Attn:	XXXXXXXXXX 	(613) 957-2122
		XXXXXXXXXX
			2003-004951

Intellectual Property as Taxable Canadian Property

This is in response to your email of November 17, 2003 in which you ask for our views on certain issues that have arisen in the course of an audit. The scenario, as you have presented it to us, is as follows:

Facts

? The Taxpayer is a former Canadian resident, who emigrated to Switzerland in XXXXXXXXXX.

? Prior to his departure from Canada, he was involved in a business with his brother operating through the brother's CCPC. An industrial intellectual property (XXXXXXXXXX), (the "Property") was developed and used in the business.

? In XXXXXXXXXX, Taxpayer acquired ownership of the Property in an out-of-court settlement with his brother and after paying $XXXXXXXXXX.

? Since XXXXXXXXXX, the Property was used in Taxpayer's own CCPC in Canada.

? In XXXXXXXXXX, the Taxpayer transferred the property to a related Canadian corporation (Canco) for $XXXXXXXXXX. The consideration consisted of cash of $XXXXXXXXXX and common shares of Canco with a PUC of $XXXXXXXXXX. The transfer was not done pursuant to section 85 of the Act.

? Canco has included the Property to Class 12 of Schedule II of the Income Tax Regulations (the "Regulations").

? The CCRA has estimated the value of the Property to be approximately $XXXXXXXXXX in XXXXXXXXXX.

Questions

You would like to know if the Property is "taxable Canadian property", as that term is used in the Income Tax Act (the "Act"), even though the capital gain on the transfer to Canco would be exempt from tax in Canada by virtue of paragraphs 6 and 7 of Article 13 of the Canada-Switzerland Tax Convention (the "Treaty"). You would also like us to confirm your understanding of the application of subsections 15(1) and 84(1) of the Act on the transfer of the Property to Canco.

Our Comments

1. Paragraph (b) of the definition of "taxable Canadian property" ("TCP") (i.e. the only relevant paragraph in this case) in subsection 248(1) reads as follows:

property used or held by the taxpayer in, eligible capital property in respect of, or property described in an inventory of, a business carried on in Canada, ...

You would like to know if the "business" in the definition of TCP can be any business in Canada, or must it be a business carried on by the Taxpayer. It is clear that the Property was used in a business carried on in Canada by the CCPC, but, in our view, the business had to have been carried on in Canada by the Taxpayer, in order for the Property to be TCP. (We have assumed that the Taxpayer was not in the business of licensing intellectual property.) Since the Property was not used or held by the Taxpayer in, nor eligible capital property in respect of, a business carried on in Canada by him, we conclude that the Property was not TCP to the Taxpayer, based on the following reasoning:

The definition of TCP in subsection 248(1) was amended in 2001 effective after October 1, 1996, except that, prior to December 24, 1998, paragraph (b) read as "capital property used by the taxpayer in carrying on a business in Canada". The former definition of TCP, which was imbedded in paragraph 115(1)(b), read, "a capital property used by the non-resident person in carrying on a business in Canada". In its Technical Notes to the 2001 amendment, the Department of Finance states that the substance of the existing subsection 115(1) definition is incorporated into the new definition of TCP in subsection 248(1), and that under the new single definition, includes "property used or held by the taxpayer in carrying on a business in Canada". These excerpts all imply that it must be the taxpayer who carries on the business in Canada.

Furthermore, subparagraph 115(1)(a)(ii) includes in the non-resident's taxable income earned in Canada "incomes from businesses carried on by the non-resident person in Canada". If the taxpayer holds the property as a passive investment, it is not relevant for purposes of subparagraph 115(1)(a)(ii) that another entity may use the property in its business in Canada. Similarly, subparagraph 128.1(4)(b)(ii) excludes from the deemed disposition rules "capital property used in ... a business carried on by the taxpayer ...". By extension, then, it is our view that the term "taxable Canadian property" would include property used or held by the taxpayer in a business carried on in Canada, but only if the business is carried on by the taxpayer. That is, the taxpayer must be the one who "uses" or "holds" the property in carrying on a business.

The term "eligible capital property" is defined in section 54 and subsection 248(1), and through the provisions in section 14, refers to an "eligible capital expenditure of a taxpayer in respect of the business". The term "eligible capital expenditure of a taxpayer in respect of a business" is defined in subsection 14(5) of the Act to mean, inter alia, "any outlay or expense made or incurred by the taxpayer ... on account of capital for the purpose of gaining or producing income from the business". In our view, the "business" referred to in the preceding definitions is the business of the taxpayer. Therefore, if the Taxpayer did not acquire the Property to gain or produce income from his business, the Property will not be eligible capital property to him.

2. The Taxpayer has transferred the Property to a Canadian corporation, and taken back as consideration cash of $XXXXXXXXXX and shares with a PUC of $XXXXXXXXXX. You have estimated the value of the Property to be $XXXXXXXXXX, and the fair market value of the shares to be $XXXXXXXXXX. Based on the example in paragraph 7 of IT-432R2 Benefits Conferred on Shareholders, you have computed a deemed dividend of $XXXXXXXXXX under subsection 84(1), and a shareholder benefit of $XXXXXXXXXX under subsection 15(1). We agree with these computations, but point out that the deemed dividend under subsection 84(1) should be allocated among all of the shares in the class, even those held by other shareholders.

The Taxpayer is liable to pay Part XIII tax on the deemed dividend pursuant to subsection 212(2), and on the shareholder benefit by virtue of paragraph 214(3)(a). The Treaty reduces the withholding rate on dividends (including deemed dividends) to 15%.

We trust that our comments have been helpful.

Olli Laurikainen, Manager
for Director
International and Trusts Division
Income Tax Rulings Directorate
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