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: Whether non-compete payments made to non-resident are subject to 212(1)(d)(iv)?
Reasons: The payments are made pursuant to an agreement between a person resident in Canada and a non-resident person not to use any other thing whatever.
S. E. Thomson
March 24, 2004
Re: Non-Compete Payments to Non-Residents
This is in reply to your letter of October 28, 2003, in which you ask for our views on the taxation of non-compete payments paid to a non-resident. The hypothetical facts that you have presented to us are as follows:
? Canco1 is a resident of Canada, and carries on business in Canada.
? Parentco is the parent company of Canco1, and is a resident of Germany. Parentco has never carried on business in Canada.
? Canco2 is a resident of Canada, and deals at arm's length with Canco1 and Parentco.
? Canco1 sells the assets of its business to Canco2.
? Canco2 pays a non-compete payment to Parentco.
You would like to know if the non-compete payment paid by Canco2 to Parentco is subject to Part XIII tax in Canada. In your view, Part XIII would not apply to the payment, for the following reasons:
1. The courts in Tod T. Manrell v. The Queen 2003 DTC 5225 found that the non-compete payments in that case were payments for the disposition of a right to compete. Although the right was capital property, it was a non-exclusive, commonly held right, and was therefore not included in the definition of "property" in subsection 248(1) of the Act, and did not give rise to a taxable capital gain.
2. Part XIII applies only to items of "income", not to payments on account of capital.
3. It is your understanding that Germany would include the non-compete payment in the business income of Parentco. Since Parentco does not carry on business in Canada through a permanent establishment, it is your view that Article 7 of the Canada-Germany Tax Agreement (the "Treaty") would prevent Canada from taxing the non-compete payments.
4. The definition of the term "royalties" in Article 12 of the Treaty does not include non-compete payments.
5. Since the non-compete payment is not for the disposition of "property", Article 13 of the Treaty does not apply.
6. Since the non-compete payment is not "income", Article 21 of the Treaty does not apply.
7. Article 24 of the Treaty requires that Canada not subject German nationals to taxation more burdensome than nationals of Canada in the same circumstances. Therefore, since non-compete payments are not taxable when paid to a Canadian resident (prior to October 7, 2003), they should not be taxable when paid to a non-resident.
Your questions appear to involve actual taxpayers and a factual situation. As such, we are unable to definitively reply to your question until we have had the opportunity to review all the facts and related documentation. Such a review is conducted by the relevant tax services office where the query relates to a completed transaction, or by this directorate where the arrangement is the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5. We nevertheless offer the following general comments regarding the relevant provisions of the Act. Since these comments are general in nature, they may or may not apply in your situation and are not binding on the Canada Revenue Agency.
In our view the non-compete payment to Parentco would be subject to Part XIII withholding tax under subparagraph 212(1)(d)(iv) of the Income Tax Act (the "Act"). Subparagraph 212(1)(d)(iv) of the Act provides that a non-resident person shall pay an income tax of 25% on an amount paid by a person resident in Canada to the non-resident person that is made pursuant to an agreement between the person resident in Canada and the non-resident person under which the non-resident person agrees not to use any thing referred to in subparagraph 212(1)(d)(i). Subparagraph 212(1)(d(i) applies to any property, invention, trade-name, patent, trademark, design or model, plan, secret formula, process or other thing whatever. In our view, the right to compete is an "other thing whatever".
1. Subparagraph 212(1)(d)(iv) does not require that there be proceeds of disposition from the sale of property in order to apply. Rather, it applies when a payment is made pursuant to an agreement under which the non-resident person agrees not to use any other thing whatever, whether or not that "thing" is also property under the Act.
2. Part XIII applies whether the payment described is on account of income or capital, and this is apparent from a reading of several of the provisions of section 212.
3. If Canada does not consider the non-compete payment to form part of the business income of Parentco, Canada would not apply Article 7 of the Treaty, and would not be precluded from taxing the non-compete payment under Part XIII.
4. We agree that Article 12 of the Treaty does not apply.
5. We agree that Article 13 of the Treaty does not apply.
6. Even if Article 21of the Treaty does not apply, Canada would still not be precluded from taxing the non-compete payment under Part XIII.
7. Article 24 of the Treaty applies to "nationals" in the same circumstances. Non-compete payments to a German national who is a non-resident would be taxed the same as if they were paid to a Canadian national who is a non-resident.
Note that we have not considered how the draft amendments to the Act released on February 27, 2004 might impact on our response.
We trust that we have been of some assistance.
Olli Laurikainen, C.A., Manager
International & Trusts Division
Income Tax Rulings Directorate
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