14 November 2007 External T.I. 2007-0253321E5 - Non-resident withholding tax

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 franchise fees paid to a non-resident are subject to withholding tax.

Position: Question of fact.

Reasons: The nature of the payment needs to be analysed.

								2007-025332
XXXXXXXXXX 							D. Zhang
(613) 957-2104
November 14, 2007

Dear XXXXXXXXXX:

Re: Non-resident withholding tax

We are writing in response to your facsimile transmission of September 21, 2007 in which you requested our comments regarding non-resident withholding tax requirements on payments that your client refers to as a "franchise fee".

You indicated in your facsimile that your client purchased a franchise from a company located in the U.S. for a fixed sum. In addition, your client makes a monthly payment to the franchisor determined as a percentage of sales. All parties concerned have always referred to this latter payment as a "franchise fee". Upon reviewing the franchise agreement, you noted that it is in fact referred to as a "service fee". Further, you indicated that under the terms of the franchise agreement, the franchisor provides the franchisee with technical assistance, systems information, training and advertising in return for the fee charged. The franchisor does not provide any management services to the franchisee. You would like to know whether the "franchise fee" is subject to non-resident withholding taxes.

For purposes of responding to your query, we assume that any payment made to the franchisor company is not a "management or administration fee or charge" for purposes of paragraph 212(1)(a) of the Income Tax Act (Canada) (the "Act"), and that the franchisor company is a resident of the U.S. for purposes of the Canada-U.S. Income Tax Convention¹ (the "Treaty"). Unless otherwise specified, all statutory references herein are to the Act.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, "Advance Income Tax Ruling", dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at http://www.cra-arc.gc.ca. The determination of the withholding tax applicable to payments, such as those described in this letter, involve questions of fact that can only be determined after reviewing all of the relevant documentation and agreements related to the particular payments. This review and determination is the responsibility of the local tax services office. Your specific inquiry should therefore be addressed to your tax services office, which is listed on the "Contact Us" page of the CRA website. Nevertheless, based upon the limited information provided to us, we are prepared to offer the following general comments.

Whether a payment is labelled as a "franchise fee" or a "service fee" does not, in and of itself, change the non-resident withholding tax requirement on the payment, which is determined based on an analysis of the nature of the payment.

Paragraph 212(1)(d) imposes a 25% withholding tax on the gross payment to a non-resident if the payment is "rent, royalty or similar payment, including, but not so as to restrict the generality of the forgoing, any payment", inter alia,

(i) for the use of or for the right to use in Canada any property, invention, trade-name, patent, trade-mark, design or model, plan, secret formula, process or other thing whatever;

(ii) for information concerning industrial, commercial or scientific experience where the total amount payable as consideration for that information is dependent in whole or in part on, inter alia, production or sales of goods or services;

(iii) for services of an industrial, commercial or scientific character performed by a non-resident person where the total amount payable as consideration for those services is dependent in whole or in part on, inter alia, production or sales of goods or services; and

(v) that was dependent on the use of or production from property in Canada whether or not it was an instalment on the sale prices of the property, but not including an instalment on the sale price of agricultural land.

However, where the recipient of the payment is a resident of the U.S., the Treaty may, in the circumstances described below, apply to reduce the rate of the withholding. Royalties

Article XII(4) of the Treaty defines the term "royalties" to mean "payments of any kind received as a consideration for the use of, or the right to use, ..., any patent, trade mark, design or model, plan, secret formula or process,...or for information concerning industrial, commercial or scientific experience,..." Where a payment to a resident of the U.S. meets this definition, Article XII (2) of the Treaty will reduce the rate of the withholding to 10% of the gross payment.

Business Profits

Where a payment is for services rendered by a U.S. resident, the amount paid would generally be governed by Article VII of the Treaty and would not be subject to withholding tax. Pursuant to Article VII(1) of the Treaty, the business profits of a U.S. resident are only taxable in Canada to the extent that the U.S. resident carries on business in Canada through a permanent establishment ("PE") situated in Canada. As defined in Article V of the Treaty, the term "PE" means a fixed place of business through which the business is wholly or partly carried on, and may include a place of management, a branch, an office, a factory and a workshop.

Where a payment represents in part a royalty and in part business profits for purposes of the Treaty, a taxpayer must make reasonable efforts to separate the two. Where a taxpayer fails to, or is unable to, identify the royalty component and the business profits component, the entire payment will be taxed as a royalty and be subject to withholding tax pursuant to paragraph 212(1)(d) (as reduced by the Treaty). The Canadian resident payer is responsible for withholding and remitting the applicable taxes and filing an NR4 return in respect of the taxes withheld. Failure to withhold and remit the appropriate amount of tax within the time limit specified may result in penalties and interests.

Although you did not specifically request our comments regarding the initial fixed sum paid for the purchase of the franchise, it is our view that the above analysis would also be applicable in determining whether such fixed sum would be subject to non-resident withholding tax.

We trust that these comments are of assistance.

Yours truly,

Daryl Boychuk
Manager
International Section I
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
ENDNOTES

¹ Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital Signed on September 26, 1980, as Amended by the Protocols Signed on June 14, 1983, March 28, 1984, March 17, 1995 and July 29, 1997.