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) Whether royalties paid to a non-resident person for the right to use copyrights and trademarks are subject to withholding tax under paragraph 212(1)(d). (2) Whether the portion of a royalty payment, made in respect of a mixed contract, that is attributable to a copyright or a trademark can be exempted from withholding tax under any of subparagraphs 212(1)(d)(vi) to (xii). (3) Whether a person is considered to have carried on a business in a country other than Canada for the purpose of subparagraph 212(1)(d)(x). (4) What determines the application of the exception in subsection 212(1)(d)(vi).
Position: (1) Yes, unless one of the exceptions applies. (2) Yes, if the conditions of application of subparagraph 212(1)(d)(vi) and (x) are otherwise satisfied in respect of the portions of the payments attributable to the copyright or trademark, respectively. (3) It depends on all of the facts and circumstances in a given situation. (4) General comments provided.
Reasons: (1) Unless one of the exceptions described in subparagraphs 212(1)(d)(vi) through (xii) applies, a payment to a non-resident person which is in the nature of a “rent, royalty or similar payment” is generally subject to withholding tax, under the preamble of paragraph 212(1)(d). (2) A payment under a mixed contract should generally be apportioned between the various items provided under the contract for the purpose of paragraph 212(1)(d). (3) General comments provided. See below. (4) Where a contract provides for a payment subject to tax under paragraph 212(1)(d) and for a payment that is not otherwise subject to tax under the Act, the CRA can change an apportionment that is not reflective of the actual types of royalty payments which are described in paragraph 212(1)(d).
February 18, 2022
Mr. Paul Oatway Income Tax Rulings Directorate
Senior Technical Specialist International Division
Small Business Audit and Non-Resident Division Jean-Bernard Dion
Compliance Program Branch
2020-083635
Section 212(1)(d), Copyrights, Trademarks and XXXXXXXXXX
This is in response to your request for a technical interpretation dated November 19, 2019, wherein you requested our views on the application of paragraph 212(1)(d) of the Income Tax Act, R.S.C. 1985 (5th Supp.), c.1, as amended (the “Act”), in respect of royalty payments attributable to the use of copyrighted and trademarked XXXXXXXXXX. This letter should not be construed as implying that we have considered or that we are giving an opinion on whether the provisions of an income tax treaty applies to any amount, or person, in respect of any transaction.
Unless otherwise stated, all references to a statute are to the Act, and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated. The singular should be read as plural and vice versa, where the circumstances so require.
FACTS
a) XXXXXXXXXX (“Canco”) is a corporation resident in Canada for purposes of the Act;
b) XXXXXXXXXX (“ForeignCo”) is a corporation resident in XXXXXXXXXX for purposes of the Act;
c) Pursuant to a license agreement between Canco and ForeignCo (the “License Agreement”), ForeignCo licenses to Canco, in exchange for royalty payments (the “Royalties”), the non-exclusive rights to use certain XXXXXXXXXX in connection with the design, creation, manufacturing and sale of Canco products in countries of XXXXXXXXXX region;
d) The License Agreement provides that XXXXXXXXXX% of the Royalties paid by Canco is attributable to the use of copyrights and XXXXXXXXXX% is attributable to the use of trademarks;
e) The Royalties paid by Canco are deductible in computing its income, under Part I, from a business carried on by it;
f) Canco does not have a permanent establishment outside of Canada; and,
g) Canco and ForeignCo deal at arm’s length within the meaning of section 251.
QUESTIONS
You have asked us to comment on the following questions:
1) Whether the Royalties are subject to withholding tax under paragraph 212(1)(d) and, more specifically, whether paragraph 212(1)(d) requires that the trademarks be used in Canada in order for the provision to apply;
2) Whether a portion of the Royalties is excluded from withholding tax under any of subparagraphs 212(1)(d)(vi) to (xii) where the conditions for the application of any of these subparagraphs are satisfied in respect of such portion of the Royalties only and not in respect of the remaining portion of the Royalties;
3) Whether Canco can be considered to have carried on a business in a country other than Canada for the purpose of subparagraph 212(1)(d)(x); and,
4) Whether the application of the exception in subparagraph 212(1)(d)(vi) is based on the determination made under the License Agreement (i.e., XXXXXXXXXX% copyrights and XXXXXXXXXX% trademarks).
Question 1: Whether the Royalties are subject to withholding tax under paragraph 212(1)(d) and, more specifically, whether paragraph 212(1)(d) requires that the trademarks be used in Canada in order for the provision to apply.
In general, paragraph 212(1)(d) provides that any amount paid as rent, royalty or similar payments to a non-resident person should be subject to a withholding tax. Subparagraphs 212(1)(d)(i) through (v) include, but not so as to restrict the generality of the preamble of paragraph 212(1)(d), specific types of payments that are subject to withholding tax, while subparagraphs 212(1)(d)(vi) through (xii) exclude specific types of payments.
In particular, subparagraph 212(1)(d)(i) provides that a payment for the use of or for the right to use, in Canada, namely a trademark should be subject to withholding tax. However, as mentioned above, if the payment already constitutes a rent, royalty or similar payment, the amount need not fall within the wording of subparagraph 212(1)(d)(i) in order to be subject to withholding tax. In other words, if a payment for the use of or for the right to use a trademark constitutes a rent, royalty or similar payment for the purpose of the preamble of paragraph 212(1)(d), it is not relevant to consider the extent to which the trademark is used in or outside of Canada for the purpose of subparagraph 212(1)(d)(i).
The legal relationships between the payer and the payee will generally determine whether a payment constitutes a rent, royalty or similar payment for the purpose of the preamble of paragraph 212(1)(d). That being said, in the present case, it is not disputed that the Royalties constitute a royalty, within the meaning of that term in the preamble of paragraph 212(1)(d).
It is, thus, not necessary to consider the extent to which the trademarks granted to Canco under the License Agreement are used in or outside of Canada for the purpose of paragraph 212(1)(d). Without taking into account the potential application of an income tax treaty, the Royalties should therefore be subject to withholding tax by virtue of the preamble of paragraph 212(1)(d), unless one of the exclusions described in subparagraphs 212(1)(d)(vi) or (x) applies (subparagraph 212(1)(d)(x) is discussed in question 3 below).
Question 2: Whether a portion of the Royalties is excluded from withholding tax under any of subparagraphs 212(1)(d)(vi) to (xii), where the conditions for the application of any of these subparagraphs are satisfied in respect of such portion of the Royalties only and not in respect of the remaining portion of the Royalties.
For the purpose of paragraph 212(1)(d), we are of the view that where a single price is agreed upon, for items described in both the preamble of subsection 212(1) and subparagraphs 212(1)(d)(i) to (v) on the one hand, and in subparagraphs 212(1)(d)(vi) to (xii) on the other hand, the paragraph requires that such price be apportioned to determine the payments to which those subparagraphs apply. More information on mixed contracts can be found in the Transfer Pricing Memorandum TPM-06 “Bundled Transactions”, May 16, 2005.
With respect to a payment, more specifically, of royalties under a mixed contract comprised of copyrights and trademarks XXXXXXXXXX, the payment should be apportioned between the copyrights and the trademarks for the purpose of determining whether there is a payment to which the exemptions provided in subparagraphs 212(1)(d)(vi) or (x) apply.
Therefore, in the present case, the payment of a portion of the Royalties that would be attributable to copyrights or trademarks, if any, would be exempted from withholding tax under paragraph 212(1)(d), by virtue of subparagraphs 212(1)(d)(vi) or (x), to the extent that the conditions for their application are otherwise satisfied in respect of the payment of that portion of the Royalties that would be attributable to such copyrights or trademarks.
For example, in this case, a payment by Canco on or in respect of a copyright could be exempted from withholding tax under subparagraph 212(1)(d)(vi), to the extent that it is in respect of XXXXXXXXXX.
Question 3: Whether Canco can be considered to have carried on a business in a country other than Canada for the purpose of subparagraph 212(1)(d)(x).
Subparagraph 212(1)(d)(x) provides that a payment by a Canadian-resident taxpayer to a non-resident person with whom the taxpayer is dealing at arm’s length, as rent, royalty or similar payment, including the payments described in subparagraphs 212(1)(d)(i) to (v), is not subject to withholding tax under paragraph 212(1)(d) to the extent that the amount is deductible in computing the income of the Canadian-resident taxpayer, under Part I, from a business carried on in a country other than Canada.
Whether a particular business is carried on in a particular country other than Canada, for the purpose of subparagraph 212(1)(d)(x), can only be determined after a complete review of the relevant facts and circumstances.
In general, the determination of whether a person resident in Canada is carrying on a business in a country other than Canada requires that three questions be considered:
1. Whether there is a "business", as defined in subsection 248(1);
2. Whether the business is “carried on”, which generally requires an element of continuity and regularity; and,
3. Whether the business is being carried on “in a country other than Canada”.
It may be possible for a taxpayer to carry on more than one business. Whether the carrying on of two or more simultaneous business operations by a taxpayer is the same business is dependent upon the degree of interconnection, interlacing or interdependence and the extent of the unity embracing the business operations. More information on this can be found in the archived Interpretation Bulletin IT-206R “Separate Businesses”, October 29, 1979.
For the purpose of determining the specific country in which a particular business is carried on, different factors should be taken into consideration, including where the operations in substance or profit generating activities take place. More information on this can be found in paragraphs 1.53 and 1.54 of the Income Tax Folio S5-F2-C1 “Foreign Tax Credit”, February 6, 2014.
Where a taxpayer carries on a single business partly in Canada, and partly in one or more countries other than Canada, paragraph 4(1)(b) generally requires that the taxpayer’s income or loss from the business that is carried on in a particular country be computed in accordance with the Act as if the taxpayer had no other income or loss, except from the part of the business that was carried on in that particular country. Further, paragraph 4(1)(b) generally provides that the income or loss must be computed as if the taxpayer was allowed no deductions in computing it’s income, except such deductions as may reasonably be regarded as wholly applicable to the part of the business that was carried on in that particular country and except such part of any other deductions as may reasonably be regarded as applicable thereto.
As a result, for the purpose of subparagraph 212(1)(d)(x), where a royalty payment is deductible in computing the income of a taxpayer, under Part I, from a business carried on partly in Canada and partly in countries other than Canada, paragraph 4(1)(b) requires that the payment be allocated between the part of the business that is carried on in Canada, and the parts of the business that are carried on in each of the countries other than Canada. Only the portion of the royalty payment that is allocated to the parts of the business that are carried on in countries other than Canada would qualify for the exclusion provided under subparagraph 212(1)(d)(x).
The Act itself does not provide a detailed method of expense allocation to the different parts of a business that is carried on in two or more countries. In general terms, where a royalty payment is deductible in computing the income of a taxpayer, under Part I, from a business carried on partly in Canada and partly in countries other than Canada, for the purpose of paragraph 4(1)(b), the allocation of the payment must be made for each particular country. Ordinarily, such an allocation can be made on the basis of the factual relationship between the deductible royalty payment and the gross income arising from each of the parts of the business that is carried on in a particular country.
In the present case, given that Canco and ForeignCo are dealing at arm’s length, and that the Royalties are deductible in computing the income of Canco, under Part I, from a business carried on by it, a portion of the Royalties could be exempted from withholding tax under paragraph 212(1)(d), by virtue of subparagraph 212(1)(d)(x), to the extent that it is a payment that is deductible in computing the income of Canco under Part I from a business carried on by Canco in a country other than Canada.
Question 4: Whether the application of the exception in subparagraph 212(1)(d)(vi) is based on the determination made under the License Agreement (i.e., XXXXXXXXXX% copyrights and XXXXXXXXXX % trademarks).
In general, where a contract provides for a payment subject to tax under paragraph 212(1)(d) and for a payment that is not otherwise subject to part XIII tax under the Act, the onus is on the CRA to determine which portion of the payment is subject to tax. This is consistent with the decisions rendered in The Queen v. Farmparts Distributing Ltd., 80 D.T.C. 6157 (FCA), Quality Chekd Dairy Products Association (Co-operative) v. MNR, 67 D.T.C. 5303 (Ex. Ct.), Brad-Lea Meadows Ltd. v. MNR, 90 D.T.C. 1269 (TCC) and Hasbro Canada Inc. v. The Queen, 98 D.T.C. 2129 (FCC).
Where arm’s length parties to a transaction agree, under the terms of a mixed contract, to an apportionment of a royalty payment between copyrights and trademarks that is reasonable and realistic in the sense that it is reflective of the actual consideration paid for a copyright described under subparagraph 212(1)(d)(vi), this apportionment will generally be accepted by the CRA.
In the context of the present situation, should the apportionment of the Royalties between copyrights and trademarks in the License Agreement not be reflective of the actual consideration paid for a copyright described in the exemption provided under subparagraph 212(1)(d)(vi), the role of the CRA is to administer that provision and to assess the parties based on their statutory obligation.
Whether a particular apportionment of the consideration paid is reflective of the actual payments described in the exemption under subparagraph 212(1)(d)(vi) depends namely on the legal nature of what is being provided under the mixed contract, the legal relationships between the parties and the facts of the particular situation including the commercial reality of the parties and the consideration paid in these circumstances. In determining if the apportionment provided under the License Agreement is prima facie reflective of the obligation of the parties under subsection 212(1), consideration could be given, namely, to whether the parties had divergent interests in respect of the apportionment. Having one of the parties mainly indifferent to the apportionment might be an indication that the allocation in the contract might not be reflective of the obligations dictated by subsection 212(1).
Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.
We hope that the above comments are helpful to you.
Yves Grondin
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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