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: USco’s employees update software, etc., on a third-party server in Canada on which Canco has purchased space. Are services rendered in Canada for purposes of reg. 105 or provided in Canada for purposes of Art. V:9(b) of the Canada-U.S. Tax Treaty?
Position: Although obviously fact specific, the anticipated answer is no to both questions.
Reasons: Consistent with prior positions and with the Technical Explanation to the Fifth Protocol.
2022 CTF Annual Conference
CRA Roundtable
Question 4: Servers/Data Centres and Location of Services Rendered
With the expansion of e-commerce and more people working virtually, what is the CRA's position on the taxation of a non-resident physically located outside of Canada that provides support services related to servers and data centres physically located inside Canada?
To be more precise, assume the following scenario: a Canadian customer (Canco) has engaged Serverco, an arm’s length server provider, to host Canco’s copy of a software program and the data related to it. Canco also enters into an agreement with a company incorporated in the United States (USco) which will provide Canco with the right to use the software and to receive updates and support services (“the Canco-USco agreement”). Canco and USco are non-arm’s length parties. For regulatory purposes and/or in order to ensure that Canco’s Canadian customers’ data are protected under Canadian privacy laws, the server running the software and storing the data will be located in Canada. As part of the services provided by USco, U.S. based employees of USco will frequently access the server in order to provide application support and upgrades.
More specifically, the employees of USco will access the Canadian server periodically to provide the following services:
- Ongoing software maintenance, i.e., maintaining network communications, fixing any software issues, and supplying technical support;
- Customization of the software and upgrades, as needed; and
- Quality control and disputes, i.e., periodic quality control tests and investigating customer complaints regarding software output.
The services described above are being provided by USco to Canco. Canco uses USco’s software to provide other products and services to its Canadian customers such as selling the output of the software (i.e., data and analytics) to create reports for Canadian customers. Thus, it is not selling USco’s software to its customers.
In such a scenario, could part of the services rendered by USco be:
A) considered “services rendered in Canada” for purposes of Regulation 105 of the Income Tax Act; and
B) considered “services… provided in that other State" for purposes of Article V:9(b) of the Canada-U.S. Tax Treaty?
For each of these provisions, would USco’s remote application support and upgrade on the server located in Canada be considered services performed in Canada or does the physical presence of its employees outside of Canada prevail in making that determination?
CRA Response (A)
The Canco-USco agreement described above is somewhat different from a regular “Software as a Service” (SaaS) since it appears to be a hybrid arrangement in which a separate copy of the software is maintained on a server in Canada owned and operated by Serverco which has agreed to host software and data for Canco.
We made a number of assumptions to clarify the context of the question:
a) Employees and possibly clients of Canco can remotely access the server and use the software.
b) The software is developed by USco and the particular client (Canco in this case) may use features of the software to provide for a degree of customization like featuring client logos but fundamentally, the software is designed to be used by multiple clients of USco.
c) The server hosting the software will also store Canco’s client specific data because the geographic location of the server is important to Canco’s clients, which explains why the related group maintains two separate servers with copies of the same software on both, thus giving up some of the efficiency of SaaS but providing assurance to clients as to which regulatory or privacy laws apply to their data.
d) Canco will pay a fee to USco that is consistent with the transfer pricing standards.
e) When unbundling the payment to analyze the Canadian income tax consequences of the payment, a portion of it is for the right to use the software and another portion is for the accessory support services described above with only a nominal portion of the payment being in respect of support services possibly rendered in Canada.
f) The nature of USco’s support personnel’s work related to the Canadian server is essentially one of monitoring and communicating with the server. That work includes activities like checking to see that the proper version of the software is running, monitoring internal logs to see what errors have occurred, and delivering updated software to ensure that identified bugs or security risks are addressed.
Regulation 105 provides that every person paying to a non-resident person a fee, commission or other amount in respect of services rendered in Canada shall deduct or withhold 15 per cent of such payment. Whether Regulation 105 applies depends on whether a portion of the services are rendered in Canada. As we have noted previously in CRA document E2003-TEI-QA (question 8), the client and the service provider are required to use reasonable efforts to determine the portion of the payment which is in respect of services rendered in Canada.
The determination as to what services are rendered in Canada is a question of fact. It seems likely that all of the support services described above that are provided by USco’s employees are rendered in the United States and delivered through a communication system such as a computer (or a telephone) to Canco and its employees.
CRA Response (B)
Where a non-resident person carries on a business in Canada, an income tax shall be paid, pursuant to subsection 2(3) of the Act, on that person's taxable income earned in Canada. However, if the person is a resident of the United States, it may be exempt under Article VII of the Canada-U.S. Tax Treaty if the person does not carry on business in Canada through a permanent establishment situated in that country.
Article V:9(b) of the Canada-U.S. Tax Treaty provides that where an enterprise of the United States provides services in Canada, that enterprise is deemed to provide those services through a permanent establishment in Canada if the services are provided in Canada “for an aggregate of 183 days or more in any twelve-month period with respect to the same or connected project for customers who are either residents of [Canada] or who maintain a permanent establishment in [Canada] and the services are provided in respect of that permanent establishment”.
Since Canco is a single Canadian customer being serviced by USco as part of the same project, Article V:9(b) could apply if the other conditions of this provision were met. However, according to the Technical Explanation to the Fifth Protocol notes, the intent of the parties to the treaty appears to be that Article V:9(b) should not apply in circumstances where services are performed or provided in the United States but are furnished to customers in Canada through a telephone or computer:
“Paragraph 9 only applies to services that are performed or provided by an enterprise of a Contracting State within the other Contracting State. It is therefore not sufficient that the relevant services be merely furnished to a resident of the other Contracting State. Where, for example, an enterprise provides customer support or other services by telephone or computer to customers located in the other State, those would not be covered by paragraph 9 because they are not performed or provided by that enterprise within the other State.”
Furthermore, to the extent that any support services rendered in Canada by USco by telephone or computer are of a preparatory or auxiliary nature and that USco does not otherwise have other activities in Canada that are more than preparatory or auxiliary, USco would not have a permanent establishment in Canada pursuant to Article V:6 of the Canada-U.S. Tax Treaty.
Charles Taylor
2022-095056
November 29, 2022
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2022
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2022
Email this Content