28 May 1986 Income Tax Severed Letter 5-1290

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Dear Sirs:

This is in reply to your letter of March 19, and further to the writer's telephone conversation with XXX on May 20, concerning payments made to a U.S. resident for the use of computer software.

With respect to such payments made after June 1983 and before October 1984, other than a lump sum payment for perpetual use, we agree with your understanding that a 15% Part XIII tax is payable thereon and that this 15% should be withheld by the payer. We also agree that all such payments made after September 1984 are subject to a 10% Part XIII tax.

Annual Maintenance or Updating

With respect to payments for annual maintenance or updating of the computer software, it is your understanding that the 10% withholding is required only on such payments made after January 1, 986 (or first taxable year after January 1, 1986).

We do not agree with your understanding. Where such payments are considered to be subject to Part XIII tax, the comments in paragraph 2 above with respect to payments for the use of computer software will apply. If such payments, or a portion thereof, are found not to be subject to Part XIII tax on the basis that they represent payments for services, a withholding pursuant to subsection 105(1) of the Income Tax Regulations is applicable if the related services are performed in Canada. Normally, the rate of withholding under subsection 105(1) is 15%. However, with respect to payments made to an individual during the individual's taxation year beginning on or after January 1, 1985, the subsection 105(1) rates is reduced to 10% on the first $5,000 per annum pursuant to Article XVII and part 2(b) of Article XXX of the Canada-U.S. Income Tax Convention (1980).

Normally, it requires a review of the particular contract to determine the extent to which a payment for the maintenance or updating of computer software is subject to Part XIII tax. Our general views in this regard are as follows:

A. Maintenance

• Provided the amount of the payment is reasonable in the circumstances, a payment for the maintenance of computer software will be exempt from Part XIII tax if the maintenance is optional. This is, if the failure to enter into, the cancellation of, or the failure to renew an agreement to acquire the maintenance services would cause the loss of the right to use the licensed software, we normally consider the payment for such services to be part of the software license fee and, thus, subject to Part XIII tax.
• If the maintenance is optional but the amount of the charge therefor is unreasonable in relation to the software license fee, the unreasonable portion will be considered part of the license fee and, thus, subject to Part XIII tax.

B. Updates

• We understand that computer software updates include modifications, improvements and additions to the software originally licensed. Therefore, strictly speaking, we consider payments for software updates to be the same in nature as the original software licence payments; that is, as falling within the provisions of subparagraph 212(1)(d)(i) of the Income Tax Act (the "Act") and the meaning of "royalties" in paragraph 4 of Article XII of the Canada-U.S. Income Tax Convention (1980) (if such Convention is applicable) rather than as being payments for services. Howevever, it is possible that in some cases software update payments could be treated as part of the payments for services, which are not subject to Part XIII tax, if the software update payments represent a minor portion of the total maintenance payments.

With regard to the provision of services by way of a telephone or electronic mail hotline, it is our view that where the person providing information or advice on such hotlines is outside Canada, the services will not be considered to be rendered in Canada and thus the payments will not be subject to withholding tax under subsection 105(1) of the Income Tax Regulations.

With regard to the additional questions raised by XXX during his telephone conversation with the writer on May 20, our comments are as follows:

When Canadian Part XIII tax is payable by the U.S. resident, we presume that a foreign tax credit would be available to the non-resident when filing his U.S. return. The fact that the U.S. resident might be in a loss position, such that the U.S. foreign tax credit provisions would be of no benefit, is irrelevant in determining his Canadian tax liability. If for some reason the U.S. resident considers that the Part XIII tax was incorrectly withheld, subsection 227(6) of the Act provides that he may file a request for a refund within two years from the end of the calendar year in which the relevant payment was made to him. A form NR7-R should be used for this purpose. Such forms are obtainable from, and when completed should be forwarded to, the Ottawa District Taxation Office, 360 Lisgar Street, Ottawa, Canada K1A 0L9.

With respect to amounts withheld under subsection 105(1) of the Income Tax Regulations on account of a potential Part I tax liability, such amounts will be refunded if, on filing the Canadian income tax return for the relevant year, the non-resident is found to have no Canadian Part I tax liability. For example, if the U.S. resident was an individual who had no fixed base regularly available to him in Canada, he would have no Canadian Part 1 tax liability by virtue of Article XIV of the Canadian-U.S. Income Tax Convention (1980). If the U.S. resident was a corporation which had no permanent establishment in Canada, it would have no Canadian Part 1 tax liability by virtue of Article VII of that Convention.

We trust that the above comments will be of assistance.