8 November 1989 Income Tax Severed Letter 5-8855 - Questionnaire on software

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.

Recently you requested our view on the questions raised, in the above-mentioned questionnaire. Attached is a copy of the questionnaire (Exhibit A) and our comments on the questions contained therein (Exhibit B).

EXHIBIT A
QUESTIONAIRE ON THE TAX TREATMENT OF SOFTWARE

• 1. Legal Classification
• 1. 1. Is protection provided under your domestic legislation for the intellectual property in software?
• 1. 2. If it is protected, is it under the copyright legisiation, patent legislation or other form of legislation?
• 1. 3. If it is protected, does it apply only to the author or does it also cover those who may adapt or transform the software:
• 1. 4 Are the following distinctions {*} of significance in your internal law? ----------------------------------------------------------------------- {*} For a description of some of the terms used see Annex I ----------------------------------------------------------------------- 1.4.1 System or operational software and application software,
• 1. 4.2. Software as an integral part of hardware or canned software,
• 1. 4.3. Bundled or unbundled software product, and
• 1. 4.4. Other distinctions?
• 1. 5. Please add any remark which may facilitate understanding the legal classification of rights related to software.
• 2. Tax Classification as the country of source
• Assume that payments for the use of software are made by a resident of your country to a resident of another country with which you do not have a tax treaty.
• 2. 1. Under your tax legislation would you classify any payment from the use of software as a capital payment?
• 2. 1.1. only if it was for the outright acquisition of all rights relating to the software
• 2. 1.2. in other circumstances and if so what?
• 2. 1.3. no.
• 2. 2. Under your tax legislation, under what circumstances would you classify a payment, other than a capital payment, as either:
• 2. 2.1. a payment for goods and services?
• 2. 2.2. a royalty payment?
• 2. 3. where payments are for a right to use and for services under a contract requiring advice and information to be provided without any separately stated consideration, would you in any circumstances, break down the total consideration into the separate elements of payment for services and royalty payment respectively?
• 2. 3.1. If no, is this because there is no power in your legislation to enable this to be done?
• 2. 3.2. If yes, on what basis is the split calculated?
• 2. 4. Does your country provide for taxation at source on the following payments
• 2. 4.1. a capital payment
• 2. 4.2. a payment for goods and services
• 2. 4.2. a royalty payment?
• 2. 5. In each case referred to in 2.4. is this because they are:
• 2. 5.1. classified as royalties
• 2. 5.2. for some other reasons.
• 2. 6. If they are classified as royalties subject to tax at source, does the definition in your tax legislation coincide with the definition in Article 12 of the Model Convention and, if not, how does it differ?
• 3. Tax classification as the country of residence
• Assume that payments for the use of software are made by a resident of another country with which you do not have a tax treaty to a resident of your country.
• 3. 1. Under your tax legislation would you classify any receipt for the use of software as a capital payment:
• 3. 1.1. only if it was for the outright disposal of all rights relating to the software
• 3. 1.2. in other circumstances and if so, what?
• 3. 1.3. no.
• 3. 2. Under your tax legislation, under what circumstances would you classify a receipt, other than a capital receipt, either as
• 3. 2.1. a receipt for goods and services
• 3. 2.2. a receipt for royalty?
• 3. 3. Where payments are for a right to use and for services under a contract requiring advice and information to be provided without any separately stated consideration, would you in any circumstances, break down the total consideration into the separate elements of receipt for services and receipt for royalty respectively?
• 3. 3.1. If no, is it because there is no power in your legislation to enable this to be done?
• 3. 3.2. If yes, on what basis is the split calculated?
• 3. 4. Are there any provisions in your tax legislation that would prevent you from giving a credit for the tax due to the country of source (or from exempting the receipt) that do not apply to income received from residents of other countries generally?
• 4. Are the distinctions referred to in 1.4 above relevant for any of the answers in paragraphs 2 and 3 above and, if so, how and in what ways?
• 5. Double Taxation Conventions
• 5. 1. Do you consider the payments and receipts referred to in 2.1 and 3.1 come under Article 12 of the Model Convention? If not, under which Article would you consider they fall?
• 5. 2 Do you consider the payments and receipts referred to in 2.2.1 2.2.2. and 3.2.1., 3.2.1., 3.2.2. come under Article 12 of the Model Convention? If not, under which Article would you consider they fall?
• 5. 3 In the cases described in 2.3. and 3.3. would you apply Article 12 to none, part only or all of the payment/receipt?
• 5. 4 Do you generally adopt Article 12 of the Model Convention in your tax treaties with other Member countries? If nor please describe the main deviations.
• 5. 5. When a right to tax royalties at source is provided, do you take the definition of "royalties" found in Article 12 as is or do you modify it (and if the latter, please specify)?
• 5. 6 If you consider Articles other than Article 12 apply to software payments, do you make any specific provision in your treaties for software?
• 5. 7. Where you have a treaty with the country of source which has exerted taxing rights having classified the income differently from your internal law, would you give double taxation relief and if so how and upon what measure of income?
• 5. 8. Do you consider that the Model Convention and its Commentary need to be revised to deal in a clearer way with software payments and, if so, what suggestions would you make?
• 5. 9. Any other comments?

EXHIBIT B
QUESTIONNAIRE ON THE TAX TREATMENT OF SOFTWARE

• 1. Legal Classification
• 1. 1. Yes.
• 1. 2. It is protected under copyright legislation.
• 1. 3. It applies to the author and those who may adapt or transform the software provided the persons who do the adaptation or transformation do so with the author's permission.
• 1. 4. No.
• 1. 4.1. See 1.4.
• 1. 4.2. See 1.4.
• 1. 4.3. See 1.4.
• 1. 4.4. See 1.4.
• 1. 5. We do not have any additional remarks to make on this subject.
• 2. Tax Classification as the country of source
• 2. 1. See 2.1.1.
• 2. 1.1. Canada would not require withholding tax on an amount paid with respect to the outright disposal of all rights relating to the software. However, because of the nature of computer software such outright purchases are unusual.
• In general it has been our experience that payments made by Canadian end-users in respect of computer software are for the right to use the computer program in perpetuity. The contract usually includes various restrictions as to what can be done with the software and accordingly complete ownership does not pass to the purchaser. Thus, any payment made in respect of the software generally represents a payment for the use of or the right to use the program. Canada requires that 25% tax be withheld from such payments at source when the payments go to a non-treaty country.
• Canada does not withhold on a payment, where the foreign owner of a computer program has granted a Canadian resident the right to produce or reproduce computer software in Canada for distribution to Canadian end-users, and the payment from the Canadian resident to the foreign resident is in respect of a copyright in respect of the right to produce or reproduce the software (See discussion under 2.6.).
• 2. 1.2. See 2.1.1.
• 2. 1.3. See 2.1.1.
• 2. 2.
• 2. 2.1. See 2.1.1.
• 2. 2.2. See 2.1.1.
2. 3. We would not break down the payment into separate elements in this situation. We would consider the full amount of the payment to be a royalty and would require that tax be withheld from the full amount. It is our general position that the following two conditions must be met in order for payments for any services provided in connection with the use of computer software not to be considered part of the software license fee which is subject to Canadian withholding tax at source:
• a) The amount being paid for services must be defined in the contract and the payment for such services must be optional. If the failure to enter into, the cancellation of, or the failure to renew an agreement to acquire the services would cause the loss of the right to use of the licensed software we usually would consider the payments for the services to be part of the software license fee subject to withholding tax.
• b) The payments for the services should be reasonable in relation to the software licence fee. Any unreasonable portion of the service payments would be viewed as a portion of the licence fee subject to withholding tax.

In addition we consider payments for, or payments to obtain discounts on, updates as being essentially the same in nature as the original software licence payments which are subject to withholding tax at source, rather than as being payments for services.

• 2. 3.1. See 2.3.
• 2. 3.2. See 2.3.
• 2. 4.
• 2. 4.1. See 2.1.1.
• 2. 4.2. Payments to non-treaty countries for services in relation to computer software if performed in Canada are considered to be business income in the recipient's hands for Canadian tax purposes and are subject to Canadian income tax.
• Canadian Income Tax Regulations require that 15% be withheld from all payments to non-residents for services performed in Canada in relation to computer software. The amount withheld only represents a payment on account and is applied against the actual Canadian taxes payable. Any portion in excess of such taxes payable is refunded.
• 2. 4.3. See 2.1.1.
• 2. 5.
• 2. 5.1. See 2.1.1.
• 2. 5.2. See 2.1.1.
• 2. 6. The definition of amounts subject to withholding at source in Canadian tax law is similar to the definition of royalties in Article 12 of the Model Convention except that royalty payments in respect of a copyright in respect of the production or reproduction of any literary, dramatic, musical or artistic work are specifically excluded from withholding at source. For purposes of this exception computer programs are copyright and are considered to be literary works.
• 3. Tax Classification as the country of residence
• 3. 1.
• 3. 1.1. receipts in respect of computer software would only be considered to be capital payments if a) the software is being sold, b) all rights relating to the software are being sold, and c) the person selling the software held it as capital property.
• 3. 1.2. See 3.1.1.
• 3. 1.3. See 3.1.1.
• 3. 2.
• 3. 2.1. Where a person receives payments for the use of computer software and receives payments for providing services with respect to that software, such payments are business income and there would be no concern about the classification of the receipt.
• 3. 2.2. See 3.2.1.
• 3. 3. See 3.2.1.
• 3. 4. No.
• 4. No
• 5. Double taxation Convention
• 5. 1. See discussion under 2.1.1. and 3.1.1.
• 5. 2. We would consider payments and receipts for royalties referred to in 2.2.2. and 3.2.2. to come under Article 12 of the Model Convention We would consider payments and receipts for services referred to in 2.2.1. and 3.2.1. to be business profits and to come under Article 7 of the Model Convention.
• 5. 3. See 5.2.
• 5. 4. Yes. However, we normally require withholding on royalty payments to non-residents whereas Article 12 of the Model Convention exempts royalty payments from withholding in the country of payment.
• 5. 5. In general terms we use the "royalties" definition in Article 12 in Canadian tax legislation.
• 5. 6. Not applicable.
• 5. 7. We would classify the relevent income according to Canadian tax law and give a tax credit up to the amount of Canadian tax that would have been payable on this income.
• 5. 8. No.
• 5. 9 No.

Subparagraph 110(1)(f)(iii) of the Act