5 February 1990 Internal T.I. 5-8897 F - Hardware and Software Developers Entitlement to Small Business Deduction

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.

February 5, 1990

Dear Sirs:

Re: Hardware and Software Developers Entitlement to the Small Business Deduction Pursuant to Subsection 125(1) of the Income Tax Act (the "Act")

We are writing in reply to your letter of October 12, 1989 wherein you requested a technical interpretation as to whether royalty income can be considered to be active business income of a hardware and software developer for the purpose of the small business deduction.

You have described a particular fact situation and we must advise that this should be discussed with your District Taxation Office. Although we cannot address your particular fact situation, we are prepared to provide the following general comments.

In considering whether royalties received by a corporation in any business can be considered to be income from an active business for the purpose of subsection 125(1) of the Act as opposed to income from property and therefore constituted income from a specified investment business within the meaning of a paragraph 125(7)(e) of the Act, we believe that as a general rule royalty income is income from a source that is property. Furthermore, where royalty income is derived by a corporation through the carrying on of a business "the principal purpose of which is to derive income from property", that business will be a specified investment business unless one of the conditions described in subparagraph 125(7)(e)(i) or (ii) is satisfied.

The phrase "principal purpose" is not defined in the Act and therefore must be given its usual meaning with the result that this determination can only be made on the basis of all the relevant facts of a particular situation. As noted in paragraph 11 of Interpretation Bulletin IT-73R4 the word "principal" is considered synonymous with the words "chief" and "main". In our opinion, since it is a "purpose" test which is involved in this provision all the relevant factors concerning the earning process of a particular situation would have to be considered to determine whether or not the income derived constitutes income from property, i.e., the source of the revenue would not necessarily be the only relevant factor in determining whether or not the revenue would constitute income from property. However, where it can be established that the royalty income is incidental to an active business carried on by the recipient corporation or the corporation is in the business of developing the property from which the royalties are received, such income would not normally be considered as income from property.

These comments represent our opinion of the law as it applies generally. As indicated in paragraph 24 of Information Circular 70-6R dated December 18, 1978 this opinion is not a ruling and accordingly is not binding on Revenue Canada, Taxation.

We trust that these comments will be of assistance.

Yours truly,

R.E. Thompsonfor DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch