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.
This is in reply to your letter of November 1, 1989 in which you asked for our views on whether withholding under subsection 105(1) of the Regulations would be required in seven different situations regarding contracts with a United States ("U.S.") corporation for the maintenance of computer software programs and hardware.
Before we provide our views on these situations, we would like to offer the following general comments:
The rate of Part XIII tax on a computer software licence fee payment made by a Canadian resident to a person considered to be a resident of the UPS, for purposes of the Canada-U.S. Income Tax Convention (1980) (the "Canada-U.S. treaty") would be reduced from 255 to 105 by virtue of Article XII of the Canada-U.S, treaty.
It is our position that the following two conditions must be met in order for payments for any services, including a hotline service, provided in connection with the use of computer software not to be considered part of the software licence fee which is subject to Part XIII tax:
- (i) The acquisition of the services should be optional. That is, 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 the licensed software, we usually would consider the payments for the services to be part of the software licence fee subject to Part XIII tax.
- (ii) 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 Part XIII tax.
If the payments for services are not considered to be part of the computer software license fee, they could still be subject to a 155 withholding tax under subsection 105(1) of the Regulations if the services are rendered in Canada by the non-resident person. Taxes withheld under Regulation 105(1) are on account of any possible tax liability under Part I of the Income Tax Act. If the non-resident payee is considered to be a resident of the U.S. for purposes of the Canada- U.S. treaty, such payee will be exempt under Article VIl of the Canada- U.S. treaty, from Canadian tax on the business profits earned from the provisions of the services unless the payee carries on business in Canada through a permanent establishment in Canada and the profits are attributable to such permanent establishment. A payee who is exempt from Canadian taxation by virtue of Article VII of the Canada-U.S, treaty may obtain a refund of taxes withheld under Regulation 105(1) by filing a Canadian tax return (note that Article VlI of the Canada-U.S treaty does not prohibit the initial withholding under Regulation 105(1) but does entitle a payee who is exempt thereunder from Canadian tax to obtain a refund of amounts so withheld).
If, on the other hand, the non-resident payee who renders the services does not do so in Canada, there will not be any requirement to withhold under Regulation 105(1). Thus, for example, where the service in question is providing information or advice by way of a telephone or electronic mail hotline, and where the person so providing such information or advice is not in Canada, the service will not be considered to be rendered in Canada and no Regulation 105(1) withholding will be required.
Finally, we understand that computer software updates represent modifications, improvements and additions to the software originally licensed. Therefore, strictly speaking, we consider payments for, or payments to obtain discounts on, such updates as being essentially the same in nature as the original software license payments which are subject to Part XIII tax, rather than so being payments for services. Where a particular payment is both for the acquisition of services, such as hotline services, and for software updates (or the obtaining of discounts thereon), Part XIII tax need only be withheld on the portion of the payment pertaining to the updates assuming that a reasonable and acceptable allocation between the service and update portions of the payment can be made.
With respect to your specific situations, we have summarized our understanding of each situation and added our comments thereunder.
Situation 1
The service contracted for is completed by you sending the program to the U.S. Corporation in the US for the maintenance.
Our Comments
If the terms of the contract and the actual facts indicate that the payment for such service is not considered to be part of the computer software license fee, withholding under Regulation 105(1) would not be required since that service is not considered to constitute the rendering of services in Canada.
Situation 2
The services contracted for are completed when the U.S. Corporation sends you various discs, manuals or instructions which tell you how to do the maintenance.
Our Comments
Same as situation 1.
Situation 3
The U.S. Corporation with which you have the maintenance contract sends you the maintenance instructions by phone line originating in the U.S. On the basis of these instructions, you do the maintenance yourself.
Our Comments
Same as situation 1.
Situation 4
The maintenance service is completed in Canada by an agent of the U.S. Corporation and the agent is a U.S. resident.
Our Comments
In our opinion, the U.S. Corporation is rendering services in Canada through its agent in this situation. Accordingly, withholding under subsection 105(1) of the Regulations would be required.
Situation 5
The maintenance service is completed in Canada by an agent of the U.S. Corporation. The agent is a Canadian resident.
Our Comments
As with situation 4, we are of the view that the U.S. Corporation is rendering services in Canada through its agent. Accordingly, withholding under subsection 105(1) of the Regulations would be required.
Situation 6
The method of fulfilling the maintenance contract is not known at the time the contract with the U.S. Corporation is signed and paid for.
Our Comments
If it is not known whether or not the non-resident will be rendering services in Canada at the time of payment under the contract, we suggest that you withhold from the entire amount of the payment under subsection 105(1) of the Regulations.
Situation 7
A combination of the services described in situation 1 to 5 are used by the U.S. Corporation to fulfil the maintenance contract.
Our Comments
You should withhold tax under Regulation 105(1) on any portion of a payment that relates to services performed in Canada by the U.S Corporation and you should withhold Part XIII tax on any portion of a payment that is considered to be part of the computer license fee with the U.S. Corporation.
Miscellaneous
Notwithstanding our comments about tax required to be withheld under subsection 105(1) of the Regulation, the Department may consider waiving the withholding requirement if certain conditions are met. We have attached a copy of Information Circular 75-6R which outlines the conditions under which such a waiver would be considered (see paragraphs 10 to 16). If the U.S. Corporation wishes to request a waiver of withholding in any of the situations you have outlined, it should do so at the London District Taxation Office. We trust this will be of assistance to you.
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