31 August 1989 Ruling 58533 F - Treatment of Maintenance Fees of Computer 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.

August 31, 1989

Dear Sirs:

This is in reply to your letter of August 10, 1989 concerning the treatment of maintenance fees covered by a licensing agreement for computer software in the following hypothetical situation:

(a)       A corporation in the U.S. supplies computer software to a Canadian purchaser ("Purchaser");

(b)       The purchaser may be a taxable or nontaxable Canadian corporation as well as a non-taxable society;

(c)       The U.S. supplier does not have a permanent establishment in Canada;

(d)       The purchaser and the U.S. supplier deal at arm's length;

(e)       The purchaser will not be producing or reproducing the computer software; and

(f)      The computer software costs are covered by a licensing agreement as well as a maintenance contract.

You have requested our opinion on whether the maintenance fees, which are billed separately from the computer software licensing agreement, are subject to withholding tax under Part XIII of the Income Tax Act (the "Act") when paid to a U.S. resident.

It is our view that all payments made to non.residents of Canada under a license agreement to use computer software, whether for a specified term or under a perpetual or unlimited term, are subject to withholding tax pursuant to subparagraph 212(1)(d)(i) of the Act at the rate of 25 per cent of the gross amount of the royalties unless reduced by a tax agreement or convention.  In the case of the Canada-U.S. Income Tax Convention the rate is reduced to 10 per cent of the gross amount of the royalties in accordance with paragraph 2 of Article XII.

It is our general position that the following two conditions must be met in order for payments for maintenance service fees, 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:

1.     The acquisition of the services should be optional. That is, if he 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 licence fee subject to Part XIII tax.

2.     The payments for the services should be reasonable in relation to the software license 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 payment for services are not considered to be part of the computer software license fee, they could still be subject to a 152 withholding tax under subsection 105(1) of the Income Tax 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 Convention, such payee will be exempt under Article VII of the Convention, 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 Convention may obtain a refund of taxes withheld under Regulation 105(1) by filing a Canadian tax return (note that Article VII in the Convention 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).

We trust this is adequate for your purposes.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch