10 January 1990 Internal T.I. 58627 F - Computer Software - IC 77-16R2

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.

January 10, 1990

Dear Sirs:

This is in reply to your letter of August 30, 1989 concerning Information Circular 77-16R3 ("IC 77-16R3") and its earlier version IC 77-16R2.

Your letter indicates that the previous wording in paragraph 38 of 16 77-16R2 issued on November 26, 1984 has caused considerable amount of confusion as a result of the change in wording in.paragraph 38 of 16 77- 16R3 dealing with the treatment of withholding tax with respect to the use of computer software. You concluded that the wording in paragraph 38 of IC 77-16R2 clearly indicates that royalty payments for the use of computer software under perpetual or unlimited agreements are exempt from withholding tax.  Since the Canada-U.S. Income Tax Convention (1980) (the "current Convention") entered into force on August 16, 1984 you were of the view that the statement concerning such royalties pertained to the current Convention since IC 77-16R2 was issued more than three months after the entry into force of the current Convention. Based on this assumption and the change in wording in IC 77-16R3 to tax all-rental and royalty payments made to U.S. residents in respect of the: use of computer software you concluded that the change in wording would not have arisen from the current Convention.

Paragraph 38 of  IC 77-16R2 reads as follows:

     Effective July 1, 1983 rental or royalty payments to U.S. residents under term agreements for the use of or the right to use computer software will be subject to Part XIII tax.  Such amounts are not considered to be exempted by virtue of the Canada-U.S. Tax Convention.  Payments under perpetual or unlimited term agreements are not affected by this interpretation.

This paragraph is simply reiterating a change in Departmental practice announced by press release on January 26, 1983 to be effective July 1, 1983.  As the Current Convention was not in force on July 1, 1983, it is our view that this paragraph can only apply with respect to the Canada-U.S. Income Tax Convention (1942) (the "1942 Convention").

It has been our opinion since the Saint John Shipbuilding case (80 DTC 6272) that payments made to U.S. residents for the use of computer software under perpetual or unlimited agreements would not constitute rental or royalties for the purpose of the 1942 Convention and therefore such payments would not be subject to withholding tax.  The definition of "royalties" in the Current Convention is significantly broader than the same definition in the 1942 Convention, in that it means payments of any kind received as consideration for the use of, or the right use certain properties, in this case computer software.  In our view based on the examination of licence agreements between end-users and the owners of computer software, ends-users do not make an outright purchase of the computer software and as a result of various restrictions in the license agreements, they only acquire a right to use the computer" software.  During 1981 and subsequent years, we determined and advised many taxpayers that the wording in the current Convention (when ratified) would have application to all payments for use of computer software in view-of the new definition of royalties and we were not aware of any confusion caused by the issuance of IC 77-16R3.

In summary, our change in IC 77-16R3 with respect to the treatment of computer software payments made under perpetual or unlimited agreements to residents of the United States arose because of the change in the definition of royalties in the current Convention.  Accordingly, the wording in paragraph 38 of  IC 77-16R3 provides for the taxation of all payments made to U.S. residents for the use of computer software.

We trust these comments will be of assistance to you.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings Directorate Legislative and Intergovernmental Affairs Branch