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.
RE: Computer Software payments to non-residents
This is in reply to your Round Trip Memorandum of July 2, 1986 concerning the withholding requirements on payments to residents of the U.S. for use of computer-software and on payments under computer maintenance agreements. Your enclosures included two schedules and four contracts between XXX and XXX. You have asked, for comments on your understanding of the general tax implications with respect to payments for use of software and or the conclusions you have reached with respect to specific contracts, all as set out in the two enclosed schedules.
Our Comments
Prior to July 1, 1963 Part XIII tax was not required to be withheld from payments that were rental or royalty payments made to residents of the United States for the right to use computer software. Effective July 1, 1983 Canadian residents making rental or royalty payments under term agreements for the right to use computer software were required to withhold federal income tax a the rate of 25% which was reduced to 15% pursuant to Article XI of the 1983 Canada-U.S. Income Tax Convention. Payments made under perpetual or unlimited term agreements were exempt (pursuant to the 1942 Convention) from withholding until the introduction of the 1980 Canada-U.S. Income Tax Convention. Article XII of the 1980 Convention contains the words "The term royalties' as used in this Article means payments of any kind ..." thus all rental and royalty payments in respect of the use of commuter software made to U.S. residents since October 31, 1984 are subject to withholding of 10%.
With respect to maintenance payments, our general position is that the two following conditions must be met in order for them not to be considered part of the computer license fee subject to Part XIII tax:
1) The payment for maintenance services should be optional. That is, if the failure to enter into, the cancellation of, or the failure to renew an agreement to acquire maintenance services would cause the loss of the right to use the licensed software, we usually would consider the payment for such maintenance services to be part of the software license fee subject to Part XIII tax.
For residents of the United States these fees are covered by a specific binding agreement between Revenue Canada and the U.S. Internal Revenue Service. XXX
Positions
The following pertains to foreign drilling companies that are not residents of the United States. We will distinguish between the situation where the fees represent business income to the nonresident from the provision of drilling services and cases where the facts indicate the fees represent rental income from the lease or rental of the drilling rig to a Canadian resident.
(1) Rental Income
The fees will be subject to tax pursuant to paragraph 212(1)(d) of the Income Tax Act (the "Act") as codified by the provisions of the tax treaty (if any) in force between the company's country of residence and Canada.
(2) Business Income
(a) In cases where there is no treaty between the company's country of residence and Canada the mobilization and demobilization fees (net of any applicable expenses) will be taxable in Canada pursuant to subparagraph 115(1)(a)(ii) of the Act.
(b) In situations where a treaty is in place and the foreign drilling company has no P/E in Canada other than the drilling rig, the scope of our position will be limited to those cases where there is an attempt to avoid tax by inflating the mobilization and demobilization fees in such a manner that the daily drilling rate is reduced to less than a reasonable amount. In these cases the excess of the fees over a reasonable amount will be assessed, not as a mobilization (or demobilization) fee per se but as an amount related to drilling services performed while the drilling rig is situated in Canada. Expenses of mobilization and demobilization incurred by the drilling company will not be deductible in determining the company's income from drilling.
(c) Where a treaty is in place and the company has a P/E in Canada other than the rig, we should investigate whether the mobilization and demobilization fees (net of expenses) can be attributed to that P/E and taxed as business profits.
Current Amendments Division will be asked to inform the Department of Finance of our decision.
3. The payment for maintenance services should be reasonable in relation to the software license fee. Any unreasonable portion of the maintenance payments would be viewed as a portion of the license fee subject to Part XIII tax.
If the provision of the above noted services are not considered part of the computer software licence fee they could still be subject to a 15% withholding under subsection 105(1) of the Income Tax Regulations (the "Regulations") such services are rendered in Canada by non-resident personnel. We have taken the position, however, with respect to the provision of these services by way of a telephone or electronic mail hot line that where the person providing information or advice on such hotlines is outside Canada the services will be considered to be rendered in Canada and thus the payments will not be subject to withholding under Regulation 105.
In addition to the foregoing we understand that computer software updates include modifications, improvements and additions to the software originally licensed. Therefore, strictly speaking, we consider payments for software updates to be the same in nature as the original software license payments, that is, as falling within the meaning of "payments" in subparagraph 212(1)(d)(i) of the Income Tax Act (the "Act") (and also as falling within the meaning of "royalties" in paragraph 4 of Article XII of the 1980 Canada-U.S. treaty if such treaty is applicable), rather than as being payments for services. However, it is possible that we could in some cases treat software update payments as part of the payments for services which are not subject to Part XIII tax if the software update, payments represent a minor portion of the total maintenance services payments.
Your schedule headed "Software Payments" appears to conform to the foregoing comments.
The following is in regard to your conclusions concerning the tax implications of the enclosed contracts with the XXX the XXX and XXX. As it would be virtually possible (because of the quality, as well as somewhat redundant (because we feel this is a District office function) for this section to review all computer related contracts, our review of the contracts and your conclusions has only been cursory. We do confirm however that we are generally in agreement with your comments as set on pages 1 and 2 of your schedule entitled XXX Software Payments.
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© Her Majesty the Queen in Right of Canada, 1986
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© Sa Majesté la Reine du Chef du Canada, 1986
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