4 December 1986 Income Tax Severed Letter 7-0954 - [Know-how and similar payments to non-residents]

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.

DEC 4 1986

HAMILTON DISTRICT OFFICE Business FIles Audit

Mr. G. Barsky

HEAD OFFICE S. Parnansone (613)957-2088

XXXX

This is in response to your memorandum of August 20, 1986 and confirms our telephone conversations concerning advertising expenses of the above-noted taxpayers. As we understand them the relevant facts are as follows:

1. XXX

2. XXXX

3. XXX

XXX

OPINION

XXX

Whether or not the TV advertising is directed primarily to a market in Canada is a question of fact, and your office is in a better position to make such a determination and resolving the question of credibility present in this case.(The information on the invoices suggests a certain relationship between the Canadian Companies and the U.S. parties, whereas the companies' representative describes another type of relationship.). The following comments are intended for your guidance for the resolution of the issue whether the TV commercials are directed primarily to a Canadian market.

The intention of section 19.1 of the Act is to discourage Canadian taxpayers from placing advertising, aimed primarily at a Canadian market, on foreign radio and television stations and by implication to encourage Canadian taxpayers to place such advertising on Canadian radio and television stations. On this basis, our interpretation of section 19.1 of the Act is that any claims for radio or television advertising on U.S. radio and television stations are not deductible if the advertising is aimed primarily at Canadian residents.

Some of the factors to be taken into consideration in determining whether or not an advertisement is directed primarily to a market outside or inside Canada are:

(a) the wording of the particular message,

     (b) the normal listening or viewing audience of the
         foreign broadcasting undertaking,

     (c) the concurrent use of Canadian media to at least an
         equivalent extent to reach potential Canadian
         customers, and

     (d) the need to attract non-residents to the taxpayer's
         facility in view of its proximity to major cities
         in the U.S.

In determining whether a commercial is directed primarily to a particular geographical market (Canada or the U.S.), one must consider the target market (e.g. persons within an income or social scale) which is a subset of the potential public audience (i.e. persons who happen to tune in on the commercial) rather than who pays the cost.

As regards the case at hand, in our view, the TV commercials are directed to a market in Canada as indicated by the toll- free number provided in the dubbing and the leads generated. However, to disallow the expenses claimed by the Companies, one must also find that the TV commercials are directed primarily to a market in Canada. The major factors supporting this finding are:

     (a) The Ontario leads represent more than 50%
         of total leads: we are assuming that this 
         percentage reflects also the Companies' share of 
         the total TV advertising costs.

     (b) The existence of the toll-free Ontario listing on
         T.V. commercials.

     (c) The control over the arrangement for T.V.
         advertising exercised by the Companies as evidenced
         in the invoices, although the Companies, through
         their representative, give a different explanation:
         you would have to reconcile the discrepancy.

In your memorandum you also requested our comments as to the eligibility of Part XIII tax on the payments of XXXX lead in 3(d)(iii) above. Since the applicability of Part XIII tax will depend on the legal obligations which have not been yet defined, as indicated on XXXX our comments can only be general in nature.

The payments in question will be subject to Canadian tax if there is a tax provision in the Act that would make them taxable and if the Canada-U.S. Income Tax Convention (1980) does not exempt them from Canadian taxation. Since you have advised that the U.S. parties do not have in Canada a "permanent establishment" as defined in Article V of the Convention, if the payments are for services they would constitute business profits of the U.S. recipient and would be exempt from Canadian taxation by virtue of Article VII of the Convention.

If the payments are regarded as a "royalty" as defined in Article XII(4) of the Convention, they would not be exempt from Part XIII tax by virtue of the exception in Article XII(3) of the Convention provided that they constitute royalties in respect of motion pictures and works on film, videotape or other means of reproduction for use in connection with television. It would appear that to subject the payments to Canadian taxation one must rely upon subsection 212(5) of the Act.

As indicated in paragraph 9 of IT-303 , in general, rent or royalty is a payment to the owner of property for the right to use such property for a given period of time. We don't believe subsection 212(5) of the Act could be applied to the Companies' payments to the U.S. dealer since the medium containing the commercials (film or videotape) is owned by RT and not by the U.S. dealer. In any case, the payments for the leads and not for the right to use or reproduce in Canada the film or videotape.

We hope this will be helpful to you.

ORIGINAL SIGNED BY ORIGINAL SIGNÉ PAR D.B. Morphy

Chief Services, Public Utilities &Exempt Corporations Section Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch

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