9 October 1992 Income Tax Severed Letter 9230057 - Royalty to Non-resident to Distribute Films

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.

RULINGS TAX SEMINAR

CENTRAL REGION

OCTOBER 14 & 15, 1992

ROYALTIES EXEMPTION - MEANING OF IN RESPECT OF PRODUCTION OR REPRODUCTION

Subparagraph 212(1)(d)(vi) exempts certain copyright related payments in respect of the production or reproduction of any literary, dramatic, musical or artistic work.

Recently we became aware of a copyright arrangement whereby the payments made by the Canadian distributor were based upon sales of copyrighted video taped presentations. The right to reproduce and sell further copies was not sold. Production/reproduction of the tapes to be delivered to the customers was done by the U.S. copyright holder.

We concluded the payments were not exempt under 212(1)(d)(vi) as they were based on sales and as such could not be construed as payments in respect of production/reproduction.

The distributor's accountants suggested the 212(1)(d)(vi) exemption could be acquired by documenting a license agreement giving the Canadian distributor the right to reproduce, paying a royalty based on the sales of the reproduced videos and paying the U.S. distributor a fee for making the reproductions. They

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concluded the royalty payments would be exempt under subparagraph 212(1)(d)(vi).

Ignoring potential GAAR considerations, would we accept such an argument? Is it necessary that the royalty schedule be tied directly to production/reproduction activities or is it an adequate linkage to assume that a royalty schedule based on sales will result in royalty amounts that vary directly with production/reproduction levels?

Response

It should be noted that in our view, subsection 212(5) of the Act is the relevant provision to deal with payments for copyrighted video tapes and 212(5) generally overrides the subparagraph 212(1)(d)(vi) exemption whenever both provisions apply. However, the "royalties" article in a particular income tax convention may provide a possible exemption for consideration paid for the right to produce or reproduce copyrighted video tapes. For example, as indicated in the Technical Explanation notes of the Canada- U.S. Income Tax Convention concerning paragraph 3 of Article XII of that Convention, there is an exemption for copyright royalties in respect of the production or reproduction of any literary, dramatic, musical, or artistic work, including royalties from such works on video tape or other means of reproduction for private (home) use.

In most of these type of cases, it has become quite apparent
that before a position can be taken, it will be necessary to
examine the facts and the actual agreements to determine:
- what amounts are paid for the right to produce or
reproduce the video tapes;
- what is the basis for calculating the payments:
the number of video tapes sold, the number of
times a video tape is rented, used, shown
in public, etc.;
- what amounts are paid for the right to
distribute, sell or rent such tapes; and
- whether any of the amounts are subject to, or
exempt from, tax in Canada.
We are presently reviewing situations such as described
above and would be interested in examining some actual
agreements.

We would definitely recommend that the Department challenge any arrangement where a Canadian distributor supposedly enters into an agreement with a non-resident person to acquire the right to produce or reproduce video tapes and then turns around and enters into another contract with the same non-resident, or a person related or connected to that non-resident, to have the video tapes reproduced by such a person. Despite what the agreements stated, our concern would be whether the Canadian distributor

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has, in fact, acquired the right to produce or reproduce the video tapes and whether or not it is actually paying for such right.

Prepared by: G. Middleton
Date: October 9, 1992
Control #923005

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