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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
NOVEMBER 1994 CANADIAN TAX FOUNDATION CONFERENCE
COMMENTS ON WITHHOLDING TAX RULES ON IMPORTED SOFTWARE
Where payments are made by a Canadian resident to a non-resident and such payments are in respect of the use of, or the right to use, software it is Revenue Canada's view that the payments represent compensation for the right to use a secret formula or process and are considered to be royalties for the purpose of most, if not all, of Canada's income tax treaties. As a result, these payments are subject to tax under subparagraph 212(1)(d)(i) of the Act. The rate of tax that subsection 212(1) of the Act imposes on a royalty payment to a non-resident is 25%.
This rate may be reduced by an income tax treaty and is generally 10% under most income tax treaties Canada has with industrialized nations.1
Payments for the Right to use Shrink-wrap and Custom Computer Software
As a result of a recent study, Revenue Canada will now treat a transaction whereby a non-resident sells a Canadian resident "shrink-wrap computer software" as a sale of tangible goods, and therefore, Part XIII tax will not be applicable to the proceeds received by a non-resident in respect of such transaction.2 However, Revenue Canada continues to view a payment to a non-resident for the use of, or the right to use, "custom computer software" for a specified or indefinite period of time as being subject to Part XIII tax under subparagraph 212(1)(d)(i) of the Act.
The term "shrink-wrap computer software" is generally used to describe software that is pre-packaged and commercially available through mail order or at a retail store. Generally, such software is packaged along with a copy of the other related information, including the general licensing agreement, under a plastic shrink-wrapped cover. The general license agreement does not contain the name of the particular end-user of the software or the amount of the license fee. Moreover, the end-user of the software is not normally required to acknowledge in any manner that he has read or agreed to the terms of the software license.
The term "custom computer software" on the other hand, generally describes computer software the use of which is subject to a specific computer software license agreement. As a condition to the end-user acquiring the right to use the computer software, the end-user is required to enter into a computer software license agreement with respect to the use of the software. Such agreement will usually set out the amount of and the description of, the fees to be paid under the particular computer license and the agreement will usually be signed by both parties to acknowledge acceptance of its terms. While custom computer software includes computer software that has been designed for a particular end-user's needs, the Department views all software as being custom computer software where an end-user acquires the right to use any computer software program under a specific license agreement. It does not matter that copies of the particular software program may also be available to the end-user and other end-users, as shrink-wrap computer software.
Related Services
Related services such as maintenance, training and technical support may be provided either as part of the software license agreement, or under a separate agreement. To the extent that any payments for such services are reasonable and are not really for the right to use the licensed software or any additional software including; product updates, enhancements, modifications or improvements to the original software, the payments for such services are not subject to Part XIII tax. However, as will be discussed below, a withholding tax under section 105 of the Regulations to the Act may be required.
Where the payments are in respect of software additions, product updates, enhancements, improvements, or modifications to the original software, such payments are considered by Revenue Canada to be part of the original software licence fee and taxed accordingly. If the payments for the right to use software and the related services are combined, then a reasonable allocation of the payments should be made to establish the service component and the software license component.
If the payment for the related services are not taxable under Part XIII of the Act, and the services are performed in Canada by the non-resident software supplier or the non-resident's agent, a withholding tax of 15% will generally be required under section 105 of the Regulations to the Act. Where the non-resident software supplier establishes that he is resident in a country with which Canada has an income tax treaty, and for the purposes of that income tax treaty the non-resident does not have a permanent establishment in Canada; or based on estimated income and expenses the withholding otherwise required will be in excess of the ultimate Canadian tax liability, a waiver certificate may be issued authorizing the reduction of the Canadian resident payer's obligation to withhold.3
Where Part XIII tax was withheld and the non-resident taxpayer was not liable to pay any Part XIII tax, or the amount withheld was in excess of the amount the non-resident taxpayer was otherwise liable to pay, a refund request can be made pursuant to subsection 227(6) of the Act. Such a request must be made in writing within two years from the end of the calendar year in which the amount was paid.4 For example, for amounts remitted in 1994, only those requests received before 1997 will be considered for refund.
Payments for the Right to Produce or Reproduce Custom Software
Payments in respect of a copyright in respect of production or reproduction of any literary, dramatic, musical or artistic work are exempt from withholding tax by virtue of subparagraph 212(1)(d)(vi) of the Act. As a result of amendments to the Canadian Copyright Act in 1988 a computer software program is considered a literary work, and pursuant to subsection 3(1) of that Act, the owner of the copyright has the sole right to produce or reproduce that program. Therefore, as set out in the Department's response to Question 29(4) of the Revenue Canada Roundtable session of the 1993 Tax Conference, payments in respect of the production or reproduction of computer software are exempt from withholding tax.
In this regard it should be noted that the right to make back-up copies as provided by the Copyright Act is not considered a right to produce or reproduce for the purposes of subparagraph 212(1)(d)(vi) of the Act. In addition, where a Canadian resident only acquires the right to make additional copies of custom software for his own use, the Department would expect that the portion of the payment, if any, for such a right would be nominal in comparison to the portion of the payment for the right to use the program.5
Other
The Department of Finance announced as part of the 1993 budget that it is committed to exempting from Part XIII tax, all arm's length payments made for the use of software, and that such exemptions would be provided on a bilateral basis and included in Canada's income tax treaties as they are (re)negotiated. To date, only the Protocols to the respective income tax treaties between Canada and the Netherlands, and Canada and the U.S. contain such exemptions, and only the Netherlands Protocol is in force at this time.
Olli Laurikainen
December 13, 1994
file: 0-943056
1 Information Circular IC 76-12R4
2 Revenue Canada Roundtable, 1993 Conference Report in Report of Proceedings of the Forty-Forth Tax Conference (Montreal: Canadian Tax Foundation, 1993), Q29 at 58:15-16
3 Information Circular IC 75-6R.
4 Information Circular IC 77-16R4.
5 Robert D'Aurelio, "International Issues: Revenue Canada", in Report of Proceedings of the Forty-Second Tax Conference, 1990 Conference Report (Montreal: Canadian Tax Foundation, 1990), 44:3
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