19 August 1986 Income Tax Severed Letter 95-1827 F

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.

Dear Sirs:

RE: Computer software payments to U.S. residents

This is in reply to your letter of June 30, 1986 requesting information concerning Canadian withholding taxes as they apply to computer software marketed in Canada by a U.S. based software company.

Our Comments

Payments made under license to use computer software in the circumstances outlined above, whether under a perpetual or term agreement, are subject initially to Canadian Part XIII withholding tax of 25%. This 25% rate, however, is reduced (effective October 1, 1984) to 10% pursuant to Article XII of the Canada-U.S. Tax Convention (1980). We are enclosing a copy of Information Circular 76-12R3 for your purposes. Details of withholding rates are set out in Appendix A of the circular. The rates applicable to payments for the use of so care are covered by the column in Schedule A entitled "Rents, Royalties, etc".

Computer software licensing agreements usually include provision for payments in respect of maintenance or technical support services. In order that payment for these types of services not be considered part of the computer software license fee subject to Part XIII withholding tax the following two conditions must be met:

1) The payment for these 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 or technical support services would cause the loss of the right to use the licensed software, we usually would consider the payment for such services to be part of the software license fee subject to Part XIII tax.

2) The payment for maintenance or technical support services should be reasonable in relation to the software license fee. Any unreasonable portion of the 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 license fee they could still be subject to a 15% withholding under subsection 105(1) of the Income Tax Regulations if such services are rendered in Canada by non-resident personnel. Taxes withheld under Regulation 105 are on account of any possible tax liability under Part I of the Income Tax Act and may be refunded as a consequence of filing a Canadian income tax return and requesting the appropriate refund. If the non-resident payee does not have a permanent establishment in Canada to which the related business profits of the non-resident are attributable, it is not liable to Part I tax thereon.

Where, however the services are provided by way of a telephone or electronic mail hotline, and where the person providing information or advice on such hotlines is outside Canada, the services will not be considered to be rendered in Canada and thus the payments will not be subject to withholding tar under subsection 105(1) of the Income Tax Regulations.

Finally, 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 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 technical support or maintenance payment.

We trust you will find our comments helpful.