23 September 1986 Income Tax Severed Letter 95-1862 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

This is in reply to your letter of July 10, 1986 requesting details with respect to Canadian withholding taxes on payments made to U.S. residents under computer software licensing agreements. You enclosed a copy of your software licence agreement, two schedules relating to software licence agreements and a software maintenance agreement for our perusal. You ask whether your Canadian customers are exempt from withholding and, if not, what rate of withholding applies under the 1980 Canada-U.S. Income Tax Convention (the "ereaty").

Our Comments

Payments made to non-residents of Canada under licence agreements to use computer software, such as those included with your letter, whether for a specified term or on a perpetual basis, are subject initially to the Canadian Income Tax Act, Part XIII, withholding tax of 25%. This 25% rate, however, is reduced (effective October 1, 1984) to 10% pursuant to Article XII of the Treaty. 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 software are covered by the column in Schedule A entitled "Rents, Royalties, etc."

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 software licence fee subject to Part XIII withholding tax.

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 licence fee subject to Part XIII tax.

2) The payment for maintenance or technical support services should be reasonable in relation to the software licence fee. Any unreasonable portion of the payments would be viewed as a portion of the licence 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 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. If the non-resident payee does not have a permanent establishment in Canada to which the related business profits of the non-residnet are attributable, it is not liable to Part I tax thereon and the amount withheld on its behalf may be refunded as a consequence of the payee filing a Canadian income tax return and requesting the appropriate refund.

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 tax 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.