20 November 1987 Income Tax Severed Letter 95-3857 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:

This is in reply to your letter of September 1, 1987.

You have asked for our opinion on whether payments by a Canadian resident to a non-resident for a computer software hotline service which provides for discounts on software updates would be subject to a 25% Part XIII tax by virtue of subparagraph 212(1)(d)(i) of the Income Tax Act. In connection with this question, you have provided sales literature from a U.S. software supplier.

We would first of all like to point out that the rate of Part XIII tax on a computer software licence fee payment made by a Canadian resident to a person considered to be a resident of the U.S. for purposes of the Canada-U.S. Income Tax Convention (1980)(the "Canada-U.S. treaty") would be reduced from 25% to 10% by virtue of Article XII of the Canada-U.S. treaty.

It is our position that the following two conditions must be met in order for payments for any services, including a hot line service, provided in connection with the use of computer software not to be considered part of the software licence fee which is subject to Part XIII tax:

1. The acquisition of the service should be optional. That is, if the failure to enter into, the cancellation of, or the failure to renew an agreement to acquire the services would cause the loss of the right to use the licensed software, we usually would consider the payments for the services to be part of the software licence fee subject to Part XIII tax.

2. The payments for the services should be reasonable in relation to the software license fee. Any unreasonable portion of the service payments would be viewed as a portion of the licence fee subject to Part XIII tax.

If the payments for services are not considered to be 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 the services are rendered in Canada by the non-resident person. Taxes withheld under Regulation 105(1) are on account of any possible tax liability under Part I of the Income Tax Act. If the non-resident payee is considered to be a resident of the U.S. for purposes of the Canada - U.S. treaty, such payee will be exempt under Article VII of the Canada - U.S. treaty, from Canadian tax on the business profits earned from the provisions of the services unless the payee carries on business in Canada through a permanent establishment in Canada and the profits are attributable to such permanent establishment. A payee who is exempt from Canadian taxation by virtue of Article VII of the Canada - U.S. treaty may obtain a refund of taxes withheld under Regulation 105(1) by filing a Canadian tax return (note that Article VII in the Canada - U.S. treaty does not prohibit the initial withholding under Regulation 105(1) but does entitle a payee who is exempt thereunder from Canadian tax to obtain a refund of amounts so withheld).

If, on the other hand, the non-resident payee who renders the services does not do so in Canada, there will not be any requirement to withhold under Regulation 105(1). Thus, for example, where the service in question is providing information or advice by way of a telephone or electronic mail hotline, and where the person so providing such information or advice is not in Canada, the service will not be considered to be rendered in Canada and no Regulation 105(1) withholding will be required.

Finally, we understand that computer software updates represent modifications, improvements and additions to the software originally licensed. Therefore, strictly speaking, we consider payments for, or payments to obtain discounts on, such updates as being essentially the same in nature as the original software licence payments which are subject to Part XIII tax, rather than so being payments for services Where a particular payment is both for the acquisition of services, such as hotline services, and for software updates (or the obtaining of discounts thereon), Part XIII tax need only be withheld on the portion of the payment pertaining to the updates assuming that a reasonable and acceptable allocation between the service and update portions of the payment can be made.

We trust that the above will be of assistance to you.