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.
Principal Issues:
Whether payments to non-residents for systems/operating software are subject to Part XIII withholding tax.
Position TAKEN:
Depends on whether they are sold as "shrink-wrap computer software" or as "custom computer software".
Reasons FOR POSITION TAKEN:
If sold as shrink-wrap computer software they are sales of tangible property and therefore not subject to withholding tax. If they are custom computer software then the payments are in respect of the use of, or the right to use, software and these payments are subject to withholding tax pursuant to Part XIII.
950216
XXXXXXXXXX A. Seidel
Attention: XXXXXXXXXX
April 26, 1995
Dear Sirs:
This is in reply to your letter dated January 19, 1995 wherein you requested clarification as to whether payments made to non-residents for systems/operating software are subject to withholding tax under Part XIII of the Income Tax Act (the "Act").
In your letter you refer to the definition of an operating system as being "a program that controls a computer and makes it possible for users to enter and run their own programs" and that under the control of the operating system "the computer recognizes and obeys commands typed by the user".
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 (including systems/operating software) it is Revenue Canada's view that these 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 that Canada has with industrialized nations.
As a result of a recent study, it is the Department's position that any transaction whereby a non-resident sells a Canadian resident "shrink-wrap computer software" is a sale of tangible goods such that Part XIII tax will not be applicable to the proceeds received by the non-resident. The Department 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 under a plastic shrink-wrapped cover and includes a general licensing agreement. 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 software 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.
Whether or not systems/operating software is shrink-wrap computer software or custom computer software is a question of fact which can only be determined by reviewing the licensing agreement associated with the right to use a particular program. In the situation where the systems/operating software is sold in a manner that is similar to the sale of shrink-wrap computer software and is sold subject to a general licensing agreement which does not identify the particular end-user or the amount of the license fee, it is our view that such systems/operating software would not be subject to tax under Part XIII of the Act as it would be considered to be a sale of tangible property.
These comments are provided in accordance with the guidelines set out in paragraph 21 of Information Circular 70-6R2.
Yours truly,
for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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