8 May 1987 Income Tax Severed Letter 97-1631 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.

RE:     Taxability of Computer Software Payments under Part XIII

This is in reply to your memorandum of March 12, 1987 and attachments concerning whether certain payments made to a non-resident are subject to Part XIII tax as royalties.

XXX

In your view all of the payments noted above except (2) are subject to Part XIII tax under paragraph 212(1)(d)(i) with no exemption available in the Canada-U.S. Income Tax Convention (1980) (the "Convention"). The exception in (2) is due to the fact that the software development work is performed in the U.S. You indicate that the applicable withholding rate except for (2) is 10% including the maintenance fee payments.

In our view, the payments in (1) are for the grant of an irrevocable worldwide exclusive licence in perpetuity to use, operate, manufacture and sell certain property and are not for the grant of a patent or any other property. We find no basis in the Agreement or the Amendment for XXX suggestion that these payments are for the outright purchase of a patent. However, assuming that there was a 'sale' of a patent, Part XIII would still apply because of certain clauses in the Agreement.

Clause 8.02 of the Agreement indicates that the intellectual property interests in respect of the prototype are vested in XXX from the date of creation. It would appear from clause 5.04 that XXX and the other original owners retain the remaining intellectual property interests in the software. Clause 8.02 goes on to provide that XXX interests are subject to a list, charge and reservation in favour of XXX until all amounts due under the Agreement are paid in full. We understand that the prototype is developed and built by XXX. Assuming the prototype can be the subject of a patent (a point not covered in the Agreement) and assuming XXX obtains from XXX an assignment of a patent or of the right to obtain a patent, in our view such an assignment is not absolute and thus is not an "outright purchase of a patent". In our view, until the lien, charge and reservation is discharged there can be no absolute assignment and thus no outright purchase of a patent. In the interim, XXX has only a right to use the patent. Any payments to a non-resident for the use of or for the right to use a patent in Canada are subject to withholding under subparagraph 212(1)(d)(i) of the Act.

XXX also claims that the payments in (1) are for an outright assignment of an assignment of an existing licence from the licensee. Again, in our view, this is not evident from the Agreement or the Amendment. The main licence appears to originate with XXX and is not stated to be an assignment of an existing licence. While XXX has agreed to procure additional licences from other owners of the software, it would appear that any licence procured will be a new licence from the original owner and not an assignment of an existing licence. Accordingly, in our view, the payments in (1) are subject to Part XIII withholding as royalties to which the reduced rate of 10% under Article XII(2) of the Convention applies.

We agree with XXX that if the software development work described in (2) is carried out by --- in the United States, payment by XXX in respect thereof are not taxable in Canada. We also agree that the payments described in (3) and (4) are royalties and thus are subject to a reduced withholding rate of 10% under Article XII(2) of the Convention.

XXX claims that the annual licence and maintenance fee described in (5) is exempt from tax because it does not fit within subparagraph 212(1)(d)(iii) of the Act. While we agree that subparagraph 212(1)(d)(iii) does not apply to this fee, it is our view that subparagraph 212(1)(d)(i) does apply because this fee is primarily for the right (a licence) to use software. Clause 6.04 of the Agreement provides that this fee includes software maintenance and enhancement. We agree with your view that the maintenance and enhancement is in the same nature as the licence and thus also falls within subparagraph 212(1)(d)(i) of the Act. Thus the fee described in (5) in our view is subject to withholding at 10% under Article XII(2) of the Convention.