7 September 1988 Income Tax Severed Letter 97-3015 F - XXX

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.

This is in reply to your round-trip memorandum dated June 28, 1985 concerning the withholding requirements on payments made to a non-resident by XXX with respect to certain payments made under a "Program License Agreement" and a "Maintenance Service Contract".

Program License Agreement Fees

The Program License calls for payment of a total license fee of XXX which provides XXX with the right to use the computer software in perpetuity. Such payments are subject to 25 per cent withholding tax by virtue of paragraph 212(1)(d) of the Income Tax Act. Where payments are made to a resident of the United States, who is the beneficial owner of such payments, the rate of withholding is reduced to 10 per cent by virtue of paragraph 2 of Article XII of the Canada - U.S. Income Tax Convention (Convention). Accordingly, payments made by XXX under the Program License Agreement to XXX a corporation organized the laws of XXX would be subject to 10 per cent withholding tax.

Maintenance Service Contract

It is our general position that the following two conditions must be net 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 services 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 of 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 payment for services are not considered to be part of the computer software license fee, they could still be subject to a 15% withholding tax under subsection 105(1) of the Income Tax Regulations (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 Convention, such payee will be exempt under Article VII of the Convention, 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 Convention ma>' obtain a refund of taxes withheld under Regulation 105(1) by filing a Canadian tax return (note that Article VII in the Convention 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 tax under subsection 105(1) of the Regulations. Thus, for example, where the service in question is providing in formation 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 subsection 105(1) withholding tax will be required.

The Program License Agreement provides that XXX agrees to permit XXX to purchase a service contract which will also provide the XXX with the right to receive all updates, corrections or amendments to the particular software. It is our position that payments of updates, including modifications, improvements and additions to computer software, are the same in nature as the original software licence payments, accordingly such payments are subject to Part XIII tax. Where a particular payment is both for the acquisition of services and for software updates, Part XIII tax is only required to be withheld on the portion of the payment made for updates assuming that a reasonable and acceptable allocation between services and updates can be made.

It would appear that payments made for "Dial-Up modem Access" are similar to payments made for a hotline service. If such is the case, such payment could be exempt from withholding tax as set out above.

Bill C-60, which received Royal Assent on June 8, 1988, amended the Copyright Act in Canada. The Bill basically changed the definition of "literary work" for purposes of the Copyright Act, to include "computer programs". The question then arises as to whether or not the amendments to the Copyright Act would bring computer programs within the exemption from withholding tax provided in subparagraph 212(1)(d)(vi) of the Act.

The exemption provided in subparagraph 212(1)(d)(vi) of the Act only applies to royalty or similar payment on or in respect of a copyright in respect of the production or reproduction of any literary work. In the cases we have reviewed, the end-user of computer software programs merely acquires a right to use a computer program under a license agreement and not the right to produce or reproduce the program. Accordingly, we have taken the view that payments made for the right to use computer programs do not qualify for the exemption provided in subparagraph 212(1)(d)(vi) of the Act. Since the XXX has not acquired the right to produce or reproduce the software program under the Program License Agreement, it is our view that the payments are made for the use of the computer software program and not for the right to produce or reproduce the computer software. Accordingly, any payments made under the Program License Agreement will continue to be subject to withholding tax.

We trust these comments are suitable for your purposes.