7 July 1988 Income Tax Severed Letter RCT-0001 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: Rent and Royalties - Part XIII Canada - U.S. Tax Conventions

No comprehensive definition of rents and royalties' is possible because the meanings to be given these expressions will always depend upon the circumstances of the particular case and the sense in which these expressions are used. Of course, 'the sense in which these expressions are used' is presumably the object of this inquiry. Regretably, there is no easy escape from this obvious tautology.

On the other hand, the resulting rule that the context is of paramount importance itself provides at least some direction and suggests a method for determining the characterization of certain types of payments for tax purposes. To say that the factual context is of singular importance is really no more than to say th in each case it is the legislative intent, properly ascertained, which must govern. Ultimately, in difficult cases, where the legislative intent is unclear, it is necessary to reason by analogy and, in more difficult cases, where no correspondence by analogy may be adduced, the tax administrator has no choice but to decide on a fair and reasonable basis. This procedure is not to be regarded as an extra-legal activity, inasmuch as it may normally be presumed, in the absence of contrary indications gleaned from the strict letter of the law, that the legislator intends to be fair and reasonable.

This analysis will primarily be devoted to the meaning of rents, royalties, and similar payments for the purposes of part XIII of the Income Tax Act. The basis for this inquiry is therefore the use of these terms in the Anglo-Canadian common law. Some comment will also be made concerning the nature of these and other expressions found in the present and proposed Canada - U.S. tax agreements.

ROYALTIES

1. Usage

In its original or primary usage, royalty' refers to a prerogative or inherent residual right of ownership in respect of all property located in the realm which is vested in the Crown, be it in right of a province or of Canada. It refers to, and stands on the same footing as bone vacantis, escheats in respect of lands (where no heir or legatee), the ground between high and low water mark, the bed of the sea, felon's goods, treasure trove, warren, piscary and other analogous rights. In this sense royalties' may also be identified with the tangible things to which they relate and are roughly comparable with the res communes' of Roman law and of the Civilian systems erected upon it.

In usage which appears to derive from the original usage, royalty may also mean a payment to an owner in respect of things to be won from the soil; i.e. the Crown was able to exact payments in respect of its jura regalia' (for example, original grants or letters patent respecting land were often made by the Crown with reservations of mineral rights). Royalties may thus arise as payment for the exercise of rights similar to those secured to the owner of a profit a prendre, which is right to enter on the land of another to take some profit from the soil which is itself capable of ownership.

The word "royalty" has also been used to describe an interest in property (usually real property) analogous or tantamount to a profit a prendre. Although this usage may with the passing of time be sanctioned by custom and commercial convenience, it cannot but be regarded as a corruption of the ordinary meaning of royalty', which designates a payment tied to or dependent upon the gain to be derived from an income producing property.

Royalty is also commonly employed to describe the economic return enjoyed by the owners of certain intellectual' property, or Rights, secured by law as monopolies to persons in their capacity as inventors or creators (as for example patents, copyrights, trademarks, franchises, and the like).

2. Income vs Capital

The greatest difficulty in fixing the scope of the expression royalties' lies in deciding to what extent, if it all, it relates to transactions on capital account. In other words, to what extent can royalties also effectively constitute proceeds of disposition?

Without doubt the most significant case decided in Canada on the nature of royalties is MNR v Wain-Town Gas and Oil Company Limited, 1952 SCR 377, not only because it is a judgement of the Supreme Court of Canada but also because the matter was there lucidly and elaborately discussed both by the majority and minority judges. The case contains a wealth of information useful in addressing all tax problems where the nature of royalties is an issue of central concern.

In Wain-Town the taxpayer corporation assigned to another company of franchise to supply a town with natural gas. The franchise was for a period of ten years with options to renew for further ten year terms indefinitely. Provision was made whereby the town could under certain conditions and at the end of any ten year period purchase the franchisee's rights under the agreement. The taxpayer was to be paid by its assignee a percentage of actual gross sales and, in the event of the town exercising its right to purchase the franchise at the end of any ten year term, 25% of the net proceeds of such sale. Paragraph 3(1)(f) of the Income War Tax Act defined income subject to tax to include

rents, royalites, annuities or other like periodical receipts which depend upon the production or use of any real or personal property, notwithstanding that the same are payable on account of the use of sale of any such property.

Paragraph 3(1)(f) had been enacted as a consequence of the famous Spooner case, (1933) A. C. 684 affirming (1931) S.C.R. 399, in which it was held that receipts on account of a reservation of a 10% interest in the petroleum and natural gas production by the grantor of certain lands, described as a royalty' in the agreement of sale, were of a capital rather than of an income nature and accordingly were not subject to tax.

There is some justification in the case law for maintaining that a royalty taxable as income cannot for tax purposes overlap with proceeds of disposition. The Spooner case is perhaps most significantly in this regard, although it is well to remember that the charging section at that time (section 3 of the Income War Tax Act, 1927) did not purport to tax royalties, as Newcombe J. points out, as follows:

The stipulated tenth is not rendered annually, but at least every thirty days after productions, and that irrespective of whether the operation results in profit or loss. It is by the agreement for the lack of an apt definition, termed a royalty'; but, whether or not it may appropriately be named a royalty or an annuity, the statute does not, in terms charge either royalties or annuities, as such; and here appellant has converted the land, which is capital, into money, shares and ten per cent of the stipulated minerals which the company may win. What the appellant will realize under the covenant is, of course, uncertain; although it may be ascertained in the event.

Since the issue in Spooner concerned whether the royalty (if royalty it was) constituted an annual profit or gain' within the relevant provision, any comments in the Supreme Court or the Privy Council on the nature of royalties are necessarily obitur. The comments of Lord MacMillan are nevertheless important and instructive.

Given the statutory background against which the case was to be decided, Lord MacMillan (Privy Council) properly begins by invoking the distinction derived from the writings of the early english econmists between income from a source and gains from the realization of a source, which is enshrined as a presumption in construing taxing statues;

The question whether a particular sum received is of the nature of an annual profit or gain or is of a capital nature does not depend upon the language in which the parties have chosen to describe it. It is necessary in each case to examine the circumstances and see what the sum really is bearing in mind the presumption that "it cannot be taken that the Legislature meant to impose a duty on that which is not profit derived from property, but the price of it" per Hanworth M.R. in Perrin v. Dickson, quoting previous authorities.

He then deals with the possibility that certain types of royalties' are taxable as income receipts under the Act. He says:

It may be that ordinary mineral royalties, though not expressly mentioned in the definition section are taxable income in Canada, subject to an allowance for exhaustion. The term 'royalty' occurs in section 27 of the Act, which provides that any non-resident person who receives a royalty "for anything used or sold in Canada shall be deemed to be carrying on business in Canada and to earn a proportionate part of the income derived therefrom in Canada." This section may have been enacted to obviate the argument that the mere receipt of royalties is not a carrying on of business, as was decided in the excess profits duty cases: Commissioners of Inland Revenue v. Marine Steam Turbine Co. and Commissioners of Inland Revenue v. Korean Syndicate, Ltd. It seems, however, to indicate that some royalties' at any rate may be taxable under the Act.

It is apparent that according to Lord MacMillan royalties are taxable as income in circumstances where they represent the recipient's share of the profits of a business activity actively or passively pursued by him jointly with others. Indeed, the Crown had tried to assimulate the arrangement in Spooner to a mining lease under which the company acquired only a right to search for oil and reduce it into possession on terms that a percentage of whatever oil was found should remain the property to Mrs. Spooner. Lord MacMillan peremptorily rejected this submission as follows:

But this is not really so. The agreement provides for a sale to the company of all the respondent's right, title and interest in the land, which includes the right to any oil which it may contain. The respondent was not in any sense a join-adventurer with the company in the business of oil prospecting or oil production.

From this we may deduce that the payment in Spooner was not an annual profit or gain, or income. It is not open for us also to conclude that, as proceeds of disposition, it was not a royalty. To the contrary, it appears from Lord MacMillan's opinion that royalty payments may be of an income or capital nature, depending upon the circumstances.

Arguably, a devise a minerals by way of lease involves a use rather than a disposition of capital such that any royalty' earned by the lessor is properly a share of profits. However, a payment made pursuant to the granting of a profit a prendre (a transaction whereby the grantor disposes of a portion of his capital) will, if the payment is tied to production or use, also be a royalty. In this connection the judgement of latham C. J. (1944), 69 C. L. R. 235, at page 240-241, is particularly relevant. He says:

In my opinion the word royalty' is properly used for the purpose of describing payments made by a person for the right to enter upon land for the purpose of cutting timber of which he becomes the owner, where those payments are made in relation to the quantity of timber cut or removed. Thus I am of opinion that the money received by (the appellant) were royalties and accordingly were part of his assessable income.

and McTiernan J. at pages 245-246 expressed himself as follows on the subject of mineral leases:

The word royalty' is also commonly applied to moneys which the lessee of a mine pays to the lessor for the right to work it: the amount of the royalty may be fixed by reference to quantities of material won from the mine. Hence in its business or commercial sense the words may be sued to refer to moneys which are part of the proceeds of the sale of a capital asset.

Thus, even before the Supreme Court decision in Wain-town, it would appear that a royalty could be the price of property which as been sold. It is submitted that, since the decision in that case, the matter is beyond doubt, particularly since the majority and minority judgements took such catagorically opposed views.

All the judges in the Wain-Town case were of the view that the taxpayer had effectively sold out' or disposed of its entire interest in the franchise in consideration of the promised payments. Thus, in accordance with the language of paragraph 3(1)(f) of the Income War Tax Act, it might justly be said that the amounts were payable on account of the sale of the property in question. The question which arose squarely for decision, therefore, was whether the called-for payments were truly in the nature of "rents, royalties, annuities, or to her like periodical receipts". Locke J., Dissenting, took the view that as the taxpayer had sold the franchise outright, without the reservation of any interst in the property granted, the sale was of different nature from that considered in Spooner's case, and the payments could accordingly not accurately be described as royalties'. What we see in Locke J.'s judgement is the notion that a royalty is a payment which derives from a subsisting proprietary interest in property and is similar to rent.

His views on the nature of royalties are clearly expressed in the following passage:

It is not, however, in the sense of a royal prerogative or right that the word is used in the Income Tax Act, but rather in the sense that the word is commonly used in business transactions to described sums paid for the right to use a patent or copyright, or to exercise some like incorporeal right, or some payment to be made from the production from property the ownership of which remains vested in the grantor. In my opinion, the word in its ordinary meaning does not describe, or extend to, a payment such as was stipulated for in the agreement between the parties in this matter, where the payment is made as part of the purchase price of the outright sale of personal property transferred without reservation to the Franco Company.

In the view of the majority judges, however, a payment is properly described as a royalty regardless of whether the recipient retains or enjoys a proprietary interest in the property. Rand J., for example, plainly says "... it makes no real difference in substance or as to the nature of the payments whether they arise through a "reservation", strictly so called, or a covenant." A royalty', therefore, may be recieved as a consequence of a covenant or agreement to pay the purchase price of the transferred property. Kerwin J. was also of the view that the payments were royalties but added that "even if the payments were not received as royalties, they fell within the expression "other like periodical receipts". They are at least similar to percentage "as on output, paid to the owner of an article, esp. a machine, by one who has the hire of it": Webster's New International Dictionary sub nom "royalties"."

A reservation is something that does not exist but is newly created or reserved but of what is granted. A reservation of all or part of the mineral wealth upon a grant of land may create a rent charge (an incorporal hereidtament or right, constituting real property) which effectively charges the grantee's estate with the obligation to pay an amount. In such a case the grantor does not actually continue to own the minerals as such. A reservation may also create a profit a prendre (another right which did not exist independently prior to the grant) in which case it operates technically as a grant of the whole estate to the grantee with a reconveyance of the profit to the grantor. The grantor and owner of the profit does not own that which is to be taken from the land until it is actually reduced to possession. In the case of a reservation, therefore, the grantor continous to enjoy an interrst in land but does not actually own any part of it which exists in esse. What he owns is a right enforced only be personal action unless a written agreement, usually incorporated to the deed, also confers on him powers of distress and entry.

A covenant requiring the grantee to do or to abstain from doing something cannot defeat an estate and give a right of re-entry upon the breach thereof, but merely a right of action. Positive covenants e.g. to deliver 10% of the minerals produced from granted land, are mere contractual obligations and not real property. Thus, in emphasizing the fact that the payments in Spooner were proceeds of disposition, Newcombe J. distinguished the right to receive the 10% of production from any interest in the nature of real property. (Thus it could not be in the nature of a rent or other income receipt).

"It will be observed that clause 3, quoted above, by which as well as by clause 7, the royalty is said to be reserved, introduces a convenant, on the part of the company, by way of further consideration for the sale; and that the company thereby agrees to deliver to the vendor, on the premises, ten per cent of the petroleum, natural gas and oil produced and saved from the lands sold, free of cost to the vendor; the delivery to be made at lest once in every thirty days; and this suggests a question as to whether the consideration or so-called royalty, which consists of ten per cent of the minerals recovered, is validly reserved; for, it is said in Sheppard's Touchstone (80), paragraph 10:

If a man grant land, yielding or paying money or some such like thing (as a rose, a pound of cummin, etc.) yearly (or at any other period) this is a good reservation. But if the grantee covenant to pay such a sum of money, or to do such a thing yearly, this is no good reservation, but a covenant to pay a sum of money in gross, and not as a rent, (but whether a clause shall amount to a reservation, or to a covenant, is frequently a question of construction)."

Mr. Justice Rand's view that a royalty may be paid pursuant to a reservation or a covenant therefore emphatically indicates that proceeds of disposition may take the form of royalties.

The cases Calgary and Edmonton v. M.N.R. 55 DTC 1099; New Continental Oil v. The Queen, 77 DTC 5202; Wilder v. M.N.R. (1952) 1 SCR, 123; Alberta and Southern gas v. The Queen, 77 DTC 5244; have been considered and would appear not to impact upon the conclusions delineated above.

Importance of Contract: Relevance of British Precedents

An important point also made by the majority judges in Wain-Town is that in determining whether a payment is a royalty due regard must be given the language employed by the parties (though this is of course not conclusive) and particularly accepted and current commercial usage. Kerwin J. says

It is settled by authority both here and in England that the appearance of the word "royalties" in the assignment does not necessarily dispose of the matter but, to quote Finlay J. in British Salmson Aero Engines Ltd. v. Commissioners of Inland Revenue, "the fact that people who, after all, now all about it, choose in their agreement to refer to these annual sums *** as "royalties", is a matter not to be entirely neglected". Furthermore, the word is used in the respondent's tax returns for each of the years 1944 and 1945, to describe the money received by it from Franco. I quite agree that this is not decisive but that circumstance, added to the first, are at least evidence of the manner in which, in a business sense, the word is looked upon in this country. A particularly useful judgment is that of the High Court of Australia in MacCauley v. The Federal Commissioner of Taxation, where it is pointed out that in an agreement drawn in England the term "royalties" has been used to describe payments for removing furnace slag from land (Shingler v. P. Williams and Sons and, in an agreement drawn in New Zealand to describe payments for flax cut: Akers v. Commissioner of Taxes.

and Rand J. added that

The word "royalty" in the agreement is not, of course, controlling, but it does bear upon the propriety of the use of the word, in the minds of business men, to describe the type of payment involved. The statutory language, dealing with the results of accounting processes determining economic gain in business, must, in large degree, use the vocabulary employed in them; and the meaning of the word as it appears in the statue must be regard to its general acceptation in the course of property and business transactions.

It is apparent, therefore, that the expression "royalty" may comprise many different types of payments. If, according to the customs of the book publishing business, for example, a lump sum payment in respect of the sale of a copyright is known as a 'royalty' being based upon the estimated number of copies of a work which may be sold, there can be no doubt that the payment would also be a royalty for tax purposes notwithstanding that amounts are not disbursed periodically as a fraction of the number of copies actually sold. On the other hand, there can be little doubt that amounts are not disbursed periodically as a fraction of the number of copies actually sold. On the other hand, there can be little doubt that the commonly accepted business understanding of 'royalties' implies periodical receipts depending upon the production or gain to be derived from the use of real or personal property. The judgement of Lord Greene M. R., in the English case of Nethersole v. Withers, 711, should be mentioned in this regard, inasmuch as it was there said that a lump sum paid in arrears or in advance of royalties was also royalty, as well as a lump sum arrived at by reference to some anticipated quantum of user. In that case, however, it was also held that a payment in respect of the license of a copyright was on capital account, and it is therefore well to bear in mind Kerwin J.'s important admonition to the effect that

It has not been overlooked that even if the town should so exercise its right to purchase, the respondent had disposed of part of its property (the franchise) for the intervening period just as Miss Nethersole had disposed of a portion of her copyright in Nethersole v. Withers (1). However, in that case the claim of the Inspector of Taxes was that, under Case VI of Schedule D of the English Act, a certain amount received by Miss Nethersold was "annual profits or gains not falling under any of the foregoing cases and not charged by virtue of any other schedule". It was held by the Court of Appeal and the House of Lords that the payment was not an annual profit or gain.

The determination of this appeal depends upon the property construction of clause (f) of subsection 1 of section 3 of the Income Tax Act and I have unable to ensure any assistance from the Nethersole case or any of the other English cases cited by counsel on either side. They must be read with care and always bearing in mind the different statutory enactments with which they were concerned.

RENTALS AND SIMILAR PAYMENTS

1. Meaning of Rentals

With respect to the matter of 'rentals', we have the useful opinion of Mr. Cleland, formerly of legal services, with which the present writer generally agrees. A few additional comments, however, appear to be in order. Mr. Cleland traces the evolution of the concept through the United Geophysical (1961) DTC 1099 (Ex. Ct.), and C.I. Burland (1967) DTC 5289 (Ex. Ct.) and (1967) DTC 5220 (S.C.C.) cases to mean payments

(a) in fixed amounts

(b) for the use of personal or real property

(c) for a certain time.

This is, effectively, an accurate description of Mr. Justice Cattanach's comments at page 5292 in the C.I. Burland case. It should be noted, however, that the Supreme Court of Canada did not in terms approve this conclusion and in fact reversed Cattanach J.'s conclusion on the main issue of whether the payment of property taxes by a non-resident were rents or similar payments' for 212(1)(d) purposes. The important point to be noted from the Supreme Court Judgement is that any payment without which the use of property would not be granted or enjoyed is taxable as rent or a similar payment under 212(1)(d).

It is furthermore the case that Cattanach J.'s comments were something of a gloss of Mr. Justice Thurlow's observations in United Geophysical. One might get the impression from Cattanach J.'s rules of thumb that in order for a payment to be a rental, the exact amount payable and the certain' time must be specified in a written or verbal agreement. However, informal arrangements between e.g. a subsidiary and its parent or between arm's length parties where there is a course of dealing under which any payments are only for the use of property will be a rental. In other words, all that is necessary is that the reversionary interest' or property' remain vested in the lessor' (and this is to distinguish a lease from a sale).

2. Paragraph 212(1)(d): Sale of Intangibles

In connection with subparagraph 212(1)(d)(i), the obiter observation of Thurlow J. (in Saint John Shipbuilding, 80 DTC, 6272) that lump sums paid to acquire intangible property are taxable within the provision, is probably incorrect. It should, however, in fairness be noted that in the case before him all that had been transferred was right to use, albeit a right to use in perpetuity. it is therefore possible to argue that subparagraph 212(1)(d)(i) would not apply where all of the incidents of ownership in the property have been transferred. Indeed, this would clearly seem to be the better view. It is true that the preamable in paragraph 212(1)(d) refers to any payment' and that Mr. Justice Rand indicates in Wain-Town that the price of intangibles may depend upon the use' (or exercise) thereof, however this does not mean that any payment for the acquisition of rights is for the use (or exercise) only. Rights may be cquired from a competitor so that they may not be exercised; rights may be acquired in order to be surrendered to a third party; and according to Mr. Justice Heald's holding in Farmparts Distributing, 1980 DTC, 6157, the acquisition of (intangible) property for resale is not a use (or exercise) thereof. A possible problem, however, created by Farmparts is the suggestion that the acquisition of tangible property for e.g. use in carrying on a manufacturing concern would be a use within subparagraph 212(1)(d)(i). The subparagraph should be taken as referring to intangible property only, and subparagraph 212(1)(d)(v) should be regarded as precluding the incidence of withholding on the price of tangible property unless the payment is dependent upon the use of production derived therefrom by the grantee.

3. Payments for rights to use Computer Software Programmes

Paragraph 212(1)(d)(i); Articles I, II, XI Canada - U. S. Convention, Protocol, Article 6(a), Articles XII of New Canada - U. S. Convention.

In Saint John Shipbuilding 80 DTC 6272 it was held that payments made to a U. S. resident enterprise in respect of the non-exclusive perpetual license of a computer software programme were industrial and commercial profits and not rents and royalties' as those expressions are defined in Article 6(a) of the Protocol to the Convention. I should be noted that the judgement does not rest upon the assumption that the transaction constituted an outright sale of the magnetic tapes. In other words, the software programme was personal intangible' or intellectual' property and the only right granted in respect thereof was a right to use, albeit a right to use indefinitely. All the incidents of ownership of the programme, including the right to use, remained vested in the licensor, who effectively merely divested himself of his right to prevent the authorized user form also exercising a right to use the programme.

Thurlow J. felt that he could not treat the payments as royalties' because they were not tied in amount to the production or gain generated by the programme. Indeed, the software programme was not an income production property in which the grantor's interest might take the form of a specified share of the gain to be derived from the exploitation of the property by the grantee. The judge also felt that the payments could not aptly be described as rentals' because the right to sue was granted in perpetuity.

The necessity of having the use for a fixed or determinable period of time in connection with rentals is tied to the notion that only possession is given up and the lessor retains ownership and the reversionary interest in the property. This is particularly evident from the following comment culled from Thurlow J's opinion:

A rental can, of course, be paid in a lump sum but in my pinion the word is inseparable from the connotation of a payment for a term, whether fixed in time or determinable on the happening of an event or in a manner provided for after which the right of the grantee to the property and to its use reverts to the grantor.

It is of course in this regard that a rental differs markedly from a sale, a distinction which was uppermost in Mr. Justice Thurlow's mind. However, in dealing with intangible property the use of which is granted under the terms of non-exclusive license, it would seem that the property effectively remains vested in the grantor and it possesses the characteristics of an income production property in his hands. If the requirement that the rental of tangible property be for a term is necessary primarily to emphasize the lessor's reversionary interest in the property and to distinguish a lease from a sale, the requirement would thus appear to be unnecessary in the case of the non-exclusive license of intangible property.

On the other hand, it is probably inconsistent with the concept of a rental' (as it is commonly understood) to have the lessor' himself continue to make use of the property demised. The use of the word rentals' in connection with the licensing of intangibles therefore perhaps inevitable leads to inapposite results.

Inasmuch as Article XII (4) of the new and as yet unratified Canada - U. S. Convention defines royalties' to mean "payments of any kind received as a consideration for the use of" certain named intangible properties, it might be thought that the difficulties presented by the Saint John case would be overcome with the entering into force of the New Convention. Unfortunately, this case presents additional obstacles to the taxation of payments made to non-residents in respect of the use of computer software programmes.

According to Thurlow J., though the information obtained by use of the programme was to be held in confidence, it was not secret'. He says:

The information so obtainable by the use of the system was not secret. It was information that could have been worked out by competent technical personnel as had formerly been necessary by more laborious efforts and with the expenditure of much more time. Com/code also made the system available to other shipbuilders at a price. The respondent was, however, bound by the contract to keep the information obtained by use of the system confidential and to sue it only for the respondent's purposes.

This conclusion is somewhat startling, since the decision of Dumoulin J. in Western Electric Co. v. MNR 59 DTC, to which Thurlow J. Refers approvingly, affirms that secret' and confidential' are synonymous terms. Moreover, it is clear from the authorities that information is property only for the period during which it is not public and remains peculiar to its originators and authorized users (see Exchange Telegraph Company Limited v. Gregory & Co. 196 1 Q. B., 147; B. L. Grain Ltd. v. Ashton et al (1949) or 303). It is odd, therefore, that having found the programme to be information which was property, Thurlow J. should have also found it not to be secret. This conclusion is not without consequence since Article XII (4) of the New Canada - U. S. Convention does not add to the list of intangible property, payments for the use of which are taxable, "other thing(s) whatever" (as does subparagraph 212(1)(d)(i) of the Act) or "other like property" (as does Article 6(a) of the Protocol to the current Canada - U. S. Convention). This means that payments of the use of computer software programmes and other information which constitutes property will not, based on the Western Electric and St-John's cases, be taxable under the new Convention as "royalties" in respect of "any patent, trademark, design or model, plan secret formula or process". The argument could then be made that payments in respect of such property/information were treaty exempt as profits of an enterprise not allocable to a permanent establishment located in Canada. In order to rebut this proposition it would be necessary to identify the property as "information concerning industrial, commerical, or scientific experience", however if this characterization were carried forward for the purposes of Part XIII, Canada's authority to tax would be limited to payments dependent upon use, production or sales, or profits.

With particular regard to payments for the use of computer software, Thurlow J.'s dictum to the effect that the information which the programmes contain is not secret could very well make the phrase "information concerning industrial, commercial, or scientific experience" inapplicable since the phrase is said in the commentary to the O.B.C.D. Model Convention to refer to "know-how" or "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the production and mere knowledge of the progress of technique". A related problem might arise from the fact that the information, qua data, that the developer of computer software programmes is providing is frequently not in respect of his experience. For example, the payment in Saint John Shipbuilding was surely not in respect of engineering information concerning the construction of ship's hulls, but for a system which provided ready and efficient access to that information.

The purveyor of software could arguably be receiving a payment in respect of his experience only in circumstances where he was being paid to disclose secret information concerning the programming of computers. Again, the foregoing problems would have as a likely consequence the assimulation of payments for the use of computer software to profits of an enterprise' (which was, of course, the result in Saint John).

A further problem raised by Saint John with respect to the taxation of payments made to non-residents for the use of computer programmes is Thurlow J.'s suggestion that the grant of a non-exclusive license for perpetual use amounts to a disposition by the grantor of a portion of his capital assets. He says:

It seems to me as well that the repetition of the expression "rentals or royalties" in the definition, which, with deference, appears to me to have an unusual grammatical construction, indicates that the authors had in mind that what was being dealt with was the taxation of income, as opposed to capital ..."

Although this finding is tempered somewhat by the fact that the payments constituted industrial and commercial profits' of the U. S. enterprise, that is, that the non-resident corporation was in the business of selling software programmes, the possibility remains that such gains will be regarded under the new convention as deriving from the alienation of intangible property in which case Canada would be unable to tax lump sum payments of the kind in Saint John. As a result o the decision in Ports - Test Systems Ltd. v. The Queen 80 DTC 6046, in which it was held that an exclusive license of patent rights for a term of three years and for use in a particular defined geographical area was a transaction on capital account, the problem clearly manifests itself with regard to all intangible property. Thus, payments for use may very possibly come to be confused with payments for the acquisition of intangibles. XXX. Fortunately, the very detailed reasons given by Mr. Justice Le Dain in C.I.L. v. The Queen, 80 DTC 6163, in which all of the precedents are extensively reviewed ,correctly interprets the law to be that generally only exclusive licenses of rights granted in perpetuity will result in dispositions of capital assets (see Jeffrey v. Rolls Royce 40 TC 433; Musker v. English Electric, 41 TC 556; Wolf Electric Tools v. Wilson, 45 TC 326). The only exceptions to this rule are, in the case of a grant of a non-exclusive license of intangible property in perpetuity, a transaction whereby the licensor effectively disposes of a business actually carried on in the particular geographical area, and, in the case of an exclusive license for a term, a situation in which the grant of rights permanently affects injuriously the residual interest remaining to the grantor (see Evans Medical Supplies Ltd. v. XXX

4. Franchise Fees

XXX the present Canada - U.S. Convention and, presumably, in spite of the rather odd judgement rendered in The Queen v. farmparts Distributing Ltd., 80 DTC 6157, franchises are also taxable locally under the provisions of subspargraph 212(1)(d)(i) of the Act as "other thing(s) whatever".

The word "franchise" is of extremely general bearing and has been described as follows:

A franchise arrangement between two parties could be merely a non-exclusive sublicence or distributorship or it could be an arrangement under which one party grants to another party the right to operate a business in accordance with prescribed operating methods and procedures controlled by the grantor, which business incorporated extensive use of the grantor's know-how, expertise and trademarks or other distinguishing marks or names, with the grantor maintaining a continuing interest in the business by advising with regard to its operations, and with the grantor having a continuing right to compensation.

With this definition in mind it is difficult to make sense of the Farmparts case, which seems to cast doubt on the authority to tax franchises under 212(1)(d)(i) of the Act. In Farmparts a Canadian resident made payments to a U.S. company for the exclusive right to sell its product in the Western provinces. With regard to the applicability of subparagraph 212(1)(d)(i) Mr. Justice Heald made the following comments:

Exclusive Resale Right

I come now to the third category. In order to answer this question, it is necessary to look at the nature of the "right" here under consideration. It seems clear to me that what the respondent receives, in this category, is the exclusive right to buy and to resell the Wonder pipe bending machine within the territories set out in Exhibits 1 and 2 referred to supra. In my view, this "right" can, under no circumstances, be said to constitute the use or right to use the machine. If such be the case, then it follows, in my view, that the "right" conferred on the respondent by this category does not come within section 212(1)(d)(i).

There can be no doubt that Heald J. here misassimilates the exclusive distributorship right (which, of course, is itself property) with the machines which were to be sold pursuant to the franchise. It is apparent that amounts paid for the franchise are not to be confused with the wholesale price of the goods to be resold (see, for example, the Franchises Act of Alberta, S.A. 1971, c. 78, s. 1(1)(8)(ii)). Mr. Justice Heald moreover evidently had difficulty in seeing how intangible property was used'. It would seem that he was unaware of the decision of the Supreme Court of Canada in Wain-Town Gas and Oil, (1952) 2 S.C.R. 377 in which it was held that the word uses' was to be interpreted in connection with intangibles (in the particular case a franchise) to mean exercise' (see especially the comments of Mr. Justice Rand, at page 386).

There would seem to be little doubt concerning the propriety of taxing franchise fees, especially in view of the fact that payments made for use of trademarks, which are conceptually and commercially akin to franchise fees, are taxable. Without a specific reference to franchises a taxpayer might engage in eccentric allocations for these two items of property. XXX