30 November 1988 Income Tax Severed Letter RCT-0343 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: TREATMENT OF PAYMENTS TO NON-RESIDENTS IN RESPECT OF COMPUTER SOFTWARE PROGRAMS

This paper will discuss the requirement of a resident of Canada to withhold tax on payments made to a non-resident of Canada in respect of a right granted to the Canadian resident to use a computer program under a licence agreement with the end-user of a program or a person who produces or reproduces the program for distribution to other end-users.

Subparagraph 212(1)(d)(i) of the Income Tax Act requires every non-resident person to pay an income of 25 percent on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of or in satisfaction of rent, royalty or similar payment including any payment for the use of or the right to use any property. Subparagraph 212(1)(d)(vi) provides an exemption from such withholding tax with respect to a royalty or similar payment on or in respect of a copyright in respect of the production or reproduction of any literary, dramatic, musical or artistic work.

Property includes computer software and payments in respect of the use of computer software would be described in subparagraph 212(1)(d)i) of the Act. For a number of years prior to 1983 such payments were not considered to be in respect of a copyright in respect of the production or reproduction of any literary work as required by subparagraph 212(1)(d)(vi). Therefore, they were not considered to be exempted from withholding tax by that provision. Rather, the payments were considered to be exempted by Article XIIIC of the Canada-U.S. Convention (1942) as "royalties for the right to use copyright".

Effective July 1, 1983, Revenue Canada changed its position to require that tax under Part XIII of Income Tax Act at a rate of 15% should be withheld on rental and royalty payments made to residents of the U.S. for the use of or for the right to use computer software for distribution to end-users. On the basis that computer programs were not copyright in Canada because they were not literary works, it was considered that neither the exception in subparagraph 212(1)(d)(vi) or the exemption in Article XIIIC of the Canada-U.S. Income Tax Convention (1942) applied to exempt such payments from withholding tax. (Article XII(3) of the Canada-U.S. Income Tax Convention (1980) would not apply for the same reason.) The requirement to withhold applied to all such payments except for payments under perpetual or unlimited term agreements which were not considered to be rentals or royalties within the meaning of the Protocol to the Canada-U.S. Income Tax Convention (1942) (see The Queen vs. Saint John Shipbuilding and Dry Dock Co. Ltd., 80 DTC 6272 FCA). Such perpetual or unlimited term payments were considered to be industrial and commercial profits for the purpose of that Convention. The exception applied until the effective date of the Canada-U.S. Income Tax Convention (1980), October 1, 1984.

Payments made for the use of computer software in perpetuity are included in the new definition of "royalties" in the Canada-U.S. Income Tax Convention (1980) since that definition means "payments of any kind ... for the use of or the right to use ..." (underlying for emphasis) and do not come under the business profits article unless the beneficial owner of the royalties carries on business in a permanent establishment in Canada. Accordingly, from October 1, 1984, the effective date of the 1980 Convention, most payments made for the use of computer software in Canada became subject to withholding tax in Canada.

As a result of the 1980 Convention, the rate of withholding tax was reduced to 10 percent effective October 1, 1984 subject to the greater relief clause in paragraph 5 of Article XXX of the 1980 Convention.

A decision has not been handed down by the Supreme Court of Canada, in the case of Apple Computer, Inc., Apple Canada Inc. and MacIntosh Computers Limited, that concerned whether computer software programs are literary works and therefore protected by the Copyright Act. If it is decided that software programs are literary works, Revenue Canada will review its practice with respect to withholding.

However, Revenue Canada has reviewed its requirement to withhold payments made for the use of computer software as a result of amendments to the Copyright Bill C-60 which received Royal Assent on June 8, 1988. This Bill changed the definition of "literary work", for the purposes of the Copyright Act, to include computer programs.

In our opinion the changes to the Copyright Act does not affect the obligation to withhold from payments made to a non-resident by the end-user of the program.

The exemption from withholding tax on royalty payments provided in subparagraph 212(1)(d)(vi) of the Act only applies to a royalty or similar payment on or in respect of a copyright in respect of the production or reproduction of any literary work. In most cases, the end-user of the 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. In these cases, since the payor does not have the right to produce or reproduce the program, the exemption in paragraph 212(1((d)(vi) does not apply.

Therefore, where a U.S. owner of computer software grants the right to a resident of Canada to produce or reproduce computer software in Canada for distribution to the Canadian end-users, payments made to the U.S. owner for the right to produce or reproduce such programs for such distribution would be exempt from withholding tax under paragraph 212(1)(d) by virtue of subparagraph 212(1)(d)(vi).

XXX