8 November 1989 Income Tax Severed Letter RRRR172 - Tax treatment of software

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.

XXX

Re: Working Party No. 1
Tax Treatment of Software

As recently requested by XXX we provide the attached answers to the questionaire prepared by the Secretariat on the tax treatment of software.

We apologize for the delay in responding.

EXHIBIT B

QUESTIONNAIRE ON THE TAX TREATMENT OF SOFTWARE

• 1. Legal Classification
• 1. 1. Yes.
• 1. 2. It is protected under copyright legislation.
• 1. 3. It applies to the author and those who may adapt or transform the software provided the persons who do the adaptation or transformation do so with the author's permission
• 1. 4. No.
• 1. 4.1. See 1.4. 1.4.2. See 1.4. 1.4.3. See 1.4. 1.4.4. See 1.4.
• 1. 5. We do not have any additional remarks to make on this subject.
• 2. Tax Classification as the country of source
• 2. 1. See 2.1.1.
• 2. 1.1. Canada would not require withholding tax on an amount paid with respect to the outright disposal of all rights relating to the software. However, because of the nature of computer software such out right purchases are unusual.
• In general it has been our experience that payments made by Canadian end-users in respect of computer software are for the right to use the computer program in perpetuity. The contract usually includes various restrictions as to what can be done with the software and accordingly complete ownership does not pass to the purchaser. Thus, any payment made in respect of the software generally represents a payment for the use of or the right to use the program. Canada requires that 25% tax be withheld from such payments at source when the payments go to a non-treaty country.
• Canada does not withhold on a payments where the foreign owner of a computer program has granted a Canadian resident the right to produce or reproduce computer software in Canada for distribution to Canadian end-users, and the payment from the Canadian resident to the foreign resident is in respect of a copyright in respect of the right to produce or reproduce the software (See discussion under 2.6.).
• 2. 1.2. See 2.1.1.
• 2. 1.3. See 2.1.1.
• 2. 2.
• 2. 2.1. See 2.1.1.
• 2. 2.2. See 2.1.1.
2. 3. We would not break down the payment into separate elements in this situation. We would consider the full amount of the payment to be a royalty and would require that tax be withheld from the full amount. It is our general position that the following two conditions must be met in order for payments for any services provided in connection with the use of computer software not to be considered part of the software license fee which is subject to Canadian withholding tax at source:
• a) The amount being paid for services must be defined in the contract and the payment for such services must be optional. 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 license fee subject to withholding tax.
• b) The payments for the services should be reasonable in relation to the software licence fee. Any unreasonable portion of the service payments could be viewed as a portion of the licence fee subject to withholding tax.

In addition we consider payments for, or payments to obtain discounts on, updates as being essentially the same in nature as the original software licence payments which are subject to withholding tax at source, rather than as being payments for services.

• 2. 3.1 See 2.3.
• 2. 3.2. See 2.3.
• 2. 4.
• 2. 4.1. See 2.1.1.
• 2. 4.2. Payments to non-treaty countries for services in relation to computer software if performed in Canada are considered to be business income in the recipient's hands for Canadian tax purposes and are subject to Canadian income tax.
• Canadian Income Tax regulations require that 15% be withheld from all payments to non-residents for services performed in Canada in relation to computer software. The amount withheld only represents a payment on account and is applied against the actual Canadian taxes payable. Any portion in excess of such taxes payable is refunded.
• 2. 4.3. See 2.1.1.
• 2. 5.
• 2. 5.1. See 2.1.1.
• 2. 5.2. See 2.1.1.
• 2. 6. The definition of amounts subject to withholding at source in Canadian tax law is similar to the definition of royalties in Article 12 of the Model Convention except that royalty payments in respect of a copyright in respect of the production or reproduction of any literary, dramatic, musical or artistic work are specifically excluded from withholding at source. For purposes of this exception computer programs are copyright and are considered to be literary works.
• 3. Tax Classification as the country of residence
• 3. 1.
• 3. 1.1 Receipts in respect of computer of software would only be considered to be capital payments if a) the software is being sold, b) all rights relating to the software are being sold, and c) the person selling the software held it as capital property.
• 3. 1.2. See 3.1.1.
• 3. 1.3. See 3.1.1.
• 3. 2.
• 3. 2.1. Where a person receives payment for the use of computer software and receives payment for providing services with respect to that software, such payments are business income and there would be no concern about the classification of the receipt.
• 3. 2.2. See 3.2.1.
• 3. 3. See 3.2.1.
• 3. 4. No.
• 4. No.
• 5. Double taxation Convention
• 5. 1. See discussion under 2.1.1. and 3.1.1.
• 5. 2. We would consider payments and receipts for royalties referred to in 2.2.2. and 3.2.2. to come under Article 12 of the Model Convention. We would consider payments and receipts for services referred to in 2.2.1. and 3.2.1. to be business profits and to come under Article 7 of the Model Convention.
• 5. 3. See 5.2.
• 5. 4. Yes. However, we normally require withholding on royalty payments to non-residents whereas Article 12 of the Model Convention exempts royalty payments from withholding in the country of payment.
• 5. 5. In general terms we use the "royalties" definition in Article 12 in Canadian tax legislation.
• 5. 6. Not applicable.
• 5. 7 We would classify the relevent income according to Canadian tax law and give a tax credit up to the amount of Canadian tax that would have been payable on this income.
• 5. 8. No.
• 5. 9. No.