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.
Principal Issues: Is a royalty payment received by an employee from an employer taxable as employment income or property income when the rights to the invention may or may not vest with the employer?
Position: Question of fact.
Reasons: In accordance with subsection 5(1) of the Act, where the rights to an invention belong to the employer and the employer flows part of the royalty to an employee, the royalty payment will be considered employment income since the invention was developed in the course of the employment and the ownership of the invention belongs to the employer. Where the rights to the invention do not fully vest to the employer, the treatment of the royalty payment will depend on the facts of each case. However, where the rights to the invention remain with the employee and the employer is solely acting as a conduit to flow the royalty payment to the employee, the royalty payment will be considered royalty income to the individual.
XXXXXXXXXX 2010-039165
P. Waugh
May 17, 2011
Dear XXXXXXXXXX :
Re: Taxation of Royalty Income
I am writing in response to your letter of December 2, 2010 concerning the taxation of royalty income. More specifically, you have enquired whether a royalty payment flowing from an employer to a faculty member would be considered employment income or royalty income for purposes of reporting it on a T4 or T5.
In the situation you described, a post-secondary educational institution (the "University") employs faculty (the "Faculty") who, as part of their employment with the University, perform research. The requirement to perform research is set out in the collective agreement which allows the Faculty to devote a portion of their time to scholarly research or creative activities. As a result of this research, intellectual property ("IP") may be created and subsequently commercialized. If the IP is commercialized and used by a third party, the third party may pay a fee to the University for that use.
Under the University's collective agreement, ownership of the IP initially rests with the Faculty member. However, the Faculty member may enter into an agreement with the University to assign up to 100% of the IP ownership to the University in exchange for no consideration. Instead, the University agrees to commercialize the IP and have the University assume some/all costs associated with the development and exploitation of the IP. Full ownership of the IP is usually assigned to the University since it is not practical for the University to take steps to commercialize the IP without 100% ownership.
While the agreement may provide for the sharing of royalty income, this revenue sharing is not contingent on any event or thing. Depending on the percentage of ownership assigned to the University, it may agree to pay the Faculty member a portion of the royalties received in relation to the IP. The Faculty and University agree that, despite the University's full ownership of the IP, the University will share some of the revenues since it was the Faculty's work product, and the University may retain a portion of the revenues as compensation for the work it does to commercialize the IP. The revenue sharing is not to compensate the Faculty for assigning the IP, but rather only one piece of a larger arrangement whose main purpose is to commercialize the IP so that the public can benefit from it.
Our Comments
Written confirmation of the tax implications inherent in particular transactions may only be provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at http://www.cra-arc.gc.ca. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to provide the following general comments.
Generally, when an individual receives a royalty payment, it is taxable as either property or business income. However, when a royalty payment is received through employment, depending on the facts of each case, it may be taxable as employment income.
Where the rights to the IP belong to the University and the University flows part of the royalty to the Faculty, the royalty payment will be considered employment income since the IP was developed in the course of the Faculty's employment and the ownership of the IP belongs to the University (the employer). However, where the rights to the IP do not fully belong to the University, the treatment of the royalty payment may differ.
When the rights to an invention remain with the Faculty, and the royalty payment from a third party is flowed through the University where it is acting solely as a conduit for the flow through of the royalty payment, this payment would generally be considered royalty income to the Faculty. Where the rights to the IP belong to both the University and the Faculty and the University awards 100% of the royalty payment to the Faculty, the amount of the royalty payment that exceeds the Faculty member's share will be considered employment income.
Where some of the rights to the IP belong to the Faculty and the University is acting as more than a conduit for the royalty payment, a determination of the taxable status of royalty income earned by the Faculty from an IP could only be made after a complete review of all the facts and documentation surrounding the particular situation. This determination will depend on a number of factors, including ownership of the invention and the nature of the amounts received, as discussed in archived Interpretation Bulletin IT-316, Awards for Employees' Suggestions and Inventions. In order for us to make such a determination, we would need to review the agreement(s) between the University, Faculty and any third party, on a case by case basis.
We trust these comments will be of assistance.
Yours truly,
Randy Hewlett
Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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