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: Whether the sale of certain foreign patents would give rise to a gain on account of income or capital gain.
Position: General comments provided.
Reasons: Question of fact. The law and related jurisprudence.
XXXXXXXXXX James Atkinson CGA
April 22, 2010
Dear XXXXXXXXXX :
Re: Sale of Foreign Patents
This is in response to your letter of January 4, 2010 and further to our telephone conversation of March 31, 2010 (Atkinson/XXXXXXXXXX ) during which you requested a written response concerning the tax consequences arising under the Income Tax Act (the "Act") in connection with the sale of foreign patents.
You described a situation involving a business that holds a Canadian patent in respect of an internally developed invention. The Canadian business manufactures and sells the product, which is the subject of the Canadian patent, in Canada. You have advised that the primary activity of the Canadian business is manufacturing and not the production of inventions. Subsequently, the business has acquired a number of foreign patents in respect of the same Canadian internally developed invention. Your letter indicates that it is the intention of the business to gradually sell the foreign patents.
You ask whether the sale of such foreign patents will give rise to ordinary income taxable under subsection 9(1) of the Act or whether such sales will result in a capital gain, assuming there is a gain.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to offer the following general comments, which may be of assistance.
A Canadian patent is a right, granted by government, to exclude others from making, using, or selling your invention in Canada. Such a right is "property" as that term is defined in subsection 248(1) of the Act. The determination as to whether the gain on the disposition of such a property will treated as ordinary income under subsection 9(1) of the Act or as a capital gain is a determination of fact to be based on a review of the documents and circumstances of the case under consideration.
Such a determination depends on various factors such as the nature of the transferor's business, the nature of the payment received, the nature of the property in the transferor's hands (e.g., inventory, capital property, depreciable property), factors that motivate the disposition of the property, and the transferor's past dealings in the property. For instance, in the case where the transferor can be considered to be in the business of selling patents or patents pending, payments received would be included in business income as trading receipts. However, if the payments are based on the production or use of property, they are included in income pursuant to paragraph 12(1)(g) of the Act. In other cases where capital property has been disposed, the consideration would be proceeds of disposition, which may result in a taxable capital gain under section 38 of the Act and, if the property disposed of was depreciable property in the transferor's hands, recaptured capital cost allowance.
As regards whether patents that are sold are capital property giving rise to capital gains or inventory giving rise to ordinary income, we would mention that the courts have consistently held that one of the most important factors in the classification of a property as capital or inventory is the taxpayer's primary intention at the time the property was acquired. (see Irrigation Industries Ltd. v. MNR, 62 DTC 1131 (SCC)).
As regards a patent that is capital property, Interpretation Bulletin IT-477 (Consolidated) - Capital Cost Allowance - Patents, Franchises, Concessions and Licences, which is available from the CRA website at www.cra-arc.gc.ca, discusses certain tax consequences arising consequential to the ownership of such a property. IT-477 primarily deals with provisions of the Act and the Income Tax Regulations (Regulations) which allow a taxpayer to claim Capital Cost Allowance (CCA) in respect of the property, assuming such property is depreciable capital property in nature, that the property is available for use, and, that it is used for the purpose of earning income.
In the case of foreign patents, paragraph 10 of IT-477 indicates that such patents may qualify as depreciable property in the same way as other foreign property. This qualification is necessary because of restrictions in the Act and Regulations that may preclude the deduction for CCA (e.g., in circumstances where the property is not capital in nature or where the patent is not being used to earn income - see paragraphs 1102(1)(b) and (c) of the Regulations.).
The fact that the sale of a foreign patent might not form part of the primary activity of a business, or that such a sale might be an isolated event, does not necessarily result in a conclusion that the amounts realized from such sale would be capital in nature, giving rise to a capital gain, as it is not necessary that one operate a business in the traditional sense (i.e., of selling patents) to qualify the particular amount as being on account of business income. The definition of the word "business" in subsection 248(1) includes the concept of an "adventure in the nature of trade" which involves an isolated transaction. (endnote 1)
Given the express stated intention that the foreign patents would be obtained for the purposes of sale, it would appear that such property is inventory and would give rise to business income upon disposition.
We trust that the foregoing comments are of assistance.
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
1 The general principles used in characterizing a transaction as an adventure are found in Interpretation Bulletins IT-459 and IT-218. (See also MNR v. Taylor, 56 DTC 1125 (Ex.Ct.), and Tara Exploration and Development Company Ltd. v. MNR, 70 DTC 6370, at 6374-76.)
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