6 March 1991 External T.I. 9022785 F - Maintenance Agreements for Software Programs

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.

5-902278

Dear Sirs:

Re:  Maintenance Agreements for Software Programs

This is in reply to your letter of August 23, 1990 and further to our telephone conversation of November 1, 1990 concerning the income tax treatment on payments for services under maintenance agreements for software programs.

As mentioned to you in our telephone conversation (Middleton  19(1) we are unable to provide our views without seeing the specific terms and conditions of an actual maintenance agreement.  However, we would like to offer the following general comments:

In order for payments for any services provided in connection with the use of computer software not be considered as part of a software license agreement, we fell that the following two conditions must be satisfied:

1.     The acquisition of the services should be optional.  That is, 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, or the right to use, the licensed software, we usually would consider the payments for the services to be part of the software licence fee to Part XIII tax.

2.     The payment for the services should be reasonable in relation to the software licence fee.  Any unreasonable portion of the service payments would be viewed as a portion of the licence fee subject to Part XIII tax.

If the payments for services are not considered to be part of the computer software license fee, they could still be subject to a 15% withholding tax under subsection 105(1) of the Income Tax Regulations (the "Regulations") if the services are rendered in Canada by the non-resident person.  Taxes withheld under Regulation 105(1) are on account of any possible tax liability under Part I of the Income Tax Act.  If the non-resident payee is considered to be a resident of the U.S. for purposes of the 1980 Canada-U.S. Income Tax Convention (the "Convention"), such payee will be exempt under Article VII of the Convention from Canadian tax on the business profits earned from the provision of the services unless the payee carries on business in Canada through a permanent establishment in Canada and the profits are attributable to such permanent establishment.  A payee who is exempt from Canadian taxation by virtue of Article VII of the Convention may obtain a refund of taxes withheld under Regulation 105(1) by filing a Canadian tax return.  It should be noted that Article VII of the Convention does not prohibit the initial withholding under Regulation 105(1) but a payee who is exempt from Canadian tax by virtue of Article VII may apply for a refund of the taxes withheld.

If, on the other hand, the non-resident payee renders the services outside Canada, there will not be any requirement to withhold under Regulation 105(1).

Finally, we understand that computer software updates represent modifications, improvements and additions to the software originally licensed.  Therefore, strictly speaking, we consider payments for, or payments to obtain discounts on, such updates as being essentially the same in nature as the original software license payments which are subject to Part XIII tax, rather than so being payments for services.

We trust these comments will be of assistance to you.

for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch