20 December 1974 Income Tax Severed Letter

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.

December 20, 1974

Audit Review Division

Mr. J.A. Calderwood Director

Technical Interpretations Division (A.B. Adler)

Management or Administration Charges, Rents, Royalties or Similar Payments

This is in reply to your memorandum dated June 25, 1974 in which you requested our comments in respect of a number of questions raised by the Vancouver, Montreal and Toronto District Offices during a conference at Head Office.

The enclosed answers follow the order of the questions under item 2 of the summary attached to your memorandum. Our references are to the provisions of the Income Tax Act currently in force.

We regret the delay in replying to your memorandum.

Assistant Director Technical Interpretations Division

ABA/hb

Enclosure

Paragraphs 212(1)(a) and (d) - I.T.A. Subsections 69(2), 212(4), 214(3) and 245(2) - I.T.A. Canada - U.S. Tax Convention - Article VIII - para. 6(a) of the Protocol Canada - U.K. Tax Agreement - Articles 6, 11 and 12

Rents, Royalties or Similar Payments Payments to Non-Residents for Management or Administration Fees or Charges

Our answers to the ten questions are as follows:

(i)(1) Paragraph 212(1)(a) of the Income Tax Act provides the authority for taxing a management or administration fee or charge. This provision applies except where there is a conflicting provision in the bilateral tax convention between Canada and the foreign country of a non-resident. In particular, the Canada - U.S. Tax Agreement does not contain a conflicting provision.

(2)(a) In our view a payment to use information under subpara. 212(1)(d)(ii) would fall within the term "rental and royalties" in para. 6(a) of the Protocol of the Canada - U.S. Tax Agreement and accordingly be subject to Part XIII tax. As indicated in Western Electric Company Incorporated 69 DTC 5212 the right to use know-how is essentially the same as the right to use a patent or secret process.

(b) Payments under subparagraph 212(1)(d)(v) could, depending upon the circumstances, be regarded as royalties under para. 6(a) of the Protocol. Refer to the relevant comments concerning the Canada - U.S. Tax Convention under (2)(c) below.

(c) The view was expressed "that the taxpayers appear to be right in their contention that section 106(1)(d) (para. 212(1)(d) in current Act) is not applicable in respect to subparagraphs (iii) - (v) for U.S. corporations and subparagraphs (iv) and (v) for U.K. corporations." Presumably, such corporations do not have a permanent establishment in Canada. Our comments follow:

Canada - U.S. Tax Convention

Subpara. 212(1)(d)(iii) is overridden. In our view a payment for services dependent upon use, production or profits is in the nature of compensation for services and not a royalty and, accordingly, is properly included in the term "industrial and commercial profits" as used in this Convention.

Generally, subpara. 212(1)(d)(iv) is overridden, unless the facts of a particular case indicate that it is a royalty or similar payment.

With regard to subpara. 212(1)(d)(v), Article VIII will apply to capital assets where the conditions of this Article are met (generally, under U.S. law, the sale or exchange of a capital asset gives rise to a capital gain)*. Where a property is not a capital asset generally its sale will be included in the industrial and commercial profits of an enterprise under this Convention and this profit of a U.S. enterprise will be taxed under Part 1 of our Act or not at all. In this circumstance the property could give rise to a permanent establishment of the non-resident in Canada. A lump sum payment made to the U.S. enterprise could, depending upon the circumstances, be regarded as a royalty payment under U.S. law (Refer to (X)(c) below). Other payments which fall under subpara. (v) will be treated like a royalty to which Part XIII applies.

           Note that a resource property under our Act could be regarded as a capital 
asset under this Convention.

(d) Canada - U.K. Tax Agreement

In the case of subpara. 212(1)(d)(iv) our comments are the same as expressed under (c).

Where capital gains arise from the alienation of immovable property or movable business property in Canada by a U.K. resident or enterprise subsections (1) and (2) of Article 12 of the U.K. Agreement provide that any such gain is subject to Canadian tax. In the case of a resource property, for example, subparagraphs 115(1)(a)(ii) or (iii.1) could have application. Where, however, subsection (3) of Article 12 applies to other property neither subpara. 212(1)(d)(v) nor any other provision of our Act applies. Any gain properly included in the industrial and commercial profits of a U.K. enterprise is not subject to Part XIII tax and is only subject to Part 1 tax if there is a permanent establishment in Canada.

The treatment of other payments to which subpara. 212(1)(d)(v) applies (i.e. payments similar to royalties) is more complex under the U.K. Agreement. Article 6 excludes royalties defined under Article 11 in determining "industrial and commercial profits". Subsection 5 of Article 11 specifically excludes royalties or other amounts paid in respect of the operation of mines or quarries or of the extraction or removal of natural resources from the term "royalties" used in Article 11. As a result, amounts referred to in ss. 5 could only be taxable under Part 1 of our Act. Subsection (2) of Article 11 limits the Canadian tax on royalties as defined in the Convention (other than copyright royalties and other like payments) to 10% and copyright royalties and other like payments are exempt from Canadian tax.

(ii) The principle of "ejusdem generis" applies solely to a "similar" payment recorded in the first line of para. 212(1)(d). Our advisory counsel concurs with this interpretation.

(iii) The wording of para. 212(1)(d) does not make all the payments which fall under subparagraphs (i) to (v) inclusive rents, royalties or similar payments. As indicated in (1)(2)(c) above under the heading Canada-U.S. Tax Convention a payment for services under subpara. 212(1)(d)(iii) is more in the nature of a compensation for services rather than a royalty.

(iv) We suggest that changes along the following lines to item 41 of Information Circular 72-9 might remove some of the problems encountered.

Management or Administration Fees or Charges

41. Management or administration fees or charges paid or credited by a resident of Canada to a non-resident person after June 13, 1963, are taxed at the rate of 25% (15% until 1976 by virtue of ITAR, ss. 10(2)) of the payment. The tax is withheld by the Canadian resident payer and remitted on form NR7. When paid or credited to a non-resident firm of independent consultants such fees are not subject to tax under Part XIII (Part III) of the Act, but such amounts paid in respect of services rendered in Canada will continue to be subject to a deduction of 15% under the Income Tax Regulations on account of the recipient's liability for tax under Part 1 of the Act. Such fee or charge paid by a corporation resident in Canada to a related corporation resident outside Canada is not a management or administration fee or charge subject to tax under Part XIII (Part III) of the Act if:

(a) it was a reimbursement of a specific expense incurred by the non-resident corporation for a service that was for the benefit of the payer and

(b) the amount was reasonable in the circumstances.

To the extent that these conditions are not met, the amount will be taxed as a management or administration fee or charge, or as a rental, royalty or deemed dividend following an analysis of said amount. If the payment is a contractual amount based on a period of time, a prorating of expense or percentage of sales the onus will be on the Canadian corporation to provide a breakdown of said amount into the Canadian corporation's share of its components by specific expenses at their cost to the non-resident related company. If these expenses total at least the amount of the charge, are reasonable in the circumstances and are otherwise allowable expenses to the Canadian corporation the amount will not be taxed as a management or administration fee or charge. Salaries from Canadian corporations to a non-resident person will not be considered management or administration fees or charges under Part XIII (Part III) of the Act.

(v) Our position is what para. 212(1)(a) would cover (if ss. 212(4) does not take it out) will not be covered by para. 212(1)(d). In the case of a payment for services which are principally management or administrative in nature para. 212(1)(a) applies notwithstanding that the services are partly of an industrial, scientific character as referred to in subpara. 212(1)(d)(iii). Where, however, services of an industrial, commercial or scientific character are clearly in respect of an income producing activity (e.g. a payment to a non-resident engineering company for services in applying special know-how) subpara. 212(1)(d)(iii) applies provided the conditions described therein are met. Where this subpara. applies to a non-arm's length transaction subsections 69(2) and 214(3) or 245(2) could have application.

(vi) No comment

(vii) No comment

(viii) Subpara. 212(1)(d)(I) could apply in both situations since the payment is for the right to use know-how.

(ix) We concur with Mr. Mavor's comments. In addition, it is our view that the onus is on a Canadian subsidiary to establish the deductibility of a charge by a non-resident parent company in respect of general supervision. These services must be performed for the benefit of the Canadian subsidiary and should not duplicate services already provided by Canadian personnel.

(x) In our opinion payments in respect of initial fees on franchises are payments "…for the right to use in Canada any property" under subpara. 212(1)(d)(i) and any such payments fall within paragraph 6(a) of the Protocol of the Canada - U.S. Tax convention particularly where these payments constitute income to the non-resident. Payment for the use of a trade name would also come under subpara. 212(1)(d)(i).

(a) "Any payment" as used in para. 212(1)(d) includes payments which are income or capital in nature. Subpara. 212(1)(d)(v) refers explicitly to a capital payment i.e. an instalment on the sale price of a property.

A lump sum payment for the acquisition of a Canadian patent would not fall under subpara. 212(1)(d)(i) since this is not a payment for the "right to use" as required by this provision.

(b) No. Refer to opening paragraph under (X)(a) above.

(c) We understand under American Tax Law royalties include a lump sum payment. Revenue Ruling 55-17 rules that a specific amount paid upon execution of the contract as well as the quarterly instalments at a rate based on production are in the nature of royalty income and subject to withholding of tax at source under section 144 of the Code. Accordingly Article VIII of the Canada-U.S. Tax Convention is not of concern.

(d) We regard initial fees on franchises as royalties under paragraph 6(a) of the Protocol of the Canada - U.S. Tax Convention.

(e) Subpara. 212(1)(d)(i) would apply where the payment is predicated on the future use of the invention in Canada and would be regarded as a royalty under the Canada - U.S. Tax Convention. If, however, the lump sum payment is for the acquisition of a patent see (a) above.