Principal Issues: [TaxInterpretations translation] Are the amounts received by a corporation royalties, property or business income, or capital gains?
Position: General comments on the concept of "royalties".
Reasons: Question of fact.
XXXXXXXXXX Danielle Bouffard 2009-034779
October 29, 2010
Subject: Amount received by a corporation
This is in response to your fax of November 12, 2009, in which you requested our opinion as to whether amounts received by a corporation are, for the purposes of the Income Tax Act (the "Act"), royalties, income from property, business or capital gain. We have considered the additional information you faxed to us on March 17, 2010.
You stated that a corporation ("Holdco") that held a percentage of the voting shares of a corporation ("Opco") may receive amounts (contingent payments) from a non-resident corporation or its subsidiary, in the event that certain events (liquidity events) occur in relation to the non-resident corporation or its subsidiary. The contract relating to the payment of these amounts (XXXXXXXXXX) between the non-resident corporation, its subsidiary and, in particular, Holdco appears to take into account, on the one hand, the purchase by the non-resident corporation or its subsidiary of the assets and trademarks of Opco following the bankruptcy of the latter and, on the other hand, agreements or undertakings involving Holdco or Opco, their employees or their shareholders.
Our Comments
It appears to us that the situation described in your letter is an actual situation involving specific taxpayers and transactions. Therefore, you should submit all relevant facts and documents to the appropriate tax services office for their opinion. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. As a result, and given that your letter only briefly describes a particular situation, the comments we make below may not apply in full in a particular situation.
It is necessary to first determine whether payments made under a contract of the same type as that described represent royalties for the purposes of the Act. As the term "royalty" (or the French term “redevances”) is not defined in the Act, its ordinary meaning must be used in interpreting the Act. For example, Termium Plus (footnote 1) defines the term "royalty" as follows: "An amount paid at periodic intervals in consideration for a benefit under a contract.”; "The amount of money payable by the user of a patent to its inventor based on the number of objects manufactured.”
In Vauban Productions v. The Queen, 75 DTC 5371 (affirmed by the Federal Court of Appeal 79 DTC 5186), the Federal Trial Court stated the following:
The term "royalties" normally refers to a share in the profits or a share or percentage of a profit based on use or on the number of units, copies or articles sold, rented or used. When referring to a right, the amount of the royalty is related in some way to the degree of use of that right. This is evident from the various dictionary definitions of the word "royalty" when used in connection with a sum payable. Royalties, which are akin to rental payments, have invariably been considered as income since they are either based on the degree of use of the right or on the duration of the use, while a lump sum payment for the absolute transfer of a right, without regard to the use to be made of it, is of its nature considered a capital payment, although it may of course be taxable as income in the hands of the recipient if it is part of that taxpayer's regular business.
In Hasbro Canada Inc. v. The Queen 98 DTC 2129, the Tax Court of Canada cited the previous commentary in Vauban and defined the term "royalty" in these terms:
"A royalty or similar payment is therefore one made for the use of property, rights or information whereby the payments for such use are contingent upon the extent or duration of use, profits or sales by the user."
In light of the foregoing, the amounts described in the contract as "contingent payments" that may be paid to Holdco do not, in our view, appear to represent royalties to Holdco.
Whether, in a particular context, an amount received by a corporation is in the nature of income from property or a business or a capital gain is a question of law that must be determined having regard to all the facts. Due to the limited information provided to us, we are unable to determine the impact of the agreements and commitments between the parties (to which the contract refers) on the payments of amounts to Holdco that represent a percentage, broadly speaking, of the cash derived from the shares of the non-resident corporation's subsidiary (in the form of dividends or the sale of such shares). Among other things, we cannot determine whether the payments take into account factors such as the services rendered by the employees/shareholders of Opco and/or Holdco, the expertise and reputation of such employees/shareholders, the products and trademarks developed by Opco prior to its bankruptcy and the value of the shares of the non-resident corporation's subsidiary. Consequently, it is impossible for us to comment on the application of specific provisions of the Act in this situation.
Best regards,
François Bordeleau, Advocate
Manager
Business and Partnerships Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 The Government of Canada's terminology and linguistic data bank.