Principal Issues: 1) Whether subsection 56(4) or 56(2) would apply following the transfer of rights by a musician in favour of a corporation. 2) Whether rights of a musician are "eligible property" under subsection 85(1.1). 3) Whether the income generated by such rights is active business income for the corporation.
Position: Insufficient facts to conclude. General comments provided.
Reasons: These matters involve questions of fact.
2007-023822 XXXXXXXXXX G. Gladu (613) 946-5344 April 14, 2009
Dear Sir,
Subject: Issues relating to the transfer of certain rights held by a musician to a corporation
This is in response to your letter of June 1, 2007 requesting our comments on the application of subsections 56(4) and (2) and section 85 of the Income Tax Act (the "Act") to the transfer of certain rights owned by a musician to a corporation. You would also like to know our opinion regarding the characterization or tax nature (active business income or other) of the income derived from the transferred rights.
It appears to us that the situation described in your letter and summarized above could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and a completed transaction or transactions, you should submit all relevant facts and documents to the appropriate Tax Services Office for its opinion. However, we are able to offer the following general comments that may be of assistance.
Unless otherwise indicated, all statutory references herein are to the provisions of the Act.
1) Your Questions
You would like our comments on the potential application of subsections 56(4) and (2) to the transfer of various rights by the individual to the corporation. You also wish to know our position on the potential for the various rights that the individual wishes to transfer to the corporation, utilizing the provisions of section 85, qualifying as "eligible property", within the meaning of subsection 85(1.1),. Finally, you wish to know our position on the potential of qualifying the corporation's income from the transferred rights as income from an active business within the meaning of subsection 125(7).
2) Our Comments
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.
In order to comment on the application of the above provisions to a particular situation, we must, in particular, know the legal nature of the rights that the individual holds and wishes to transfer to the corporation. As a result, and given that your letter only very briefly describes a given hypothetical situation, our comments below will be limited to a summary of some of the main positions previously taken by the Canada Revenue Agency (the "CRA"). More specifically, we will refer to certain CRA positions with respect to the application of subsections 56(4), 56(2), 85(1.1) and 125(7) to a transfer of rights, depending on whether the right being transferred is a copyright or a royalty right.
a) Application of Subsection 56(4)
Subsection 56(4) applies where a taxpayer (the transferor) has, at any time before the end of a taxation year, transferred or assigned to a person (the transferee) with whom the taxpayer was not dealing at arm’s length the right to an amount that would, if the right had not been so transferred or assigned, be included in computing the taxpayer’s income for the taxation year. However, subsection 56(4) does not apply to an amount where the income is derived from property that the taxpayer has also transferred or disposed of. The application of subsection 56(4) is a question of fact.
In the past, the CRA has issued several opinions on the application of subsection 56(4) to the transfer of a royalty interest. In brief, the CRA generally considers that subsection 56(4) applies to a transfer to a person with whom the transferor does not deal at arm's length of a royalty interest where the transfer is not accompanied by a transfer or assignment of the property generating such revenue (e.g., of the copyright or the relevant part of such copyright). For example, in advance ruling F2002-0149781R3, the CRA took the position that subsection 56(4) would apply to the transfer to a corporation by an individual of royalty entitlements arising from contracts with a publisher, on the basis that the related copyright, no longer held by the individual, was not also transferred to the particular corporation. In this regard, the entering into of the publishing contract entailed the irrevocable assignment by the individual to the publisher of all copyright covered by the publishing contracts.
That said, the CRA took the position in advance ruling F2002-0149781R3 of not applying subsection 56(4) to the transfer of royalty rights under an agreement with the Society of Composers, Authors and Music Publishers of Canada (formerly the Society of Composers, Authors and Publishers of Canada Limited and hereinafter "SOCAN") in light of the particulars of such agreement.
b) Application of Subsection 56(2)
Under subsection 56(2), any payment or transfer of property made, at the direction of or with the concurrence of a taxpayer, to any other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person must be included in computing the taxpayer's income to the extent that it would be included if the payment or transfer had been made to the taxpayer. The application of subsection 56(2) is a question of fact.
As illustrated by the example included in paragraph 8 of IT-335R2 - Indirect Payments, the sale of a property for consideration less than its fair market value could result in the application of subsection 56(2). On the other hand, the sale of copyright or royalty interests for consideration equal to their fair market value will generally not trigger subsection 56(2). In this regard, we refer you to the position taken in advance ruling F2002-0149781R3.
c) Eligible property within the Meaning of Subsection 85(1.1)
The CRA has issued several opinions on the potential qualification of copyright as "eligible property" within the meaning of subsection 85(1.1). Whether or not copyright constitutes "eligible property" at a particular time is a question of fact. However, previous positions taken by the CRA indicate that copyright is generally an eligible property within the meaning of subsection 85(1.1). In particular, depending on the applicable facts, such copyright will constitute capital property, eligible capital property or inventory of the transferor. In this regard, we refer you to advance ruling F2002-0149781R3.
On the other hand, the question of whether various royalty rights qualify as "eligible property" within the meaning of subsection 85(1.1) is generally relevant in practice only where subsection 56(4) does not otherwise apply to the transfer of such rights. In this regard, we refer you to the comments in 2(a) above. Thus, depending on the facts and circumstances of a particular situation, the transfer of a right to royalties, together with the transfer of the copyright generating those royalties, could fall within the provisions of section 85 and not be covered by subsection 56(4). In this regard, we draw your attention to the terms of subsection 13(3) of the Copyright Act which, in general, states that, unless otherwise provided by contract, copyright in a work created in the course of employment is the property of the employer and not of the author. That being said, the CRA took the position in advance ruling F2002-0149781R3 that a right to royalties from SOCAN constituted "eligible property" within the meaning of subsection 85(1.1).
d) Classification of Income from Transferred Rights as Active Business Income
Whether royalty income represents income from an active business within the meaning of subsection 125(7) is a question of fact. The CRA's general position is expressed in Technical Interpretation 9722915 and can be summarized as follows. Although royalty income is generally income from property, where it can be established that the royalty income is related to an active business carried on in the year by the corporation receiving the royalty, or that the recipient corporation carries on in the year a business that generates property from which the royalties are received, such income will be considered to be income from an active business. Thus, if a corporation carries on a music composition business, the income it earns from the copyright attributable to that business will generally be considered income from an active business. The fact that such income is in the form of royalties is not, by itself, sufficient to conclude that the income is income from property.
In closing, with respect to your questions concerning the application of the goods and services tax provisions, we invite you to communicate with XXXXXXXXXX Ministère du Revenu du Québec XXXXXXXXXX.
We apologize for the delay in responding to your request. We hope that our comments will be of assistance to you.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
Manager
Mergers and Acquisitions Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.