February 13, 1992
| Head Office | Rulings Directorate |
| Appeals Branch | O.S. Laurikainen |
| 957-2116 |
Attention: M.S. Lalonde
911922
24(1)
Payments to Non-residents Under a License to Use Computer Software
This in response to your memorandum dated July 15, 1991 wherein you requested our comments concerning a submission
24(1)
in defence of the view that the payments by 24(1) his client, to 24(1) a resident of the United States, for the use of copyright computer software were exempt from Canadian non-resident withholding tax.
The following facts have been gleaned from the submission and the copy of the license agreement between 24(1) (the "License Agreement"):
24(1)
24(1)
We agree with 19(1) contention that the payments made by 24(1) for the use of the computer software are not in respect of copyright in respect of production and reproduction of the software and are therefore not for the use of copyright. Nevertheless, it is our view that such payments are subject to Canadian withholding tax under the Income Tax Act (the "Act") and are not exempted under the Canada-United States Income Tax Convention and Protocol (the "1942 treaty") or the Canada-U.S. Income Tax Convention (1980) (the "1980 treaty").
Subparagraph 212(1)(d)(i) of the Act and the 1980 Treaty
Payments made under the License Agreement are for the use of the software in question rather than for the purchase of an ownership interest in the program or part thereof as is clarified in paragraphs 1) and 2) above. It is our view that payments for the use of, or the right to use computer software is a payment for the use of or the right to use, a secret formula or process and is a payment described in subparagraph 212(1)(d)(i) of the Act. In addition, it is our view such payments meet the definition of "royalties" in the 1980 treaty. This view is supported by the Department of Finance 23
24(1)
Accordingly, it is our position that all of the payments made under the License Agreement fall under the provisions of subparagraph 212(1)(d)(i) of the Act and those that are made after the coming into force of the 1980 treaty would be subject to Canadian withholding tax at the reduced rate of 10% provided thereunder.
The 1942 Treaty
While we agree with 19(1) view that the payments do not meet the ordinary definition of "royalties", it is our view that both the lump sum and the periodic payments can be aptly described as "rentals" for the purposes of the 1942 Treaty. Support for this view is found in the case of The Queen v. Saint John Shipbuilding & Dry Dock Co. Ltd. 80 DTC 6272 ("Saint John Shipbuilding"), at 6275 where Judge Thurlow states that "The word "rental" is not a familiar one to use in connection with property rights of the kinds enumerated but I see no reason to think that when used in reference thereto it would connote characteristics different from those it has in its more familiar use in relation to tangible property. A rental can, of course, be paid in a lump sum but in my opinion the word is inseparable from the from the connotation of a payment for a term, whether fixed in time or determinable on the happening of an event or in a manner provided for, after which the right of the guarantee to the property reverts back to the grantor." In this case, while renewable, the License Agreement is for a term of 24(1) and any failure by 24(1) to make a one of the periodic payments when due represents a breach of the agreement which can result 24(1) having to discontinue the use of the software. Accordingly, any payment (including the lump sum payment) that has been made prior to the due date of the next periodic payment can be described as having given 24(1) the right to use the software until that time.
In our view such payments can properly be described as "rentals" under the guidelines enunciated by Judge Thurlow in Saint John Shipbuilding.
Article II of the 1942 treaty excludes "rentals" from the definition of the term "industrial and commercial profits" which are dealt in Article I thereof and Article XI gives Canada the right to tax such rentals at the reduced rate of 15%.
Other Issue
24(1)
It may be reasonable to consider a portion of the lump sum payment to have been in respect of such services and not as consideration for the use of the software.
However, since we do not have all the facts we cannot comment further on that matter.
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