| 24(1) | 5-910839 |
| O. Laurikainen | |
| (613) 957-2116 |
Attention: 19(1)
March 12, 1992
Dear Sirs:
Re: Section 17 and Paragraph 212(1)(d) of the Income Tax Act (the "Act")
This is in response to your letter dated March 22, 1991 wherein you requested a technical interpretation whether the above provisions of the Act would have application in the following hypothetical fact situation:
1. A company, resident and incorporated in Canada ("Canco"), enters a program adaptation licence agreement (the "Agreement") with an arm's length company resident and incorporated in the United States ("U.S. Co."). Canco does not have any equity interest in U.S. Co.
2. Pursuant to the Agreement, U.S. Co. undertakes to develop from one of its pre-existing computer software programs, a computer software program meeting Canco's specifications (the "Software").
3. The Agreement provides that U.S. Co. grants Canco an irrevocable exclusive right and license in Canada to demonstrate, market, distribute and copy for any of these purposes, the Software for the term of the Agreement. If Canco does not make the Software available for license within one year of Canco's acceptance of the Software, Canco's license will become non-exclusive. Canco and related companies will not use the Software internally.
4. Canco will reproduce the software for distribution in Canada and will pay U.S. Co. as royalties for each license of a copy of the Software reproduced by Canco and supplied to an end user, 35% of Canco's license revenue.
5. Canco will advance to U.S. Co. the amount of $1,000,000 U.S. as an advance against future royalties (the "Advance").Canco will advance the funds to U.S. Co. throughout the development process in order to financially assist U.S. Co. in the development of the Software.
6. Canco's Advance to U.S. Co. is non-interest bearing with no repayment obligations except as described in paragraph 7 below, and the Advance may be outstanding for one year or longer.
7. The Advance will be recovered by Canco in the following manner:
(a) until the Advance has been fully recovered, 100% of the royalty payment (i.e. 35% of Canco's license fee) for each license of Software distributed under the Agreement by Canco will be retained by Canco and applied against the Advance;
(b) until the Advance has been fully recovered, 25% of the license fee for the first four (4) licenses of Software distributed outside of Canada by U.S. Co. will be paid to Canco by U.S. Co. and applied against the Advance and 75% thereof will be retained by U.S. Co.; and
(c) until the Advance has been fully recovered, 50% of the license fee for each license of Software subsequently distributed outside of Canada by U.S. Co. will be paid to Canco by U.S. Co. and applied against the Advance and 50% thereof will be retained by U.S. Co.
When the Advance is fully recovered, Canco is not entitled to receive any payments from U.S. Co. on account of U.S. Co.'s licensing of the Software, and as discussed in paragraph 4 above, Canco will pay to U.S. Co. as royalties for each license of a copy of the Software, 35% of Canco's license revenue.
Subsection 17(1) of the Act
In order to determine whether Canco has made a loan to U.S. Co. it would be necessary to review all of the relevant evidence and to ascertain the legal rights and obligations that flow from the agreement(s) in question. However, generally where the agreements in question do not contain an unconditional covenant to repay the principal amount of money advanced, the transaction cannot be considered to represent the loaning of money. Since it appears Canco must look exclusively to the commercial success of the computer software for reimbursement of the advance, it may be that Canco has not "...loaned money to..." U.S. Co. for the purposes of subsection 17(1) of the Act.
Subparagraph 212(1)(d) of the Act
Subparagraph 212(1)(d)(vi) of the Act provides that a royalty or similar payment on or in respect of a copyright in respect of the production or reproduction of any literary, dramatic, musical or artistic work is exempt from non-resident withholding tax under paragraph 212(1)(d) of the Act. Computer programs are literary work subject to copyright under the Copyright Act. Therefore, provided a copy of a computer software program that is supplied to an end user by Canco has been produced or reproduced by Canco, it is our view that a software license fee paid or credited (against the Advance) by Canco to U.S. Co. in respect thereof would be exempt from Part XIII of the Act withholding tax by virtue of subparagraph 212(1)(d)(vi) of the Act. In addition, it is our view that no Part XIII withholding tax would be applicable to the transaction referred to in paragraph 5 above.
We hope the above will be of assistance to you.
Yours truly,
ChiefForeign SectionReorganizations and Foreign DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch