Originally published in Blakes Bulletin on Information
Technology, May 2008
When Canadian companies license computer software from U.S.
licensors and arrange for maintenance and support services for
the software, there are a number of Canadian tax issues to
In connection with the license fee itself, Canadian
withholding tax applies at the rate of 25 per cent to rents,
royalties and similar payments paid by a Canadian resident to
any non-resident of Canada, unless there is an exemption in the
Income Tax Act (Canada) or an exemption or rate
reduction in an applicable tax treaty. The U.S. licensor and
the Canadian licensee should determine which party would bear
the burden of the withholding tax, if any, and any gross-up
clause should be drafted accordingly.
Canadian companies licensing software from U.S. licensors
for use in Canada have long been able to avoid withholding tax
issues by ensuring the licensor (i.e., the "beneficial
owner" of the license fees) is a "resident" of
the U.S. for purposes of the Canada-U.S. Tax Treaty
(the Treaty). Residents of the U.S. were generally entitled to
full benefits under the Treaty. The Treaty contains a full
exemption from withholding tax in the case of payments for the
use of, or the right to use, computer software.
When in force, the Fifth Protocol to the Treaty (the
Protocol), signed on September 21, 2007, may instead require
the licensor to be a "qualifying person" in
accordance with the new limitation on benefits rules in order
to still be eligible for full Treaty benefits. Under the
Protocol, a qualifying person is a resident of the U.S. who
also meets certain criteria set out in the Protocol.
Unfortunately, the criteria are complex and may require
Canadian companies to conduct further due diligence and obtain
additional representations when licensing software from U.S.
licensors. Even if a U.S. licensor is not able to satisfy the
requirements to be a qualifying person, there are other tests
or procedures that may allow the U.S. licensor to quality for
Treaty benefits generally or, in certain situations, limited
Treaty benefits that would include the benefits relating to
license fees for software.
While the Government of Canada has completed the steps
required to give effect to the Protocol, the U.S. government
has yet to complete such steps and, consequently, it is not
clear when the Protocol will amend the Treaty.
With respect to annual maintenance and support fees, such
fees are generally for:
updates and upgrades, and
technical support provided over the phone or by remotely
accessing the computer on which the software is
To the extent such fees relate to updates and upgrades for
the licensed software, that portion of the fees will be
considered part of the licencing fees and treated in the same
manner as the license fees (i.e., there will not be any
Canadian withholding tax if the licensor is entitled to Treaty
benefits). To the extent that the fees are for technical
support (if provided from outside Canada), that portion of the
fees is for services rendered outside Canada and will not
normally be subject to Canadian withholding tax.
In addition to the services described above, a U.S. licensor
of software may provide installation and implementation
services, as well as training, to the Canadian licensee. To the
extent that payments for these services relate to services
provided from outside Canada, the payments will not normally be
subject to Canadian withholding tax. However, if the U.S.
licensor renders these services in Canada, section 105 of the
Income Tax Regulations will apply and the Canadian
licensee will be required to withhold 15 per cent of the fees
attributable to these services (excluding amounts for
reasonable travel expenses and disbursements). Depending on the
extent to which services will be rendered in Canada, the U.S.
licensor may consider applying for a Treaty-based waiver of
this withholding obligation from the Canada Revenue Agency.
The content of this article is intended to provide a
general guide to the subject matter. Specialist advice should
be sought about your specific circumstances.
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