Subparagraph 212(1)(d)(vi) of the Income Tax Act (Canada) exempts non-residents of Canada from non-resident withholding tax on Canadian royalty payments received in respect of a copyright for the production or reproduction of any literary, dramatic, musical or artistic work. In a recently released technical interpretation (2011–0427181E5, dated August 23, 2012), the Canada Revenue Agency (CRA) was asked whether a non-resident corporation receiving a bundled license fee payment in respect of custom computer software from a Canadian resident would be subject to withholding tax.
The bundled license fee consisted of:
- a payment for the right to sublicense the right to download and use custom computer software by end-users in Canada;
- a payment for the exclusive right to market and distribute the software in Canada; and
- a payment for ongoing software upgrades and support of the software through the non-resident corporation's website and telephone lines.
While its comments were non-binding, the CRA confirmed that:
- it will generally apply the royalty withholding tax exemption broadly (in keeping with the Tax Court decision in Syspro Software Ltd. v. The Queen, 2003 TCC 498) to include not only payments for the right to sublicense computer software, but also payments for the connected right of distributing the software;
- payments for software upgrades are considered to be part of the original software license fee and thus would qualify for the royalty withholding tax exemption; and
- payments for software support services are not subject to Canadian non-resident royalty withholding tax, and would only be subject to the 15% withholding under Regulation 105 if the services are rendered in Canada.
The technical interpretation is a good reminder that with forethought, appropriate drafting, and the right facts, withholding tax on cross-border license fees relating to the use of software can be reduced or eliminated.
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