Article 12 - Royalties

At the time of his emigration from Canada to the US, "Mr. X" was entitled to the "Payments" from a Canadian resident who had purchased a client list for a business previously carried on by Mr. X. The Payments were based on the purchaser's use of the client list and, until emigration, had been included in Mr. X's income under s. 12(1)(g). How does Part XIII apply?

CRA noted that the portion of the post-emigration Payments that were dependent on the use of or production from the client list in Canada would be subject to Part XIII tax under s. 212(1)(d)(v). However, they would be "royalties" under Art. XII, para. 4 of the Canada-US Tax Convention (the "Treaty"). CRA stated:

payments arising in Canada that are beneficially owned by a resident of the US and that are for the use of any information concerning industrial, commercial or scientific experience would be taxable only in the US, and not subject to Part XIII tax pursuant to paragraph 3 of article XII of the Treaty.

Mr. A, a U.S. resident, grants the right to drill for or take the oil & gas from his Canadian freehold property to a Canadian company, in consideration inter alia for annual royalties payable out of any oil & gas production. After noting that in any event the royalties could be taxable to Mr. A under s. 115(1)(a)(ii) or (iii.3) rather than s. 212(1)(d)(v), CRA stated:

The annual royalty payments arising from the oil and gas rights paid by the company to Mr. A are not included in this definition [in Art. XII of the Canada-US Treaty]. As a result, they do not qualify for the 10% treaty rate under paragraph 2 of Article XII of the Treaty. Therefore, the company must withhold and remit 25% of the annual royalties paid to Mr. A.

Canco is granted an exclusive licence, bearing a royalty, by NRCO (an arm's length resident of Ireland) in respect of patents and know-how for the production and commercialization of certain products. The licence agreement provides that Canco must make certain payments upon the occurrence of specified events respecting the extension of the term of the licence.

CRA stated (TaxInterpretations translation) that here there was "a series of lump sum payments to be made upon the occurrence of specific events, such that they do not qualify as royalties, per se." However, they were royalties under the Ireland-Canada Convention - but were exempt under Art. 12, subpara. 3(b) as royalties for the use of, or the right to use, any patent or information concerning industrial, commercial or scientific experience.

CRA was asked whether the payment by a Canadian insurance broker (Aco) to a US insurance broker (Bco) of a percentage of the commissions earned by Aco, as a result of Bco providing Aco with information respecting US customers of Bco who wanted coverage for Canadian assets, would be subject to withholding under Reg. 105 or s. 212(1)(d). After noting that such fees paid by Aco likely would be characterized as payments "for information concerning industrial or commercial experience...[within] subparagraph 212(1)(d)(ii) of the Act," CRA went on to indicate that they likely would be exempt under Art. XII of the Canada-US Income Tax Convention:

Where a resident of the U.S. is in receipt of payments for services made in the course of its business carried on in the U.S., it would be exempt from taxation in Canada by virtue of paragraph 1 of Article VII of the Treaty. However, paragraph 6 of Article VII of the Treaty states that if an element of the business profits is dealt with separately in other provisions of the Treaty, then those provisions are to be considered. In our view, payments made to a non-resident for information concerning industrial or commercial experience fall under the provisions of Article XII of the Treaty.

...The exemption under paragraph 3(c) [of Art. XII] covers payments for information concerning commercial and industrial experience. Therefore, a nil rate of tax applies to the gross amount of payments for the use of, or the right to use, information concerning industrial or commercial experience.

A US website publisher, which qualifies for benefits under the Canada-US Income Tax Convention and does not have a server or other permanent establishment in Canada, enters into an arrangement with an independent Canadian-resident promoter (the "Promoter") under which the Promoter will sell advertising space on the website to Canadian advertisers. A Canadian advertiser would agree to pay the Promoter a fee of, say, $100 for every 1,000 "clicks" generated on the advertiser's ad. The Promoter would retain, say $20 of this fee and remit the remaining amount to the US publisher.

CRA found that, although the fees otherwise would have been subject to Part XIII withholding tax under s. 212(1)(d)(iii)(A), they should be characterized as being for services of the US publisher (as its employees would by uploading the ads to the website and carrying out various maintenance functions), so that they did not come within the "royalties" definition in Art. XII of the Canada-US Convention. Assuing the US publisher had no permanent establishment in Canada, the fees also would be exempt under Art. VII, para. 1.

The taxpayer inquired about whether Part XIII tax is payable in respect of a "licence fee" paid to a non-resident for access to "an on-line marketplace trading platform" similar to eBay, and in particular whether such fees are royalties. CRA replied that the OECD Model Convention provides that a fee for the use of computer software is not characterized as a royalty for treaty purposes, and stated that such a fee would not be a royalty unless the bilateral tax treaty in issue "includes an intellectual property clause specifically providing that payments for digital property are considered taxable as a royalty."

A qualifying US-resident ("Pubco") provides Canco with an exclusive licence to manufacture and distribute some product lines in Canada, with a "royalty-free" licence of trademarks used in promoting and selling the products. Pubco provides only minimal ancillary support, e.g., the provisions of instructional materials for use by the product purchasers "and will not impose any restrictions on the manner in which Canco may carry on its business."

The amounts paid by Canco to Pubco (calculated pursuant to an agreed formula) are (to the extent that they are for the use of, or the right to use, any patent or know-how) taxable only in the US by virtue of Article 12, para. 3(c) of the Canada-U.S. Convention.

A US LLC ("Corporation C"), whose sole member was a US corporation qualifying for benefits under the Canada-US Convention, ran a platform for the provision of "Digital Content" (movies, television shows, music videos, documentaries and similar audio-visual content) which it (and affiliated corporations) were permitted to distribute under content licence agreements with the third-party holders of the copyright. Canadian distributors (described as "Customers") created online storefronts for Canadian individual home users, running on Corporation C's platform, with customized design and branding for the Canadian Customers. Although the home users were licensed the right to receive Digital Content by virtue of agreements they entered into only with the Canadian Customers, it was Corporation C which collected the fees from them and operated the "online store", and it was stated in the description of facts to be the beneficial owner of those payments.

CRA ruled that fees collected from Canadian home users were exempt from Part XIII tax under Art. XII(3)(a) of the Convention. The exclusion in that provision for "payments in respect of motion pictures," was not discussed (presumably because it was accepted not to be applicable - see 2011-0374421E5).

Oil royalty payments are covered by Art. VI, para. 2 of the Canada-US Convention ("amounts computed by reference to the amount or value of production from...resources") rather than by Art.XII, para. 4 ("payments...for...the use of...tangible personal property") and, accordingly, are not subject to the Treaty-reduced withholding tax rate.

The exemption in the Canada-US Convention for royalties paid for the reproduction of motion picture films (in this case, on videos) for private home use rests on the 1984 US Treasury Explanation to that Convention. In the case of other similarly-worded treaties, such as those with the UK, France and Thailand, this interpretation does not apply so that such royalties are subject to Treaty-reduced rates of Part XIII tax (of 10%, 10% and 15%, respectively, in the case of those three countries) rather than being exempt.

A Canadian-resident company (Canco) uses motion pictures distributed to it by a US and French company by reproducing them in Canada in digitized form and encrypting, in order that it can provide them to Canadian customers using its specialized software. The fees paid to the US distributor (a qualifying US resident) are subject to Part XIII tax at a Treaty-reduced rate of 10%, and the fees paid to the French distributor are exempt from Part XIII tax if the conditions in Art. XII, para. 4(a) of the Canada-France Convention are satisfied.

Respecting the position of Canada that after May 27, 2002 a payment for the use of custom computer software will only be subject to the royalty article of a particular convention if there is a reference to other intangible property in the royalty definition and there is no specific exclusion in the royalty article for computer software, CCRA noted that there is no change in assessing practices for payments made before March 28, 2002.

After indicating that "franchise" had its broad meaning under the Canadian domestic income tax jurisprudence as described in IT-477, RC indicated that although the term "franchise" as used in Article 12 of the Canada-U.S. Convention covers a broad range of commercial arrangements, it agreed "that the transfer of know-how, in and of itself, does not constitute a franchise agreement".

In noting that royalties paid for a licence to make videos available to the patrons of a health club, who view videos on installed televisions sets while they exercise, will not be exempt from withholding tax, RC stated:

"Royalties in respect of the production or reproduction of motion pictures or video tapes which are not for private (home) use, including but not limited to those used in connection with television broadcasting, are not exempt. Note that private (home) use does not include showing a copyright work in public, such as bars, health clubs, airplanes, or other facilities generally open to the public."

Payments made by a Canadian resident user to a U.S. resident supplier for accessing an information data base located in the U.S. via a modem located in Canada would be exempt as being for the use of, or the right to use, information concerning industrial, commercial or scientific experience. Where the information was accessed by subscription to an information CD-ROM, part of the payment would appear to be for the use of, or the right to use, software and would be exempt, instead, on that ground.

RC accepts that royalties paid for the use of, or the right to use, know-how as defined in paragraph 11 of the Commentary on Article 12 of the OECD Model Income Tax Convention constitute payments for the use of, or the right to use, information concerning industrial, commercial or scientific experience. The exemption in subparagraph 3(c) of Article 12 of the Canada-U.S. Treaty applies only to payments for the use of, or the right to use, the benefits that have arisen as a result of R&D and not the R&D expenditures that sells.

Where the Italian branch of a Canadian corporation pays royalties to a German affiliate of the Canadian corporation as the result of the licensing of a trademark by the German affiliate to the Italian branch, withholding tax is exigible by virtue of s. 212(1)(d) of the Act and Article 12 of the Canada-Germany Convention.

The exemption in Article XII of the Canada-U.S. Convention for copyright royalties does not apply to royalties for video tape works intended for private (home) use.

With respect to a situation where a Canadian company pays royalties to a resident of the U.K. for the right to reproduce certain movies, television series and children's programs in video format with the resulting videos being sold to distributors who would, in turn, rent or sell the videos to the public for private use, RC stated "that if the payments are computed on the basis of the number of times a video movie is shown and/or viewed rather than on the number of copies of the video produced, the payments would not fall within the exemption in paragraph 3 of Article 12 as they would not be considered to be in respect of the production or reproduction of the work".

The payment to a non-resident for the right to distribute computer software is generally taxable under s. 212(1)(d). Such payments made to a resident of the U.S. would not come within the definition of royalties in Article XII of the Canada-U.S. Convention and, therefore, would be exempted under Article VII unless the related income is attributable to a permanent establishment.

Payments made by a Canadian resident to a U.S. resident for the right to distribute computer software would generally be taxable under s. 212(1)(d), but would not fall under the definition of royalties in Article 12 of the U.S. Treaty and, therefore, usually would be exempted from tax under Article 7.

Where a Canadian firm agrees with an American firm to duplicate video cassettes for sale or distribution through rental establishments for non-commercial use by the end users, the payments made for such duplication rights will not be subject to Part XIII tax, even though the source of the work might be a motion picture film.

"We would definitely recommend that the Department challenge any arrangement where a Canadian distributor supposedly enters into an agreement with a non-resident person to acquire the right to produce or reproduce video tapes and then turns around and enters into another contract with the same non-resident, or a person related or connected to that non-resident, to have the video tapes reproduced by such a person."

The definition of royalties in the Canada-U.S. Income Tax Convention includes payments made to a resident of the U.S. for the use of computer software.