2013-0475751E5 Withholding Tax on Royalty Payments

Principal Issues: Whether Part XIII withholding tax applies to a royalty payment made from Canada to a non-resident taxpayer and whether Article XII of the Canada-US Tax Convention would apply to exempt the payment from withholding.

Position: The answer would depend upon the facts surrounding the payments received from Canada.

Reasons: Questions of fact.

Author: Johns, Jeffrey
Section: 212(1)(d)(ii) and (vi), 115(1), Article VII and XII of the Canada-US Tax Convention

XXXXXXXXXX
                                                      2013-047575
                                                      Jeffrey Johns
                                                      (416) 973 9084

June 19, 2015

Dear XXXXXXXXXX: 

Re: Withholding Tax on Payments from Canada

We are writing in response to your email of January 22, 2013, wherein you requested our comments regarding any withholding tax obligations applicable to payments your company (“USCo”), which is located in the United States, has received from Canada in respect of what you have described as digital XXXXXXXXXX shows that we sell in Canada.

Our comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (the “Act”) and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings.

The principal question outlined in your email concerned the appropriate withholding tax applicable to royalty payments received by USCo.  However, from the facts provided in your email and on the website you directed us to, it is not clear to us that this is the only issue in question.  For instance, you described USCo as receiving royalties, but you also indicated that USCo sells products to Canadian residents.  As well, USCo’s website appears to describe, as a significant part of its business, the provision of services to customers.  These services include both what are described as “XXXXXXXXXX” services.  We have tailored our comments to address the possible Canadian income tax consequences raised by these facts.

Carrying on Business in Canada

The taxation of a non-resident company under the Act will differ depending on the nature of the activities undertaken in Canada by the company and the nature of the payments it receives.  For instance, if the company is considered to “carry on business” in Canada in a taxation year, it will be required to file an income tax return in Canada for that year and will be subject to income tax under Part I of the Act on its business income earned in Canada in that year.  To the extent that business consists of the rendering of services in Canada, the Income Tax Regulations impose a withholding requirement of 15% on any payment made to a non-resident in respect of those services.  This withholding is credited to the non-resident’s Part I income tax liability for the year.

A company resident in the United States doing business with Canadian residents should also consult the Tax Convention between Canada and the United States (the “Treaty”), as the Treaty may operate in certain circumstances to limit the imposition of Canadian Part I income tax on the company.

The question of whether a company is carrying on business in Canada is a question that can only be determined after all of the relevant facts are fully considered.  In order to assist you in making this determination, we suggest you consult the following resources:

*     The Canada Revenue Agency provides a dedicated web page intended to provide resources to non-resident taxpayers at the following address: http://www.cra-arc.gc.ca/tx/nnrsdnts/bsnss/menu-eng.html.

*     For guidance regarding factors to consider when determining where a particular business (or a part of the business) is carried on, see paragraphs 1.52-1.56 of S5-F2-C1: Foreign Tax Credit at: http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s5/f2/s5-f2-c1-eng.html.

You may also wish to consult the Treaty, in particular Article IV, dealing with Residence, Article V, dealing with Permanent Establishment, and Article VII dealing with Business Profits.   Although the CRA does not maintain a copy of the Treaty on its website, the Department of Finance Canada does do so at the following address: http://www.fin.gc.ca/treaties-conventions/unitedstates-etatunis-eng.asp. 

Other Income Earned in Canada

In addition to the Act’s imposition of Part I tax on a non-resident that carries on business in Canada, if a non-resident receives payments from Canada, such as rental income, royalties, pensions, interest, and dividends, Part XIII of the Act imposes a withholding tax of 25% of the gross amount of each payment. 

Sub-paragraph 212(1)(d)(vi) of the Act does provide an exception from withholding tax on royalties or similar payments for copyright in respect of the production or reproduction of any literary, dramatic, musical or artistic work.  However, this general exception will not apply where the work in question is for the use or reproduction in Canada of either:

*     a motion picture film, or

*     a film, videotape or other means of reproduction for use in connection with television.

As with the determination of carrying on business in Canada, the determination of whether Part XIII withholding tax applies to any payments from Canada to USCo or whether the payments would qualify under the above noted exception could only be made upon consideration of all the relevant facts, including the exact nature of the license agreement between USCo and the Canadian payor.

Again, the Treaty should also be consulted.  For instance, in many cases, the Treaty provides relief in respect of payments to residents of the United States, either by instituting a lower percentage rate of withholding tax, or through an outright exemption.  For example, the Treaty lowers the applicable rate on royalty payments to 10%. 

In addition, as you pointed out, Paragraph XII(3) of the Treaty does provide complete exemptions from withholding tax in respect of certain royalty payments, including one for payments for the use of, or right to use, information concerning scientific experience.  Again, in order to determine whether any payments to USCo would meet the requirement of this exemption would require a thorough examination of the license agreement as well as all other relevant facts.

In order to assist you in making your determinations, we suggest you consult Information Circular 77-16R4 - Non-Resident Income Tax, which provides more detailed information on the application of Part XIII of the Act, and is available here: http://www.cra-arc.gc.ca/E/pub/tp/ic77-16r4/.  This circular may also be of use if you ultimately determine that tax has been withheld in error, as it sets out procedures for claiming a refund in paragraph 70.

The Canada Revenue Agency recognizes that complying with the tax laws of Canada as a non-resident poses challenges and attempts to ease this burden through the publication of documents like the ones listed above.  However, it is ultimately each taxpayer’s responsibility to ensure they comply with the provisions of the Act, whether they are resident in Canada or not.  Therefore we would suggest that if, after consulting the documents referenced above and comparing the particular facts of your situation to the information provided in those documents, you are still unsure of your obligations under the Act, either in respect of whether USCo is carrying on business in Canada or in respect of Part XIII withholding tax, you may wish to consider obtaining the advice of a professional services firm.

We trust that our comments will be of assistance.

Yours truly,

Lori M. Carruthers CPA, CA
Section Manager
For Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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