How Canadian withholding tax rules, copyright exemptions, and evolving CRA positions shape the treatment of cross‑border software royalty payments
How Canadian withholding tax applies to software royalties
As a general rule, royalties paid to non-residents of Canada for the use of property in Canada would be subject to non-resident withholding tax under Part XIII of the Income Tax Act (“the Act”). This arises from the wording of subparagraph 212(1)(d)(i) of the Act.
How Canadian withholding tax applies to software royalties
In the absence of a tax treaty applying, this tax will be at a rate of 25%.
However, many professional advisors are often surprised to learn that royalties with respect to the use of computer software are usually exempt as a result of the application of subparagraph 212(1)(d)(vi) of the Act. This provision exempts royalties “in respect of a copyright in respect of the production or reproduction of any literary, dramatic, musical, or artistic work."
Although one might not normally think of a computer program as being a “literary work,” the Canada Revenue Agency has taken the position that it is, within this context, because of changes to Canada’s Copyright Act, effective June 8, 1988, which define a “literary work” as including a computer program.
Tax Court decisions that broadened the exemptions
Nevertheless, at one time, the CRA had a very strict approach to the application of the 212(1)(d)(vi) exemption in connection with payments for the use of computer software. In essence, the CRA did not equate the right to use the software program with the right to copy or reproduce it. This position was of questionable validity in light of the decision of the Tax Court of Canada in Angoss International Limited v. The Queen, 99 DTC 567.
The decision is noteworthy in that royalties under a licensing agreement were held to qualify for this exemption, presumably based on the assumption that the computer software would be reproduced, and therefore copied, into the product created by the licensee. A subsequent decision of the Tax Court of Canada in Syspro Software Ltd. v. The Queen (2003 DTC 931) was consistent with Angoss, and adopted an equally broad interpretation of the exemption for copyright royalties within the context of computer software.
The current CRA approach to software royalty payments
Based on the more recent interpretations from the CRA, it would appear that they now generally accept that royalties for the use of computer software would be covered by this exemption, particularly since copying the software would normally be an integral part of such use.
For example, in Document 2011-0427181E5, the CRA stated, “It is our understanding that the right to produce and reproduce computer software would be copyright protected as a literary work under the Copyright Act and it is generally understood to include allowing an end-user to download the software onto their computer.”