Inbound Transfers of Technology

• Author: Brian D. Segal
• Pages: 277-317

277

Chapter 12

Inbound Transfers of Technology

brian d. segal

A. INTRODUCTION

There are two primary methods for transferring technology. The technol-

ogy may be sold or assig ned, or it may be licensed either for a limited dur-

ation, or in perpetuity, or by geographic area. The media for transferring

the technology may vary. The transferee may acquire the “hard copy” con-

taining the information or it may acquire a compact d isc (CD) or a digita l

video d isc (DVD) with the information embedded in it. Alternatively, the

user may access the technology through the internet and “download” the

information onto t he user’s own computer. Each type of tra nsfer, and the

medium used for the transfer, raises unique Canadian income tax issues.

For the non-resident receiv ing a payment for the use of the technology, one

issue is whether the payment will be subject to Canadian non-resident with-

holding tax under Part XIII of the Income Tax Act.1 Another issue for the

non-resident is whether t he payment will be subject to ordina ry income

tax under Part I of the Act on the basis that the non-resident is carrying on

business in Canada or has a permanent establishment in Canada. For the

person maki ng the payment to the non-resident, the issue is whet her the

payment is deductible in computing the taxpayer’s income under the Act

for the year or must be amortized or depreciated under the Act. Each of

these issues is considered in more detail in this chapter.

1 R.S.C. 1985 (5t h Supp.), c.1, as amended [the Act]. All st atutory references are to the Act,

unless other wise stated.

278 brian d. segal

B. WITHHOLDING TAX

1) Relevance of Withholding Tax to Residents and Deeme d Residents of

Canada

Tax liability imposed in the Act under Part XIII (withholding tax) applies only

to certai n types of payments, generally payments derived from property (as

opp osed to bu sine ss), su ch a s rent s or r oyal ties ,2 mad e by a r esid ent of Cana da

to a non-resident of Can ada. A lthough the tax is imposed on the non-resi-

dent,3 the issue is of more than passing interest to the Canadian payer.

First, the Canadian payer is obligated to withhold and remit the tax to

the Receiver General for Canada on behalf of the non-resident4 when the

amount is paid or credited to the non-resident5 and is jointly and severa lly

liable with the non-resident for the tax.6 Failure to remit or to remit timely

may result in penalties and interest.7

Second, the non-resident will often pass on the withholding tax cost to

the Canad ian payer. This is generally accomplished by including a “gross

up” clause in the technology agreement, requiring the payer to ensure the

non-resident receives the amount it would have received had the payment

not been subject to wit hholding in the f‌irst instance. Because the additional

payment is itself subject to withholding tax, the payer will be required to

compensate the non-resident not only for t he withholding tax, but also for

the additional tax arisin g as a result of the additional payment.8

Withholding tax may also be imposed on non-residents of Canada in

certain circumstances. For example,9 draft subsection 212(13.2), which will

2 The other types of “propert y” payments that are subjec t to withholding tax i nclude divi-The other ty pes of “property” payme nts that are subject to with holding tax include div i-

dends and interest.

3 The Act, above note 1, subs. 212 (1). Withholding tax applies to a numbe r of other types of

payments, such as d ividends and interest, but these pay ments are generally not relevant i n

the context of tech nology transfers.

4 Ibid., subs. 215(1).

5 An a mount is “credited” when it is unconditional ly available to the non-resident. A mere

journal entr y is not suff‌icient: Canad a Revenue Agency, Information Circ ular 77-16R4,

“Non-Resident Income Tax” (11 May 1992) at para. 5 a nd Income Tax Technical News, No. 14

(9 December 1998).

6 The Act, above note 1, subs. 215(6).

7 Ibid., subss . 227(8) and (8.3).

8 The payment requi red to keep the non-resident whole may be expresse d by the formula

X = royalty/(1 – rate of withholdin g). Thus, if the agreement re quires the Canadian resident

to pay a royalty of $100 to the non-resid ent and provides for a “gross up” clause, if the rate of

Canadian wit hholding tax on the pay ment is 10 percent, the payer will be re quired to “gross

up” the royalty payme nt to $111.11 (i.e., $100/.90). The payer will therefore be require d to

remit $11.11 to the Receiver Ge neral and $100 will be paid to non-res ident.

9 The Act, above note 1, subs. 212(13) a lso deems the non-resident to be a resident of Canad a

in respect of cert ain types of payments t o non-residents. This subsect ion is not likely to

Inbound Transfer s of Technology 279

apply to amounts paid or credited on obligations entered into a fter 20 De -

cember 2002, deems a non-resident to be a resident of Canada for with-

holding tax pur poses where the non-resident is carr ying on business in

Canada and the payment is deductible in computing the taxable income

earned in Canada, unless the i ncome is from a “treaty-protected business”

or a “treaty-protected property,” as those terms are def‌ined in the Act. Since

the Act uses the word “deductible,” rather than “deducted,” the payment

in question may be subject to withholding ta x in Canada, even though t he

non-resident does not claim the deduction in Canada.10 Thus, a non-resi-

dent carrying on business in Canada who has no cu rrent use for a deduc-

tion (for example, because of losses in the year) cannot avoid withholding

tax on the payment by simply not claiming t he deduction as an expense.

The exemption for a “treaty-protected business” and “treaty-protected prop-

erty”11 ensures t hat a non-resident car rying on business in Canada but not

taxed in Canada, under Part I of the Act, on income because of an exemp-

tion under a tax treaty with Canada, will not be subject to withholding ta x

on the payment to the non-resident.

Prior to the amendment, paragraph 212(13.2)(a) deemed a non-resident

to be a resident of Canada for Part XIII purposes in respect of the payment

only if t he non-resident’s business w as carried on “principally ” in Can-

ada.12 “Pr incipally” is not def‌ined in the Act but is considered by the Can-

ada Revenue Agency (CRA) to mean more than 50 percent.13 Thus, prior

apply to royalty or simi lar type payments. To avoid duplication in a ny event, subs. 212(13.2)

excludes payments cove red by subs. 212(13).

10 For a discussion of the mea ning “deductible” in respect of i nterest that is capitalized u nder

ibid., subs. 18(3.1), see R. Wer tschek, “Current Issues on With holding Tax: Interest Paid by

Non-Residents of Canada” in R eport of Proceedi ngs of the 2004 Britis h Columbia Tax Confer-

ence (Vancouver, BC: Canadian Tax Found ation, 2004), 1:1-14 at 12–14.

11 Both terms a re def‌ined in ibid., subs. 248(1).

12 Ibid., para. 212(13 .2)(b) also deemed a non-resident who manufact ured or processed goods

in Canada, operat ed an oil or gas well in Canada, e xtracted petroleu m or natural gas in Can-

ada, or extrac ted minerals from a minera l resource in Canada, to be a resident of Ca nada in

respect of such pay ment where the amount was deductible i n computing taxable income in

Canada. There w as no requirement that the act ivities described in pa ra. 212(13.2)(b) be car-

ried out principa lly in Canada. Since any busine ss activity of the non-resident is cau ght by

the amendment, t he specif‌ic activitie s described in para. (b) have not bee n carried forward

in the amendment.

13 The courts have conside red the meaning of “principa lly” with respect to inve stment tax

credits in Transport Ja cques Lemieux v. M.N.R ., 91 DTC 503 (T.C.C.), and with res pect to

standby charges for employe es of an automobile dealer in McKay et al. v. M.N.R ., 90 DTC

1064 (T.C.C.). For the CRA’s interpretat ion of the term “principally,” see CR A doc. no.

9802365 (10 July 1998), with respec t to qualif‌ied small bus iness corporation shares, and

Canada Revenue Age ncy, Interpretation Bulleti n IT-443, “Leasing Propert y — Capital Cost

Allowance Rest rictions” (14 March 1980) at para . 3, with respect to leasin g property.