2003 Ruling 2002-0143543 - INCOME FROM BUSINESS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Deductibility of a royalty paid to a non-resident for the right to distribute the non-resident's products in Canada

Position: Royalty is deductible

Reasons: The royalty will be incurred for the purpose of earning income from business and will not be a capital outlay

XXXXXXXXXX 2002-014354

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Taxpayer") XXXXXXXXXX

We are writing in response your letter dated XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted Taxpayer. We acknowledge receipt of your subsequent correspondence dated XXXXXXXXXX, as well as the information provided in our various telephone conversations.

To the best of your knowledge, and that of the Taxpayer, none of the issues involved in the ruling request is:

(i) dealt with in an earlier return of the Taxpayer or a person related to the Taxpayer;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the Taxpayer or a person related to the Taxpayer;

(iii) under objection by the Taxpayer or a person related to the Taxpayer;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(v) subject to a ruling previously issued by the Income Tax Rulings Directorate.

Unless otherwise stated, all statutory references herein are to the Income Tax Act, R.S.C. 1985 c.1 (5th Supp.), as amended (the "Act"), and, unless otherwise indicated, all terms used herein that are defined in the Act have the meaning given in such definition.

In this letter, the following terms have the meanings specified below.

(a) "A-branded products" means XXXXXXXXXX (hereinafter referred to as the "A trademark");

(b) "ACo" means XXXXXXXXXX, a corporation governed by the laws of the State of XXXXXXXXXX ;

(c) "ACo Dealers" means persons having the right to sell or lease the A-branded products in Canada at retail;

(d) "BCo" means XXXXXXXXXX, a corporation governed by the laws of the State of XXXXXXXXXX ;

(e) "C-branded products" means XXXXXXXXXX (hereinafter referred to as the "C trademark") and the X Equipment;

(f) "CCo" means XXXXXXXXXX, a corporation governed by the laws of XXXXXXXXXX;

(g) "CCo Dealers" means those persons having the right to sell or lease the C-branded products in Canada at retail;

(h) "CCRA" means the Canada Customs and Revenue Agency;

(i) "DCo" means XXXXXXXXXX, a corporation governed by the laws of the State of XXXXXXXXXX;

(j) "Pre-tax losses" means the pre-tax losses determined pursuant to the standard profit by product accounting methods and systems used by ACo and in accordance with U.S. generally-accepted accounting principles;

(k) "Pre-tax profits" means the pre-tax profits determined pursuant to the standard profit by product accounting methods and systems used by ACo and in accordance with U.S. generally-accepted accounting principles;

(l) "Products" means collectively the A-branded and C-branded products; and

(m) "X Equipment" means XXXXXXXXXX.

Our understanding of the facts, the proposed transactions and the purpose of the proposed transactions is as follows:

Facts

1. The Taxpayer is a wholly-owned subsidiary of ACo. The Taxpayer has the exclusive right to distribute A-branded products in Canada and does so through the ACo Dealers.

2. DCo is a wholly-owned subsidiary of CCo. DCo has the exclusive right to distribute C-branded products in Canada through the CCo Dealers.

3. The Taxpayer and DCo are not related and deal with each other at arm's length.

4. BCo is a wholly-owned subsidiary of ACo.

5. The Taxpayer purchases the A-branded products from BCo and distributes them in Canada.

Proposed Transactions

6. The Taxpayer, BCo and DCo will enter into a distribution agreement (the "Agreement") under which DCo will grant to the Taxpayer an exclusive right to distribute C-branded Products within Canada.

7. The Agreement will require the Taxpayer to maintain an adequate marketing, sales and after-sales service and support organization that is qualified to support the DCo Dealers. The Taxpayer will be responsible for promoting the sale of the Products in Canada, including initiating sales incentive programs, sales discount programs and advertising.

8. The Agreement will require DCo to assist and cooperate with the Taxpayer on matters pertaining to the distribution rights granted under the Agreement. However, the Taxpayer will be solely responsible for distributing C-branded products in Canada and the Taxpayer will not involve any employees or agents of DCo in Canada in the distribution activities undertaken by the Taxpayer in connection with the Agreement.

9. Under the terms of the Agreement, the Taxpayer will be obliged to pay to DCo an amount equal to XXXXXXXXXX% of the Taxpayer's Pre-tax profits (determined before the deduction of the XXXXXXXXXX% payment to DCo) from the distribution of the Products. These payments are referred to hereafter as "Royalties".

10. The Royalties will be payable in exchange for the exclusive right to be granted by DCo to the Taxpayer to distribute C-branded products in Canada and thus any Royalties will be incurred solely for the purpose of gaining or producing income from the Taxpayer's business. The Royalties will not be related to the acquisition of a capital asset and will not bring into existence an asset or advantage of an enduring nature. The Royalties will be subject to withholding tax pursuant to paragraph 212(1)(d) of the Act, subject to relief provided by the Canada-U.S. Tax Convention.

11. Under the terms of the Agreement, DCo will be obliged to pay to the Taxpayer an amount equal to XXXXXXXXXX% of the Taxpayer's Pre-tax losses (determined before the inclusion of the XXXXXXXXXX% payment from DCo) on the distribution of the Products, excluding the X equipment.

12. The Taxpayer will pay DCo the Royalties annually, prior to XXXXXXXXXX. However, the Taxpayer is obligated to pay DCo, at least XXXXXXXXXX business days prior to the due date of each quarterly U.S. federal estimated tax payment, an amount in cash at least sufficient to allow DCo to pay any U.S. federal, state and local taxes required to be paid by DCo in respect of the Royalties accrued to it at such time.

13. BCo will be obliged to reimburse the Taxpayer for the Pre-tax losses incurred by the Taxpayer on the distribution of X Equipment.

14. For accounting purposes (in accordance with generally-accepted accounting principles), the Taxpayer will treat the Royalties as an expense in the year to which they relate and will treat the reimbursements as revenue (or an expense reduction) in the year to which they relate. Any reimbursements will be included in computing the Taxpayer's income under the Act for the year to which the entitlement to the reimbursement arises.

15. The Agreement expressly provides that nothing in the Agreement shall be construed in such a manner as to constitute the Taxpayer the agent, partner or legal representative of BCo or DCo for any purpose whatsoever. The Taxpayer, BCo and DCo do not intend to carry business in common and will not be carrying on business in partnership either under the terms of the Agreement or otherwise.

Purpose of the Proposed Transactions

16. It is anticipated by the Taxpayer that the distribution of the Products in Canada by the Taxpayer will result in efficiencies and the elimination of duplication and redundancies that would be inherent in the separate distribution of A-branded products by the Taxpayer and C-branded products by DCo. Accordingly, it is anticipated that the distribution of the Products in Canada solely by the Taxpayer will result in increased profits for the Taxpayer.

Additional Information

17. The entering into of the Agreement by the Taxpayer, BCo and DCo will be part of an integration of marketing efforts by members of the ACo group of companies and members of the CCo group of companies in XXXXXXXXXX.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions, and the proposed transactions are completed as described above, our rulings are as follows:

A. Subject to limits that may be imposed by subsection 18(9) or section 67 of the Act, the Taxpayer will be entitled to deduct in computing its income for any particular year the Royalties payable by it in that year as described in paragraphs 12 and 14, above.

B. The Taxpayer will be required to include in its income for any particular year any reimbursements receivable by the Taxpayer from BCo and DCo in that year as described in paragraphs 11, 13 and 14, above.

C. Subsection 245(2) will not be applied, as a result of the proposed transactions in and of themselves, to redetermine the tax consequences confirmed in the rulings given above.

Caveat

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 (the "Circular") issued by the CCRA on May 17, 2002, and are binding provided the Agreement described in the proposed transactions is entered into on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act.

Nothing in this letter should be construed as implying that the CCRA has agreed to or accepted:

(i) that the Taxpayer and DCo will not be carrying on business in partnership or that the Taxpayer will not be an agent of DCo as a result of the Agreement or otherwise;

(ii) that the amount of the Royalty is reasonable in the circumstances or that no portion of the Royalty is attributable to the use of DCo's trademarks; or

(iii) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

??

- 6 -