Taxation of Data-Driven Transactions

The collection, analysis, and protection of data is big business, and the taxation of data-driven transactions was a theme of the 74th Congress of the International Fiscal Association (IFA), held in Berlin in September 2022. The congress included a session called “Big Data and Tax: Domestic and International Taxation of Data-Driven Business,” in which a panel discussed case studies of four data-driven business models and their treatment under domestic and international tax laws, based on reports prepared by national reporters in 37 countries. The Canadian report was prepared by Mathieu Champagne and Marie-Emmanuelle Vaillancourt, and the reports for all countries are published in IFA’s annual Cahiers de droit fiscal international. The cahiers are available online to IFA members (here’s where you take a break to sign up with IFA) and to the broader tax community through the Canadian Tax Foundation’s Research Centre, where they are available on request.

In this article, we highlight a number of the income tax issues presented by cross-border, data-driven transactions, along with some of the analysis from the cahiers. Our analysis will focus on certain aspects of the Canadian report, including (1) how data and transactions involving data may be characterized for tax purposes, (2) the treatment of data transactions involving non-residents under domestic law, and (3) the application of typical provisions in tax treaties to such transactions. In addition, we integrate into our discussion some of the recent comments made by the CRA at its round table at the 2022 CTF annual conference.

Characterization of Data

The Canadian report in the cahiers begins with a discussion of how, for the purposes of the ITA, certain data transactions will generally be characterized—namely, (1) the sale of data or of a right in respect of data; (2) the provision of services in respect of data; or (3) the licensing, lease, or grant of a right to use or have access to data.

Property. The general consensus of the cahiers reporters is that data in and of themselves are not property; in Canada and other countries, however, it is generally possible for a copyright on, or contractual right in, data to qualify as property if the holder has an exclusive right to make a claim against others.

Services. The cahiers’ Canadian report acknowledges that through the digitalization of the economy, the “service” economy has grown; as a result, we increasingly see services being provided in the form of access to software (“software-as-a-service”) and the provision of “data-as-a-service.” Because of the form of delivery, the line between a service and a licence is blurred. A service may exist when, for example, a person provides a customized data feed whereby the customer pays for the process that creates and delivers the data. In contrast, a mass-produced, or “off-the-shelf,” data feed sold to multiple customers will likely not constitute a service. Another type of service might be the provision of data analytic applications to a data set (whether that of the customer or that of the service provider).

Licensing. By granting limited rights to use data, data suppliers can license or grant access to data without transferring exclusive rights. Such transactions should generally give rise to income from business or property, depending on the taxpayer’s level of activity under general principles.

Cross-Border Transactions

The characterization of data transactions involving non-residents tends to determine how such transactions should be treated for Canadian income tax purposes.

Property. When there is a sale of property, the non-resident may be subject to part I tax if (1) the sale occurs in the course of carrying on business in Canada or (2) the property qualifies as “taxable Canadian property” because it qualifies as class 14.1 depreciable property or inventory in respect of a business carried on in Canada. Part XIII tax should generally not apply to a payment to a non-resident unless paragraph 212(1)(d) applies—as when, for example, the payment is dependent on the use of or production from property in Canada, whether or not it was an instalment on the sale price of the property.

Services. Determining whether a transaction with a non-resident involves a service is generally relevant in determining whether (1) the non-resident is carrying on business in Canada; (2) payments to the non-resident may be subject to withholding under regulation 105; or (3) payments may be subject to part XIII withholding under paragraph 212(1)(d) (for example, if the payment is dependent on profits; use; benefits or production derived from the services; or knowhow). As discussed in the Canadian report, the two former issues require additional analysis of the “place” where such services are being provided. (Note, with respect to regulation 105, that a rate of 15 percent generally applies to payments for services rendered by a non-resident in Canada. If services are rendered in Quebec, an additional 9 percent withholding applies under provincial law.)

Licensing. Regardless of whether the income is from business or property, a payment from a Canadian resident to a non-resident may be subject to part XIII withholding tax—that is, if the payment is “rent, royalty or similar payment” or a payment otherwise described in subparagraphs 212(1)(d)(i) to (v) of the ITA, subject to a number of exclusions, which include a payment made on a data compilation protected under copyright law.

Application of Tax Treaties

The Canadian report in the cahiers focuses on the application of the business profits and royalty articles typically found in Canada’s tax treaties.

The business profits article generally provides that a non-resident carrying on business in Canada is subject to income tax in Canada to the extent of the profits of the taxpayer that are attributed to a “permanent establishment” (PE) that is situated in Canada and from which or through which the business is carried on. As most readers know, the definition of PE typically includes a fixed place of business, or an employee or agent in certain circumstances; some treaties also include the concept of a services PE. The business profits article is particularly relevant to a determination of whether services in respect of data will be subject to part I tax and eligibility for a regulation 105 waiver.

At the CRA round table at the 2022 CTF annual conference, the CRA was asked (in question 4) to consider a scenario in which a US-resident corporation (USco) provides a right to use software to a Canadian corporation (Canco). In connection with that transaction, Canco engages Serverco (which is presumably Canadian) to host Canco’s copy of the software and related data. For regulatory reasons, the data must be stored on servers in Canada. USco provides the software and most of the maintenance, upgrade, and customization services remotely from the United States, through a computer or telephone. Occasionally, however, USco accesses the servers in Canada to provide such services. The CRA, although reluctant to offer any firm views on this scenario, suggested that USco is providing most services from the United States, and that the services provided to the servers in Canada are of a preparatory or auxiliary nature, such that USco should not be considered to have a PE in Canada.

The cahiers include some discussion of “peopleless PEs,” such as sensors or other data-gathering and transmitting devices. The analysis of this matter varies among the different national reports; the analysis in the Canadian report focuses largely on whether the non-resident has physical or legal control over the equipment, and on the significance of the role of the equipment to the business. In Canada, the discussion of peopleless PEs has arisen in the context of servers: the CRA’s position regarding servers as PEs in Canada has softened over time—particularly with the advent of cloud computing. However, the CRA and the OECD suggest that a server or other computer equipment may be a PE in certain circumstances (see, for example, CRA document no. 2012-0441941E5, May 24, 2012, and the OECD model tax convention commentary on article 5). For example, with respect to the scenario discussed at the 2022 CRA round table, consider whether—if the servers were owned or controlled by USco (rather than Serverco)—USco might be considered to have a PE in Canada.

As artificial intelligence, the “Internet of things,” and other technologies advance (and, in some cases, replace people who may be more transient than the equipment that requires installation), we anticipate that the analysis of peopleless PEs will need to advance as well.

Turning now to the royalty article in Canada’s treaties, there is variation in the article across Canada’s treaties, but it generally contains the following four elements: (1) the definition of “royalty,” which generally captures only a subset of the payments described in paragraph 212(1)(d); (2) a cap of 10 or 15 percent on the rate of withholding on a payment that falls within the definition of “royalty” in the treaty; (3) specific exemptions for certain types of royalties (for example, licence payments for copyrights or for software); and (4) an additional exemption from withholding if the payment is effectively connected to the non-resident’s PE in Canada (in which case the business profits article should apply). If a data-related payment does not qualify as a royalty under the treaty, one must consider whether the payment constitutes business profits and, if so, whether the payment should be exempt from Canadian tax unless the payment is attributable to a PE situated in Canada. However, if the payment is neither a royalty under the treaty nor a business profit, then part XIII withholding tax at the full 25 percent may still apply under the ITA.

Conclusion

Data-driven transactions are another example of where we must apply “old world” tax concepts to new business models. Although the tax analysis of data-driven transactions may seem daunting and uncertain at first, the cahiers provide the Canadian tax community with a helpful framework.

Kim Maguire
Osler Hoskin & Harcourt LLP, Vancouver

Camille Andrzejewski
University of Ottawa