Canada’s decision to implement a 3% digital services tax on large foreign technology companies, despite warnings from the US, has been blasted by local experts.
Tax advisers have criticised the DST for creating additional complexity for companies, for stoking a US-Canada trade war and for increasing costs for consumers.
A Canadian government notice posted online on June 28, which was first reported on by Bloomberg on July 4, confirmed the DST came into effect on June 28.
The DST emerged amid the failure of the OECD Inclusive Framework (IF) to finalise a multilateral convention on amount A of pillar one by a June 30 deadline.
Amount A applies to in-scope multinational enterprises and seeks to allocate parts of their profits to countries where they sell products and provide services.
Tax professionals had widely predicted that the lack of consensus on amount A would lead to jurisdictions introducing DSTs.
Canada’s DST will impose a 3% levy on large tech companies that make above C$20 million (US$14.7 million) in a calendar year from Canadian users.
It will apply for the calendar year 2024 and beyond and will cover taxable revenues earned since January 1 2022.
Many of the affected companies, such as Meta and Google, are based in the US.
The Office of the United States Trade Representative said on July 2 that it will do whatever is necessary to halt Canada’s DST, according to a CBC report.
‘Tone-deaf’
“There is little doubt that bringing a DST into force will trigger punitive trade retaliation from the US, likely far more costly to the Canadian economy than whatever tax revenue would be collected,” Steve Suarez, tax partner at Canadian law firm Borden Ladner Gervais, tells ITR.
Suarez, who is also co-chair of the Canadian Chamber of Commerce’s Economics and Taxation Committee, adds: “There is no doubt whatsoever that the US business community views Canada’s DST as discriminatory and unfair, and one of the few areas of bipartisan agreement in Washington is the importance of protecting US business from foreign taxes they perceive to be disproportionately directed at US companies.
“For Canada to proceed with this initiative during a US election year, when politicians are looking for high-profile ‘America first’ issues, is particularly tone-deaf, and this development is quite likely to end up as a spectacular own goal for Canada.”
Randy Schwartz, indirect tax partner at Canadian law firm McCarthy Tétrault, agrees that the DST is likely to stoke the flames of a US-Canada trade war.
“From a US perspective, politically, there is bipartisan opposition to the DST and significant, influential US industry sectors and businesses who would like to see the US take strong retaliatory measures.
“When you mix in a presidential election later this year and Canada acting as an outlier moving forward in implementing a new DST in 2024, it’s not difficult to foresee challenging times ahead for US-Canada trade relations,” he says.
Schwartz argues that Canada is taking a bold gamble with the DST and the potential implementation of pillar one.
“Unless Canada really believes that pillar one or a similar multilateral agreement will not be implemented any time soon, one wonders whether acting now on the DST was really worth it,” he adds.
Pillar one preference
A crucial question is whether pillar one will come to fruition despite the missed amount A deadline in June.
Suarez calls for patience: “For Canada to proceed with adopting a DST while other countries continue to maintain the status quo as negotiations on the OECD/G20 IF proceed, it casts Canada as an outlier from the global consensus on international tax policy.
“This is especially harmful to a country that depends heavily on good relations with countries to which we export our goods and services.
“Hard issues take time and effort to resolve, and going ahead with a DST at this time sends the wrong signal to our trade partners working in good faith on a compromise on the taxation of multinational digital services,” he says.
Despite the DST implementation, comments last week from Canada’s finance minister, Chrystia Freeland, suggested that Canada’s support for pillar one remains unwavering.
"Canada's preference is, and has always been, a multilateral solution," she reportedly said.
"It’s simply not reasonable, not fair, for Canada to indefinitely put our own measures on hold.
"A number of other countries have a DST in place right now, and they have had a DST in place for a number of years with no retaliation [from the US]," she added.
According to Schwartz, this position could lead to complexity for Canadian businesses affected by the DST.
“Based on her recent comments…the finance minister seems to be betting that the perceived benefits of the DST outweigh the risks of potential US retaliation and the reaction of those businesses affected,” he says.
“At the same time, Canada has reiterated its commitment to pillar one and its intention that the DST is a temporary measure.
“This may mean that businesses could ultimately need to manage not one, but two, new taxing regimes if the DST is ultimately replaced by pillar one or another multilateral solution.”
Costs concerns
Canada’s government will hope that the DST will enable it to extract additional sought-after revenue from in-scope companies while a resolution on pillar one awaits. But the experts ITR consulted raised doubts over the effectiveness of this new tax.
“At the end of the day, it’s likely that Canadians will end up bearing the [brunt of the] DST, as those businesses forced to pay it will likely find ways to pass it on through increased fees and prices to their Canadian customers,” reflects Schwartz.
Suarez agrees and takes aim at Canada’s policymakers: “These companies are very likely to simply adjust their pricing to pass on the cost of this tax to Canadian consumers.
“The resulting increase in costs for Canadian consumers is particularly unwelcome in today’s inflationary environment…Canada’s DST represents a triumph of politics over sound economic policy.”
Clearly, a solution on how to adequately tax the digital economy must be found. While DSTs may seem a sensible option in the interim, the risk of passing costs onto consumers and inflaming international tensions puts even greater importance on a pillar one solution being reached.
