From: Jon Johnson
To: Canadian Department of Finance and Global Affairs Canada
Date: May 3, 2021
Re: Current Developments in Digital Services Taxes, and Potential Pitfalls
There have been significant developments respecting digital services taxes (DSTs) since my January 12 Intelligence Memo on the US suspension of retaliatory tariffs against France for its tax.
While these tariffs remain on hold, the USTR has taken further action respecting digital taxes imposed by India, Italy, Turkey, Austria, Spain and the UK. In notices issued on March 29, the USTR states its intention to impose Section 301 tariffs and invites public comment, with hearings taking place in mid-May.
There have been developments on the Canadian side as well. Last month’s budget sets out detailed plans for a Canadian DST. It would apply at a rate of 3 percent on certain revenue set out in the budget document. The tax would apply only to businesses with global revenue from all sources of 750 million euros or more in the previous calendar year, and revenue associated with Canadian users of more than $20 million in the particular calendar year. Budget 2021 projects revenue from its DST of $3.4 billion from 2021/22 to 2025/6.
As with the Fall Economic Statement, Budget 2021 expresses “a strong preference for a multilateral approach to this issue,” but notes that multilateral discussions have been ongoing since 2013 and that Canada will proceed unilaterally on January 1, 2022 if there is no multilateral solution.
There are clearly aspects of the proposed Canadian DST that the USTR would find objectionable. It objected to the French DST because it applied to companies with no territorial connection to France. The same objection could be raised respecting the proposed Canadian DST.
The USTR also objected to the French DST because it applies to gross revenue rather than to income. Canada’s proposed tax does the same, as do the DSTs applied by the nations mentioned above.
Issues of double taxation occur any time when two jurisdictions tax the same activity, such as cross-border dividend or interest or royalty payments, or business income earned in several jurisdictions. Usually these issues are sorted out through bilateral tax treaties. These same double taxation issues arise with a digital services tax where several jurisdictions seek to tax the same revenue stream. Whether dealt with bilaterally or multilaterally, these issues can only be sorted out through negotiations among the interested parties.
If a multilateral approach to DSTs is not reached by next January 1, the Department of Finance will have to decide whether to unilaterally implement the proposed Canadian DST, with it the obvious risk of US action under Section 301.
There are also several CUSMA provisions that the Department and Global Affairs should carefully consider before proceeding unilaterally.
CUSMA Article 19.3(1) prohibits “customs duties, fees, or other charges on or in connection with the importation or exportation of digital products transmitted electronically, between a person of one Party and a person of another Party.” Article 19.3(2) permits internal taxes (like GST/HST) on “digital products,” which Canada applies digital services provided by sellers with a physical presence in Canada, and which Canada is considering expanding. However, the Canadian DST described in Budget 2021 is not an internal tax to which Article 19.3(2) would apply. While the proposed Canadian DST is a tax on revenue, the revenue subject to the tax could be generated in part at least by the importation or exportation of “digital products.”
CUSMA Article 32.3(6)(b) provides that taxation measures “on income, on capital gains, on the taxable capital of corporations, or taxes on estates, inheritances, gifts, and generation-skipping transfer” are not subject to CUSMA provisions including those providing for national treatment and most-favoured treatment. The proposed Canadian DST is a tax on revenue and not income, and therefore is not exempt from these obligations. As noted above, the Canadian DST will only apply to businesses with global revenue from all sources of €750 million. If US firms are the only ones meeting this criterion, the US could challenge the Canadian DST under CUSMA as de facto discriminating against US businesses.
The Department of Finance and Global Affairs Canada should carefully review these CUSMA provisions before unilaterally proceeding with the proposed Canadian DST.
Jon Johnson is a former advisor to the Canadian government during NAFTA negotiations and is a Senior Fellow at the C.D. Howe Institute.
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