In December 2021, the Department of Finance (“DOF”) released its draft Digital Services Tax Act (“DSTA”) announced in the 2021 Federal Budget. The proposed tax will impose a 3% digital services tax (“DST”) on large businesses providing taxable digital services to Canadian users – mirroring recent efforts discussed at the OECD to address the tax challenges of the digital economy.

While the DOF indicates that these measures will not be imposed earlier than January 1, 2024, and only if the treaty implementing the OECD Pillar One tax regime has not come into force, taxpayers should prepare for these changes now, since the revenue calculation requirements start as early as January 2022!

Background

Under the proposed DSTA, most businesses (including trusts, partnerships, corporations, save for a few exceptions) that cross a legislative threshold must pay a tax equal to 3% of their “total taxable Canadian digital services revenue” earned from Canadian users in a calendar year (“in-scope revenue”).

The applicable ‘threshold’ is two-fold, requiring the taxpayer (or its consolidated group) to: (1) have global revenue of at least €750 million in the immediately preceding fiscal year; and (2) have earned over CAD $20 million of Canadian in-scope revenue in the current reporting period. The DSTA will require all entities that meet this two-stage threshold to pay the 3% tax on any in-scope revenues in excess of CAD $20 million.

In-Scope Revenue

In-scope revenue is calculated from four, mutually exclusive streams, again subject to certain exceptions. Specifically, revenue from the following four streams is to be apportioned based on the user’s location – and only Canadian in-scope revenue is taxable:

1. Online Marketplace Services – Revenue earned from providing access to, or the use of, the online marketplace to users whosupply services delivered in physical form within Canada.
2. Online Advertising Services – Revenue earned from facilitation through a digital interface, or the provision of digital space, for delivery of an online targeted advertisement.
3. Social Media Services – Revenue earned from provision of access to, or the use of, a social media platform that facilitates interaction between users, or between a user and user-generated content, on the social media platform, and the provision of premium services above the standard commercial terms and other optional enhancements to the basic function.
4. User Data – Revenue earned from sale or granting access to the user data that is collected from an online marketplace, a social media platform or an online search engine.

One positive here is that the DOF has stated that the DST liability could be potentially deducted from a taxpayer’s taxable income for the reporting period (but not as a credit against income tax payable).

Commentary

If and when the DSTA comes into effect, suppliers of taxable Canadian digital services who satisfy the threshold conditions will be required to register and pay DST. These requirements will subsist regardless of the business’s physical presence in Canada. Even more problematically, these new rules are backwards looking, with revenues from January 1, 2022 being potentially subject to the tax.

From a broader tax policy perspective, Canada’s proposed DST may enflame international trade tensions between countries where these multinational entities, subject to DST, may reside. Already, the United States Trade Representative has condemned the proposal as “unilateral” and “discriminatory” – while highlighting potential retaliation.

Regardless, these rules seem to be imminent.Businesses, especially non-resident providers of digital services into the Canadian marketplace need to understand the new DSTA rules NOW.

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