Canada Implements Digital Services Tax
As part of its 2019 election platform, Canada’s Liberal government proposed a Digital Services Tax (DST). DST is meant to ensure that revenue earned through online services in Canada is subject to Canadian income tax at the federal level, even when those services are provided by non-residents. From the outset, DST was proposed as an interim measure until countries in the Organisation for Economic Cooperation and Development (OECD) come to an agreement on how multinational digital corporations should be taxed.
Canada initially delayed the implementation of its DST pending a multilateral resolution through the OECD. However, while negotiations have continued, but at a pace slower than anticipated by the federal government, Canada proceeded with enacting DST on January 1, 2024, with retroactive effect to January 1, 2022.
DST is considered controversial as it could potentially threaten trade relationships with the United Sates. Canada’s position is that it is unfair to continue to delay implementation of its DST measures while waiting for the OECD to reach a multilateral agreement.
Application of DST
DST applies at a rate of 3% on digital services revenue as of January 1, 2024, with retroactive effect to January 1, 2022.
Taxpayers are subject to DST if they meet both of the following revenue thresholds (to be calculated on a consolidated group basis):
- Global revenue from all sources of €750 million or more in a fiscal year of the group that ends in the previous calendar year; and
- Canadian digital services revenue of more than CAD $20 million in the particular calendar year.
The 3% tax is to be levied on the amount by which Canadian digital services revenue for the particular calendar year exceeds CAD $20 million. Note that the CAD $20 million deduction must be shared among members of a consolidated group in accordance with a specified proration formula.
Application of DST is limited to digital services revenue generated from users in Canada. Where there is uncertainty as to whether a user is in Canada, reasonable data should be utilized to determine the location of the user. In the event the location of a user cannot be reasonably determined, the user will be considered to be in Canada, on a default basis, for DST purposes.
In-scope Revenue
Generally, revenue earned from the following types of digital services falls within the scope of DST and is subject to tax when the service provided is associated with Canadian users.
Online marketplace services
Revenue earned from digital interfaces that provide access to online marketplaces, including commissions and service fees from facilitating supplies and revenue from premium services related to such online marketplaces, is subject to DST.
However, the legislation includes provisions to specifically exclude revenue from certain types of online marketplaces, such as those selling inventory owned by the taxpayer.
In addition, revenue obtained from providing storage or shipping services is specifically excluded from online marketplace services revenue for purposes of DST to the extent that the revenue reflects a reasonable rate of remuneration for the service.
Online advertising services
Revenue earned from facilitating the delivery of an online targeted advertising service or providing digital space for an online targeted advertisement is subject to DST.
Social media services
Social media services revenue includes earnings from providing access to a social media platform, supplying premium services related to a platform, and facilitating interactions between users and digital content.
The legislation provides an exception for revenue earned from providing access to social media associated with a taxpayer’s own digital content.
Sale or licensing of user data
This category includes any revenue earned from the sale or licensing of data gathered from users of an online marketplace, a social media platform, or an online search engine.
An exception is in place for revenue earned by a taxpayer from the sale of data collected by another party.
Specific sourcing and allocation rules are in place to determine the extent to which each type of revenue may be subject to DST. A taxpayer’s total Canadian digital services revenue for any particular calendar year is the total of all four types of revenue described above, subject to numerous exclusions and prescribed calculations.
Compliance Requirements
Taxpayers exceeding the specified revenue thresholds will have DST compliance requirements.
Businesses subject to DST with respect to a given calendar year will be required to register with the Canada Revenue Agency (CRA) by January 31 of the following year and file an annual return on or before June 30 of the calendar year following the calendar year for which the return is required to be filed. Any tax payable for that calendar year will also be due by that date. Note that the Canadian digital services revenue threshold for registration is only CAD $10 million.
As a result, where a taxpayer has revenue that exceeds the global revenue threshold and Canadian digital services revenue of CAD $20 million or less, it will not be liable to pay 3% DST. However, the taxpayer will still be required to register for DST and file an annual DST return if its Canadian digital services revenue exceeds CAD $10 million in a particular calendar year.
Because of the retroactive nature of DST and the fact that it took effect in 2024, the first DST payment must include tax calculated on subject revenues earned since January 1, 2022, and will be due on June 30, 2025.
It is important to note that any entity within a consolidated group may be jointly and severally liable for DST payable by any other member of the group.
Negative Response
In response to Canada’s implementation of DST, the United States has requested a trade dispute settlement, taking the position that the new Canadian tax disproportionately affects companies in that country and, as a result, violates Canada’s obligations under the Canada-United States-Mexico Agreement (CUSMA). Canada has responded by pointing out that many other OECD countries have put similar taxes in place in recent years – in some cases, drawing threats of retaliatory tariffs from the United States.
At the time of writing, both countries have indicated that they will engage in trade dispute consultations. In the meantime, multinational digital service companies should assess whether DST applies to them and, if so, implement procedures to capture the information that will be required to complete and file their returns.
Clyde Seymour
Principal, International Income Tax
clyde.seymour@ryan.com
Bushra Agha
Senior Manager, International Income Tax
bushra.agha@ryan.com