Tax Insights: Digital Services Tax ─ One step closer to becoming a reality

Issue 2023-26

In brief

On August 4, 2023, Canada’s Department of Finance released a revised draft of the Digital Services Tax Act (DST Act), along with revised (and complete) explanatory notes (August 2023 release). The August 2023 release:

made a number of substantive and administrative revisions to the DST Act — this includes a new election to determine a taxpayer’s Digital Services Tax (DST) liability for the initial years of application based on Canadian digital services revenue for the year in which the DST Act comes into force
did not change the timing aspects of the DST Act (i.e. that the DST would retroactively apply to Canadian digital services revenues earned since January 1, 2022)

The new election generally means that a taxpayer could elect to base its 2022 and 2023 DST liability on its 2024 ratio of Canadian digital services revenue to total revenue, and eliminate the need to develop detailed reporting systems to capture Canadian digital services revenues for 2022 and 2023.

In detail

Background

The August 2023 release of the draft DST Act comes after Canada’s refusal to agree to the July 11, 2023 Outcome Statement by the Organisation for Economic Co‑operation and Development (OECD)/G20 Inclusive Framework in the context of ongoing work on a multilateral convention (MLC) to implement Pillar One.¹ Specifically, Deputy Prime Minister and Minister of Finance Chrystia Freeland issued a statement that although Canada fully supports the MLC, it does not support a one year extension of a moratorium on imposing new digital services taxes.²

Canada has consistently indicated that it prefers a multilateral solution to the taxation of the digital economy and that it would impose the proposed DST only if an MLC implementing Pillar One has not come into force by December 31, 2023. However, as the timelines to negotiate and implement a MLC continue to be extended, it appears more likely that Canada’s DST Act will become a reality.

The proposed DST

The proposed DST is a 3% tax in respect of Canadian-source digital services revenue earned by large domestic and foreign taxpayers. It would apply on a calendar year basis, i.e. it is not based on the fiscal year of the taxpayer. The DST is proposed to be effective the later of:

the 2024 calendar year, and
the calendar year that includes the day the DST Act comes into force, and

would apply retroactively in respect of in-scope revenues earned since January 1, 2022. The first payment of the DST liability would include the DST in respect of in‑scope revenues earned since January 1, 2022, and the earliest that it would be due is June 30, 2025.

In-scope revenue would generally comprise of Canadian-source digital services revenue arising from:

online marketplace services
online targeted advertising services
social media services
the sale or licensing of user data obtained from an online marketplace, a social media platform or an online search engine

The DST would apply for a particular calendar year to businesses that 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
Canadian digital services revenue of more than CAD$20 million in the particular calendar year

The 3% tax would be levied on the amount by which Canadian digital services revenue for the particular calendar year exceeds CAD$20 million (which is prorated among group members).

New election to simplify compliance for initial years

The August 2023 release introduces an elective simplified method for calculating Canadian digital services revenue for the calendar years before the calendar year in which the DST Act comes into force (e.g. the 2022 and 2023 calendar years if the DST Act were to come into force in the 2024 calendar year). This would be relevant for both the determination of the CAD$20 million threshold and the taxpayer’s DST liability. Assuming the DST Act comes into force in 2024, the election would allow a taxpayer to forgo the detailed calculation of Canadian digital services revenue for 2022 and 2023, and instead use a ratio based on 2024 revenue amounts (i.e. the taxpayer’s Canadian digital services revenue would be divided by the taxpayer’s total revenue). That ratio would then be applied to the taxpayer’s total revenue for 2022 and 2023 to arrive at a proxy amount for its Canadian digital services revenue for each of those years.

This elective method presents a planning opportunity for those taxpayers who have tracked the relevant data for 2022 and 2023 as they will be able to either (i) use the elective method, or (ii) calculate their DST liability using the regular method. The taxpayer would elect for each calendar year, however, an election cannot be made for a year if the taxpayer did not elect for the prior year (e.g. an election cannot be made for 2023 unless the election was made for 2022).

The takeaway

We recommend that businesses start taking the following steps:

learn about the four categories of in-scope revenues and the sourcing rules, and consider whether revenues earned in 2022 and 2023 fall into these categories
calculate global consolidated revenues for 2021 and 2022 to determine whether the business meets the DST total revenue threshold for 2022 and 2023, respectively
calculate the 2022 (and, if available, 2023) consolidated revenues derived from any of the four in-scope revenue activities associated with users in Canada
for budgeting purposes, calculate estimated DST payable in 2025 for 2022, 2023 and 2024

Businesses should start implementing the necessary systems to capture the required data needed to determine Canadian digital services revenue — 2024 is fast approaching and early adopters may benefit from a planning opportunity that is available due to the new compliance-saving election.

^{1. The OECD supports a two-pillar solution to address the tax challenges arising from the digitalization of the global economy. The main element of Pillar One is to allocate a formulaic share of the consolidated profit of certain multinational enterprises to the market jurisdictions where revenue is earned. For more information, see our Tax Insights “The new international tax framework and Canada’s digital services tax.”

2. For more information, see our Tax Insights “Digital Services Tax (DST): Will the DST’s potential implementation affect your business?” (July 13, 2023 update).}

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