Tax Insights: Canada’s Digital Services Tax Act is now law ─ What is next and how can you prepare?

In brief

On June 20, 2024, Bill C‑59,¹ which includes the legislation to implement the Digital Services Tax Act (DSTA), received royal assent. Although the DSTA has now become law, the legislation requires the additional step of an order of the Governor in Council for its coming into force, the decision for which will be determined by the progress of and Canada’s preference for a multilateral solution to the taxation of the digital economy. If the DSTA comes into force, the Digital Services Tax (DST) will apply in respect of revenues earned as of January 1, 2022, so affected taxpayers would be required to calculate the cumulative amount of tax payable. These taxpayers will also need to consider at what point it is appropriate to recognize a liability, according to their relevant accounting standards.  

This Tax Insights discusses the calculation and administrative details of the DST and provides recommendations on how to prepare should it come into force.

In detail

Background

The federal government has consistently supported the Organisation for Economic Co-operation and Development’s (OECD’s) Pillar One² solution (i.e. to reallocate some portion of the profits of large multinational enterprises [MNEs] to countries where the MNE’s customers are located) on the taxation of the digital economy and confirmed its preference for a multilateral approach. However, it has also stated that the DSTA would be implemented in Canada as early as January 1, 2024, if a multilateral convention (MLC) to implement Pillar One has not come into force by the end of 2023; this follows Canada’s refusal to agree to the OECD/G20’s July 11, 2023 Outcome Statement in the context of ongoing work on an MLC to implement Pillar One. Specifically, Deputy Prime Minister and Minister of Finance Chrystia Freeland issued a statement noting that, although Canada fully supports the MLC, it does not support a one year extension of a moratorium on imposing new digital services taxes.³  

The Governor in Council must consider the following when setting the coming into force date for the DSTA:

• the intent of the OECD’s Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy⁴
• Canada’s preference for a multilateral approach to address the tax challenges arising from the digitalization of the economy and the status of international negotiations and implementation in respect of such an approach

Several countries have objected to the current draft of the MLC’s Pillar One proposal, which further reduces the likelihood of its imminent ratification and strengthens the case for entry into force of Canada’s DSTA, possibly in 2024 with retroactive effect to January 1, 2022. Potentially affected taxpayers should begin to prepare for the possibility of Canada’s DSTA coming into force, because ratification of an MLC implementing Pillar One remains in doubt, at least in the near term.

Canada’s Digital Services Tax (DST)

The DST is a 3% tax on Canadian‑source digital services revenue earned by large domestic and foreign taxpayers. It applies on a calendar year basis, i.e. it is not based on the fiscal year of the taxpayer. The DST will be effective the later of:

• the 2024 calendar year
• the calendar year that includes the day the DSTA comes into force

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

Taxpayers subject to Canada’s DST

Taxpayers are subject to the 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
• 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 (which is prorated among consolidated group members). Although taxpayers that exceed the global revenue threshold (calculated on a consolidated group basis) and have Canadian digital services revenue of CAD$20 million or less will not be liable to pay the 3% DST, they will still be required to:

• register for the DST, and
• file an annual DST return,

if their Canadian digital services revenue exceeds CAD$10 million in a particular calendar year.

In‑scope Canadian digital services revenue subject to the DST

In‑scope revenue would generally be comprised of Canadian-source digital services revenue arising from:

• online marketplace services
• online 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

Canadian online marketplace services revenue

For purposes of the DST, an online marketplace is defined as a digital interface (e.g. a website or application), which allows users to interact with other users and facilitates the supply of property or services, including digital content, between those users. Digital interfaces with a single supplier, or digital interfaces with the main purpose to provide payment services, make advances, grant credit, or lend money (or facilitate supplies of financial instruments) are specifically excluded from being an online marketplace and are therefore outside the scope of the DST.

Online marketplace services revenue includes revenue received from:

• providing access to, or use of, the online marketplace (e.g. subscription fees and pay‑per‑use fees)
• facilitating a supply between users of the online marketplace (e.g. transaction commissions and payment service fees)
• providing premium services, preferential listing services or other optional enhancements to the online marketplace service

Revenue obtained from providing storage and shipping services is specifically excluded from being online marketplace services revenue for purposes of the DST, to the extent that the revenue reflects a reasonable rate of remuneration for the service.

Canadian online marketplace services revenue is calculated based on a formula that considers the portion of online marketplace revenue that is associated with Canadian users, as follows:

• For revenue earned in respect of supplying a service that:
  • is physically performed in Canada,
  • is in respect of real property in Canada, or of goods that are situated in Canada,

all of the revenue will be sourced to Canada.

• For revenue in respect of fees for a particular transaction, such as commission fees, the portion of the revenue sourced to Canada is based on whether the users are located in Canada.
• When both the supplier and purchaser are in Canada, all of the revenue will be sourced to Canada.
• If only one of the supplier or purchaser is in Canada, half of the revenue will be sourced to Canada.
• If neither the supplier nor the purchaser is located in Canada, no revenue will be sourced to Canada.

There is also a specific formula in the DSTA to source online marketplace revenue to Canada when the revenue is non-transactional in nature, i.e. it is not in respect of a particular supply between users.

Canadian online advertising services revenue

Online advertising services revenue, for DST purposes, includes revenue earned from:

• facilitating the delivery of an online targeted advertising service through an online digital interface
• providing digital space for an online targeted advertisement

An online targeted advertisement generally refers to any content that is prominently placed for the purpose of promotion and includes sponsored content and preferential placements; it is meant to include display advertisements, rich media, video and political campaign advertising, public notices and promotions that are “targeted” within the common meaning of the term or context in the advertising industry.

To minimize the cascading of the DST, online advertising services revenue that is earned between members of a consolidated group is specifically excluded from the calculation of online advertising services revenue.

Canadian online advertising services revenue is calculated based on a formula that considers the location of the targeted user where the revenue is directly attributable to a display of, or an interaction with, an online targeted advertisement.

When the online advertising services revenue is not directly attributable to a display of, or an interaction with, a specific user or when the revenue is generated by a specific user, whose location is indeterminable, the portion of the revenue sourced to Canada is determined by a pro‑rating formula.

Canadian social media services revenue

For DST purposes, social media services revenue includes revenue earned from providing a social media platform that facilitates interactions between users, or between users and user‑generated content. This includes revenue received from:

• providing access to, or use of, the social media platform and premium services
• facilitating interactions between users, or between users and digital content generated by other users on the social media platform

Exclusions include revenue considered to be from online marketplace, online advertising or social media services arising from transactions between members of a consolidated group, and revenue earned by a social media platform for providing access to its own content.

Canadian social media services revenue is the portion of the total social media services revenue of a taxpayer, or its consolidated group, which is associated with Canadian users.

Canadian user data revenue

For DST purposes, user data revenue includes revenue earned from the sale or licensing of data (e.g. a user’s name, mailing or email address, preferences, billing data, etc.) gathered from users of an online marketplace, a social media platform or an online search engine. For a taxpayer or its consolidated group, exclusions include user data revenue that is earned from the sale or licensing of data that was not collected by the taxpayer or its consolidated group, and that is earned from transactions between members of a consolidated group.

When the user data can be traced to a single user that is located in Canada, the revenue that is earned from selling or licensing that user’s data is Canadian user data revenue for DST purposes. When the user data is collected from multiple users, and the revenue is not traceable to a specific user’s data or when the user’s location is not determinable, Canadian user data revenue is determined based on the portion of the users that are located in Canada.

DST administration, reporting and compliance

The DST requires taxpayers that meet the DST thresholds and have an obligation to pay the 3% DST to file annual tax returns and pay any tax payable by June 30 of the year following the calendar year. Canada Revenue Agency representatives have indicated that they would start issuing the relevant forms and publishing additional administrative guidance on DST reporting and compliance when the DSTA comes into force.

The takeaway

While we wait to see whether the government will bring the DSTA into force, we recommend that taxpayers who will potentially be affected by the DST start taking the following necessary steps to ensure their readiness to comply with the new rules if and when the DSTA comes into force:

• Consider whether revenues earned in 2022 and 2023 fall into any of the four categories of in‑scope DST revenues.
• Calculate global consolidated revenues for 2021 and 2022 to determine whether they meet the DST total revenue threshold for 2022 and 2023, respectively.
• Determine the consolidated revenues derived from any of the four in‑scope revenue activities associated with users in Canada for 2022, 2023 and 2024.
• For budgeting purposes, calculate the estimated DST that may become payable in 2025 for 2022, 2023 and 2024.
• Monitor the coming into force provisions to determine if or when to recognize an obligation for accounting purposes.

Taxpayers should start implementing the necessary systems to capture the required data to determine their Canadian digital services revenue. Taxpayers that are prepared and that have tracked the relevant data for 2022 and 2023 may benefit from a planning opportunity that is available due to a compliance-saving election. 

<sup>1. Bill C-59, An Act to implement certain provisions of the fall economic statement tabled in Parliament on November 21, 2023 and certain provisions of the budget tabled in Parliament on March 28, 2023 (first reading: November 30, 2023; royal assent; June 20, 2024)
2. 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.”
3. For more information, see our Tax Insights “Digital Services Tax: One step closer to becoming a reality.”
4. OECD’s October 8, 2021 Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy at www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.pdf</sup>