The implications for Canadian businesses of new global and domestic tax changes
Canada’s Digital Sales Tax, federal budget measures and OECD-led global tax agreements are shifting the corporate income tax landscape for Canadian businesses
Policymakers here in Canada and around the world have worked hard to develop—and reach agreement on—measures aimed at bringing greater tax equity to a digitized global economy. Their stated objective, broadly speaking, is to ensure companies pay their fair share of taxes.
Over the last few months, we’ve seen this vision inch closer to reality through several concrete steps that could affect some Canadian companies as early as this year.
Canada’s Digital Sales Tax, measures introduced in the 2021 federal budget and the OECD/G20 Inclusive Framework—with its headline-grabbing proposal for a minimum global tax rate—are all policies with different implications for various organizations. But there are also common threads that will affect the tax strategies of many Canadian companies.
For starters, for the first time we’re seeing the emergence of a globally agreed-upon set of tax rules that are driven by what companies report in their financial statements. This will elevate the importance of accounting information in the application of tax rules, including setting tax strategy. It will also require business leaders to be even more conversant with their global financial data, ready to defend audits and justify why various rules apply (or don’t apply) to their organization.
It’s easy to view these new tax measures simply as additional compliance costs. But there’s an opportunity to create long-term value through a more proactive approach to managing your information and business operations.
Transparent tax reporting is also a fundamental part of many companies’ approach to environmental, social and governance (ESG) issues. We’re seeing stakeholders take a greater interest in the tax behaviour of businesses and how it aligns with a company’s sustainability strategy, values and purpose. And greater global tax consistency can promote sustainable business outcomes through equitably supporting communities in which companies operate.
To realize these benefits, businesses must understand how these new tax rules will apply to their global operations. Here’s a closer look at these rules, how they affect Canadian companies and some questions that can help you prepare for them:
Canada’s Digital Services Tax (DST)
Canada’s DST will apply to revenues from certain digital services—including online marketplaces, social media and online advertising—that depend on the engagement, data and content contributions of Canadian users, as well as some sales and licensing of Canadian user data.
The tax will affect businesses with €750 million in global revenue (the same threshold used for country-by-country reporting under the OECD standard) and in-scope revenue associated with Canadian users of CAD$20 million (with a lower CAD$10 million threshold for registering with the Canada Revenue Agency). The tax will apply at a rate of 3% on applicable revenue in excess of CAD$20 million.
The federal government intends to move ahead with legislation finalizing the DST and released draft legislative proposals for the DST in December.1 It’s scheduled to be imposed January 1, 2024 if a treaty implementing the OECD’s Pillar One (see below) has not yet come into force by then. In that event, the DST would be payable in 2024 in respect of revenues earned as of January 1, 2022.
While the DST will not come into effect until 2024—or may not come into effect at all—it’s prudent to prepare for this eventuality because of its application to 2022 in-scope revenues. Companies can start by:
determining the amount of their in-scope revenue, particularly revenues from sources such as user data.
allocating in-scope revenues between Canada and the rest of the world for DST purposes and ensuring systems are in place to conduct the appropriate tracking in advance of the potential implementation on January 1, 2024.
deciding what to do economically, such as whether to pass the potential cost on to customers. Businesses will also need to consider if and how to present the DST for financial statement purposes.
Rate of Canada's planned Digital Service Tax, applied on applicable revenue in excess of CAD$20 million
OECD Pillar One
Last October, nearly all 140 countries of the OECD Inclusive Framework on Base Erosion and Profit Shifting (including Canada) committed to a two-pillar approach that would substantially change the international corporate tax system.
Under Pillar One, a portion of the profits earned by some large multinational enterprises (MNEs) will be reallocated to jurisdictions where revenue is earned. It would apply to MNEs with a global annual turnover of more than €20 billion and profitability in excess of 10%. Specifically, it would reallocate 25% of an MNE’s profit that exceeds 10% of revenue. Profits and losses are to be calculated based on financial accounting income, with certain adjustments.
Pillar One is scheduled to be implemented through a multilateral convention that would be opened for signature in 2022 and come into effect next year. This is a very ambitious timeline but it’s expected to initially apply to only a limited number of MNEs—approximately 100 globally—due to its revenue and profitability thresholds.
Pillar One and Canada’s Digital Sales Tax share a common goal of ensuring companies pay tax where they’re earning revenues. However, the two measures apply to very different groups of taxpayers.
OECD Pillar Two
While Pillar One will only apply to a small number of companies worldwide, Pillar Two—which contains provisions for a minimum global tax rate—will apply to many Canadian-headquartered MNEs.
The OECD’s Pillar Two will apply to MNEs with €750 million in annual global revenue and aims to ensure these companies pay a minimum 15% effective tax rate on the income generated in each jurisdiction in which they operate. For income not subject to a 15% minimum tax rate, a top-up tax will be typically charged in the jurisdiction of the ultimate parent of the MNE.
Pillar Two is expected to be implemented through domestic legislation that’s effective as of 2023. Similar to Pillar One, this timeline is very aggressive. The OECD released model rules for Pillar Two on December 20, 2021 to provide a guide for developing domestic legislation. Additional guidance in the form of explanatory commentary and a detailed implementation framework are expected in early and mid-2022, which should provide more background and clarity as well as examples.
With Canada expected to implement Pillar Two rules, Canadian-headquartered MNEs that meet the revenue threshold should anticipate being subject to a top-up tax regime. These companies can start preparing for this regime by:
closely following Canadian developments
evaluating how it might apply to existing structures and tax footprint
identifying what information will be needed to comply with potential minimum tax obligations
considering what changes should be made to existing structures
Canadian tax measures in the
2021 federal budget
Last year’s federal budget contained several proposals that could significantly affect corporate taxpayers. These include limitations on interest deductibility, rules relating to hybrid mismatch arrangements and mandatory disclosure rules—changes that would implement OECD Base Erosion and Profit Shifting (BEPS) action measures.
Normally, draft legislative proposals for measures contained in the 2021 budget would have been released for consultations months ago. While nothing has been released to date on account of last fall’s federal election and the ongoing pandemic, we expect draft legislation to be released in early 2022.
There may be little time for businesses—particularly those with affected structures—to prepare for these new tax measures. But businesses can start preparing by considering several important questions, including:
The impact of the limitations on interest deductibility may depend on the taxpayer’s “group ratio” (i.e., the overall third-party borrowing by the group) in some instances. Is information relating to interest expense and income for the group available? If the limitations will apply, what are the implications and can existing structures be unwound?
If hybrid arrangements are in place, can they be unwound in a way that minimizes the impact?
Have income tax provisions for financial statement purposes been evaluated against potential mandatory disclosure requirements?
How Canadian companies can prepare
These changes, significant as they are, may prove to be just the start of an increasingly coordinated global tax system. We may see more measures in the coming years aimed at creating fair and effective tax systems that promote inclusive and sustainable economies. Affected companies will have to adapt. But in doing so, they have an opportunity to build greater trust with stakeholders through increased tax transparency.
We’re seeing businesses prepare for this evolution in tax by bringing together global and domestic expertise in tax policy, accounting, auditing, digitization, automation and compliance.
When this expertise is combined with in-house leaders who have a rich understanding of their company and its environment, these companies can gain better insights into their current exposure and potential opportunities. They can also undertake more effective tax planning, monitoring and modelling—as well as communicate their tax position to shareholders, board members, tax authorities and other stakeholders with confidence.
To discuss how your organization can position itself to adapt to these and other tax changes, reach out to start a conversation.
1 “Digital Services Tax Act,” Department of Finance Canada, last modified December 14, 2021, https://www.canada.ca/en/department-finance/news/2021/12/digital-services-tax-act.html
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