Canada: Canadian Digital Services Tax – Part I: Get Ready To Comply As Soon As January 1, 2024

On July 12, 2023, Deputy Prime Minister and Minister of Finance Chrystia Freeland restated Canada's intention to implement a Canadian digital services tax ("DST") as of January 1, 2024 with retroactive effect to January 1, 2022. Minister Freeland's announcement came one day after the members of the Organisation for Economic Co-operation and Development ("OECD")/G20 Inclusive Framework on Base Erosion Profit Shifting ("BEPS") agreed to a further one year standstill on the imposition of any new domestic DSTs to allow for further negotiations on Pillar One and its implementation.

The DST is intended to apply at a rate of 3% on certain Canadian digital services revenue earned by large businesses from January 1, 2022 forward. The DST is generally intended to apply to enterprises with consolidated annual global revenue from all sources of €750,000,000 or more and consolidated annual Canadian in-scope revenue associated with Canadian users of $20,000,000 or more. On August 4, 2023, the federal Government published revised Legislative and Regulatory Proposals relating to the Digital Services Tax Act.

In Part II, we will provide a summary of the updated legislative proposals to assist businesses in ascertaining their DST registration and filing obligations as of January 1, 2024.

Background

In August 2016, the participants in the OECD/G20 BEPS Project, which included Canada, issued a 15 point action plan to address tax avoidance by organizations exploiting gaps and mismatches between the tax regimes of different countries, improve the coherence and transparency of international tax rules and tackle the tax challenges of the digital economy.¹

On October 8, 2021, the members of the OECD/G20 Inclusive Framework on BEPS (the "Members") agreed to work towards an agreement for a two-pillar approach to address the international tax challenges arising from the digitalisation of the economy (the "October 2021 Statement"):

• Pillar One focuses on the allocation of taxing rights to ensure that large multinational enterprises pay tax in the jurisdictions where their users and customers are located;
• Pillar Two consists of imposing a global minimum tax to ensure that large multinational enterprises are subject to a minimum level of tax of at least 15% in each jurisdiction they operate.

As part of the October 2021 Statement, the Members of the OECD/G20 Inclusive Framework, including Canada, agreed to not implement any new DST or similar measures from the date of the October 2021 Statement and until the earlier of (i) December 31, 2023 or (ii) the coming into force of a multilateral agreement in respect of the implementation of Pillar One. The multilateral instrument would require all parties to remove their own domestic DSTs (and other similar measures), to the extent they had one and to commit to not introduce a DST or similar measure in the future.

Prior to the release of the October 2021 Statement, in its 2020 Fall Economic Statement, the Canadian Government announced its intention to implement a DST, further details of which were announced in the 2021 Federal Budget. Draft legislative proposals were issued in December 2021, but not enacted as the federal Government agreed, in accordance with the October 2021 Statement, to temporarily pause the imposition of its DST to give the international community time to complete the necessary steps and negotiations to implement Pillar One. Canada reiterated its intention to proceed with a Canadian DST in its 2022 and 2023 Federal Budgets and in Budget 2023 indicated that a revised draft of the legislative proposals would be released for public comment before the DST comes into effect. As noted above, the draft legislative proposals were released on August 4, 2023. Canada has always indicated that a Canadian DST was intended to be an interim measure to apply until an acceptable multilateral approach comes into effect.

The latest news

On July 11, 2023, the 138 member OECD/G20 Inclusive Framework on BEPS agreed on an Outcome Statement on the Two-Pillar Solution, which provides a four-part package of deliverables, to address the remaining elements of the Two-Pillar Solution ("July 2023 Statement").

Part I of the package covers the anticipated text of a Multilateral Convention (the "MLC"), which will generally allow signatory jurisdictions to reallocate and exercise a domestic taxing right over a portion of the residual profits of multinational enterprises based on a specific formula (Amount A of Pillar One). The July 2023 Statement notes that the substantive features necessary for the preparation of the MLC for signature include establishing the conditions for the removal of existing domestic DSTs and similar measures upon the MLC's entry into effect, and a commitment not to enact new DSTs and similar measures.

In contemplation of preparing the MLC for signature before the end of 2023 and its entry into force in 2025 (along with recognition of the need to prevent disruption or delay of the ratification of the MLC), the Members agreed to refrain from imposing newly enacted domestic DSTs or similar measures between January 1, 2024 and the earlier of December 31, 2024 and the entry into force of the MLC. The agreement not to enact a new DST is conditional on having at least 30 jurisdictions accounting for at least 60% of the ultimate parent entities of in-scope multinational enterprises signing the MLC before the end of 2023. The Members have further agreed to extend this commitment for one more year if sufficient progress has been made by the end of 2024.

However, one day after the July 2023 Statement, Minister Freeland issued a Statement announcing that while "Canada's priority and preference has always been a multilateral approach", Canada could not support the "extended standstill" for the implementation of newly enacted DSTs "without any firm and binding multilateral timeline to implement Pillar One". In the Statement, Minister Freeland asserted that the further one year delay puts Canada at a "disadvantage relative to countries which have continued collecting revenues under their pre-existing DSTs".² As a result, the Minister confirmed that Canada will proceed with its own DST as of January 1, 2024, if the MLC to implement Pillar One has not come into force by that date.

Takeaway

In light of the Government's announcement, affected multinational enterprises should prepare for the implementation of a Canadian DST on January 1, 2024. Although it is still possible that the Canadian government may shift course before the end of the year, businesses should expect that the DST will proceed as planned.³ Part II , which will provide a summary of the DST based on the revised draft legislation and regulatory proposals released on August 4, 2023, will follow in the near future.

Footnotes

1. OECD (2016), BEPS Project Explanatory Statement: 2015 Final Reports, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, https://doi.org/10.1787/9789264263437-en.

2. Countries such as Austria, France, Italy, Spain and the United Kingdom had a domestic DST in place before the agreement on the October 2021 Statement took place.

3. We note that rather than providing a fixed date for the Digital Services Tax Act to come into force, the draft legislation provides the Governor in Council with the discretion to enact the Digital Services Tax Act "on a day that is fixed by order of the Governor in Council, but not earlier than January 1, 2024". Therefore, it is possible that the Digital Services Tax Act may never be enacted.

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