Taxation aims to raise short-term revenues for government expenditures such as infrastructure or civil services.
Modern taxes also usually involve a withholding mechanism. Think, for example, of payroll withholding on wages or a charge/input tax credit system in a VAT, such as Canada’s GST. The Digital Services Tax (DST), as outlined in the December 14, 2021 Notice of Ways and Means Motion, departs from these principles in interesting ways.
This article discusses some observations about the DST and who will ultimately bear its economic impact if implemented.
Basics of the DST
DST applies to 3% of a taxpayer’s digital services revenue, which comprises four subsections:
- Online marketplace service revenue
- Online advertising service revenue
- Social media service revenue
- User data service revenue.
To be in-scope, a taxpayer must meet two revenue thresholds:
- Group revenue above EUR750m
- Canadian digital services revenue that exceeds CAD 20,000,000 in a single year.
Additionally, domestic and foreign enterprises are also subject to the tax, so long as they have Canadian customers.
Raising Revenue
The Canadian government will not implement this tax until January 1, 2024. However, once effective, this tax would be payable from January 1, 2022, to the date of its effective date. In other words, the CRA would impose a catch-up tax charge.
The reason is that Canada has committed to the OECD process for a multilateral solution to taxing digital businesses. In its press release, the Federal government notes that it has a “strong preference for a multilateral approach” and will impose the DST only if a deal on Pillar One is not reached.
Unlike other forms of taxation, which primarily focus on the long-term, DST is not intended to raise revenue in the short term. As a result, Canada may never generate revenue through the DST even if it succeeds in its stated goal of pursuing a multilateral solution.
So what is the point of publishing draft legislation? Those more familiar with the ongoing negotiations between the United States and Canada have suggested that the DST announcement should be viewed in the context of ongoing trade discussions.
Enforcement
Experts expect that the DST will affect both foreign and domestic enterprises. But the draft legislation doesn’t offer a mechanism that will make it easier for Canada to compel a non-Canadian business to pay the DST.
Since the DST is a separate tax from Part I of the Income Tax Act, the proposed legislation for the DST includes enforcement and collection provisions, but none relate directly to the issue of enforcing a tax on a non-Canadian corporation.
To ensure ease of collection, the Income Tax Act includes various mechanisms, such as section 116 withholding on the sale of Canadian real property (with the obligation falling upon the buyer instead of the non-resident vendor). However, it is not apparent that the CRA will take a similar approach with the DST.
Canada may assume that taxpayers who will be subject to the DST will comply as a matter of good corporate governance or to avoid enforcement action in their jurisdiction of residence (possibly under the mutual assistance provisions of an applicable bilateral tax treaty). Perhaps Canada assumes that digital service users will carry the burden of DST.
What Is the Effective Incidence of the DST?
In 2019, France also introduced a 3% digital services tax on digital services revenue tax base. France raised Netflix’s prices in 2019 due to a rise in costs. As a formal taxpayer, a corporation can only bear a portion of the tax burden, and the rest must be shared by its shareholders, employees, and customers (in proportion).
Further complicating matters, digital companies are indifferent to where their next customers live: Netflix, for instance, does not seem concerned with whether its next new customer is French or German after setting up a platform and creating content.
The logical thing for Netflix to do is to pass this tax on immediately to its French customers to keep the after-tax return to its shareholders from the acquisition of a French user equal to what it would receive from a German customer.
In a time of epidemic and diminished in-person socializing, many digital businesses thrive. Of course, this depends on the elasticity of the demand for streaming services in France (and elsewhere).
Conclusion
Taxes like DST are strange. The country is hoping that it won’t be necessary, doesn’t want to collect any taxes until 2024 at the earliest (though it may also examine 2022 and 2023), and doesn’t have a clear method of collecting it from foreign corporations.
Canada’s digital service users will almost certainly be the only ones to pay the bill if it goes into effect. Federal governments should address the additional GST on digital sales in Canada, which is a better tax: it has been generating revenue (since July 2021) and has a more straightforward collection mechanism.
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