Canadian Digital Services Tax – Part II: Updated Draft Legislation Released – What You Need to Know!
In Part I of our update on Canada’s proposed Digital Services Tax (the “DST”), we covered the Canadian government’s August 4, 2023 announcement that it intended to proceed with the DST even though the other members of the Organisation for Economic Co-operation and Development (“OECD”)/G20 Inclusive Framework on Base Erosion and Profit Shifting (“BEPS”) agreed to a further one year delay in the implementation of new domestic digital services taxes.
However, given Canada’s divergence from the OECD/G20 Inclusive Framework, concerns raised by impacted businesses and, importantly, United States opposition to the Canadian DST, uncertainty remains as to whether Canada will actually proceed with the DST on January 1, 2024. In its November 21, 2023 Fall Economic Statement (the “FES”), Canada reiterated its intention to proceed with the DST although there was no express statement that the implementation date would be January 1, 2024. The FES stated, “Forthcoming legislation would allow the government to determine the entry-into-force date of the new Digital Services Tax as Canada continues conversations with its international partners”.However, based on follow up correspondence with the Department of Finance (“Finance”), we understand that it would not be necessary that Canada have an agreement with the United States before implementing the DST on January 1, 2024. Given this possibility, businesses should, for now, operate with the expectation that the DST will come into force on its proposed January 1, 2024 implementation date.
Concurrent with the August 4, 2023 announcement, Finance released an amended version of the Digital Services Tax Act (the “DSTA”). Subsequently on November 23, 2023, as part of the Notice of Ways and Means Motion to introduce a bill entitled 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, Finance released a new version of the DSTA with additional amendments along with a Digital Services Tax Regulations. In Part II of our update, we will discuss the general framework of the DSTA and comment on the more important amendments that are reflected in the DSTA.
Who is Subject to the DST?
Both Canadian and non-Canadian taxpayers will be subject to DST in Canada if they meet two conditions:
- The taxpayer, or a consolidated group of which the taxpayer is a member, earned at least €750,000,000 in total global revenue in the prior calendar year; and
- The taxpayer or the consolidated group earned at least $20,000,000 (CAD) in “digital services revenue” in the prior calendar year.
Where the above conditions are satisfied, the DST will apply at a rate of 3% on the taxpayer’s taxable Canadian digital services revenue earned in the particular calendar year beginning January 1, 2022. However, DST only applies to the taxpayer’s Canadian digital services revenue above $20,000,000 (CAD) in the calendar year.
The DST liability is not expected to be creditable against Canadian income tax payable. However, a deduction of the DST liability may be available in calculating taxable income for Canadian income tax purposes under general principles.
What Revenue is Subject to the DST?
The DST applies to taxable Canadian digital services revenue, which is derived from four different revenue streams that are sourced to online users in Canada: (i) online marketplace services revenue; (ii) online advertising services revenue; (iii) social media services revenue; and (iv) user data revenue. Whether revenue is sourced to users in Canada is generally based on the revenue’s association with Canadian users (data available to the taxpayer in the normal course of its business, including any address on file for the use or IP address data). The DSTA contains detailed definitions and exclusions for each revenue stream along with complex application rules to determine the revenues derived from Canadian users. A brief overview of each of the four revenue streams is provided below. The revenue streams are hierarchical and are set out in order such that if, for example, a particular revenue is online marketplace services revenue, it cannot fall within one of the other revenue streams.
(i) Canadian online marketplace services revenue
Under the DSTA, “online marketplace” is defined to mean a digital interface, including a web site or application, that allows users to interact with each other and facilitates the supply of property or services, including digital contentbetween users. However, digital interfaces operated by a single supplier and digital interfaces whose main purpose is to make supplies of financial services such as digital interfaces of credit card processors, lenders and investment trading platforms are excluded from the definition of “online marketplace” and therefore outside the scope of the DST.
Online marketplace services revenue includes fees earned from providing access to or use of the online marketplace (e.g., subscription fees), commissions or other fees earned from facilitating supplies between users of the online marketplace and from premium services ancillary to the supply. However, reasonable charges for storage and shipping services along with amounts earned from transactions between members of a consolidated group are generally excluded.
Canadian online marketplace services revenue is calculated using a formula to determine the portion of the revenue that is associated with Canadian users. The DSTA clarifies that online marketplace service revenues are entirely sourced to Canada where the revenues are earned in respect of a supply of a service between users of an online marketplace that is (i) physically performed and received in Canada (e.g., vehicle ride or food delivery), (ii) in respect of tangible personal property (e.g., car sharing or furniture assembly services) in Canada or (iii) real property (e.g., short-term accommodation) in Canada. The formula also contains rules to cover situations where one or both of the seller and buyer are located in or outside Canada and where the revenues are non-transactional.
(ii) Canadian online advertising services revenue
Online advertising services revenue includes (i) revenue from enabling the delivery of online targeted advertisements through a digital interface and (ii) providing digital space for online targeted advertisements with the in scope revenues based on the number or proportion of users (i.e., persons accessing the advertisement) in Canada. The term “online targeted advertisement” is defined in the DSTA to mean an advertisement consisting of digital content that is “prominently” placed on or transmitted through a digital interface that is targeted at users based on the data attributes of the users.
Revenue earned from transactions between members of a consolidated group is excluded from online advertising services revenue. In addition, to minimize the cascading of tax, any portion of a taxpayer’s online advertising revenues that it pays to another entity, which are included in the online advertising services revenue of that other entity are excluded from the paying entity’s online advertising revenues. The determination of Canadian online advertising services revenue will be based on the location of the targeted user where the revenues are “directly attributable” to specific displays of or interactions with online targeted advertisements and by a pro-rating formula where the revenues are not specifically traceable.
(iii) Canadian social media services revenue
Social media services are provided via social media platforms, which are digital interfaces whose main purpose is to permit users to find and interact with other users or with digital content created by users. However, a platform whose main purpose is the provision of property or another service, for example the provision of online games, will not be considered a social media platform where the user interaction component is incidental to that main purpose. Social media revenue includes subscription or pay-per use fees earned from providing access to or use of the social media platform, premium services and revenues derived from facilitating interaction between users or between users and digital content. However, revenue earned by a social media platform from providing access to its own content (i.e., not user-generated content) is excluded from social media revenue. In addition, revenues in respect of social media services arising from transactions between members of a consolidated group are generally excluded. A taxpayer’s Canadian social media services revenue will be that portion of its revenues associated with users in Canada, which will generally be based on the number of social media accounts located in Canada to the total social media accounts of the taxpayer that have an address that can be determined.
(iv) User data revenue
User data revenue includes revenues from data (e.g., a user’s name, address or a user’s behaviour such as web pages visited and services used) that is collected by a taxpayer in respect of users of an online marketplace, social media platform, or search engine. Revenues from the sale of or provision of access to the data (e.g., licensing the use of the data) will generally be considered user data revenue. However, revenue from the sale or use of data that was not collected by the taxpayer or another member of its consolidated group and data revenue earned from transactions between members of a consolidated group will generally not be in scope. In addition, revenue from consulting or business advisory services that rely on user data is excluded from user data revenue.
If the data can be traced to a single user in Canada, the revenue earned from selling or licensing that data is sourced to Canada will be considered Canadian data service revenue. If the data is collected from multiple users, Canadian user data revenue is determined by reference to the proportion of users located in Canada.
A taxpayer must register under the DSTA if the taxpayer or its consolidated group meets the following three conditions:
- the taxpayer or the consolidated group had digital services revenue in a particular calendar year;
- the taxpayer or the consolidated group had total revenue of at least €750,000,000 in the particular calendar year; and
- the taxpayer or the consolidated group had Canadian digital services revenue of at least $10,000,000 in the particular calendar year.
Where the above requirements are met in a particular calendar year, the taxpayer must register under the DSTA by January 31 of the following year. However, as noted above, the DST will only apply to revenues earned by the taxpayer above the $20,000,000 (CAD) Canadian digital services revenue threshold. Therefore, a taxpayer may have a registration and filing requirement even if it has no obligation to pay DST.
Taxpayers who fail to register are subject to a penalty of $20,000 (CAD) per year beginning in the calendar year the taxpayer was required to register and ending in the year it registers. A taxpayer can deregister from the DSTA if it would not have satisfied the three thresholds in the prior three years.
(ii) Filing and Payments
Taxpayers must file DST returns and make payments for a particular year by June 30 of the following year. Members of a consolidated group can jointly elect to designate one member to pay all DST owing by the consolidated group on the group’s behalf.
Taxpayers who fail to file and pay DST in a timely manner are subject to interest and penalties. If a taxpayer is a member of a consolidated group, each member of the taxpayer’s consolidated group is jointly and severally liable for the unpaid DST.
Key Legislative Changes From 2021 to Today
It is important to note the amendments set out below that were introduced in the August and November 2023 versions of the DSTA :
- Election to account the estimated revenues: Taxpayers can elect to use a simplified method to calculate their DST owing for years prior to the first year of application (i.e., the year in which the DSTA comes into effect). Taxpayers making the election will use the proration of their Canadian digital services revenue to their total revenue in the first year of application of the DST. For example, if the DST comes into effect in 2024 with retroactive effect to January 1, 2022 and 20% of a taxpayer’s revenue in 2024 is from Canadian digital services revenue, the taxpayer would determine its DST payable for 2022 and 2023 by multiplying its total revenue by 20%. However, the taxpayer may not make the election if it could have made the election in a prior year but failed to do so.
- “In-scope period” digital services revenue: The concept of “in-scope period” is clarified and provides that when a taxpayer joins a consolidated group, its digital services revenue earned prior to joining the consolidated group is excluded from its DST obligation. Accordingly only the revenue earned by the taxpayer after it joins the consolidated group would be subject to DST.
- “Anti-avoidance” rule: The DSTA contains several enhancements to the anti-avoidance provisions and includes its own general anti-avoidance rule similar to that in the Income Tax Act (Canada). The amendments include a new specific anti-avoidance provision to address situations involving non-arm’s length transfer of property and a related penalty for avoidance planning.
- Extended application to partners of a partnership: The DSTA now addresses how DST applies to partnerships and partners of a partnership and establishes that the partnership is a separate entity from the partners. In this regard, the obligations under the DSTA generally apply at the partnership level.
- Joint and several liability: The DSTA clarified some of the rules regarding the joint and several liability for DST among members of a consolidated group electing to have a designated member taking on the DST reporting obligations for the consolidated group.
- Electronic Payment and currencies: A new requirement to pay electronically is introduced for DST payments exceeding $10,000 (CAD), unless the taxpayer cannot reasonably pay by electronic means. In addition, while payments in Canada dollars are required under the DSTA, the Minister may authorize the payments of the DST in other currencies.
- Financial difficulties: New provisions were introduced to address the application of the DST where a taxpayer becomes bankrupt or its business or assets become subject to receivership.
Although, to date, Canada and the United States have not reached an agreement regarding the DST, Canada has indicated that it still intends to proceed with a January 1, 2024 entry-into-force date for the DST. As a result, Taxpayers should operate on the basis that the DST will become effective at the beginning of the new year with retroactive effect to January 1, 2022 and prepare accordingly. The McCarthy Tétrault tax team will be providing a webinar on the DST on December 7, 2023 to provide a more detailed analysis on the DST and what to expect.
 In particular, Canada is seeking to reach an agreement with the United States.
 The DSTA defines a “consolidated group” as: two or more entities that are required to prepare consolidated financial statements for financial reporting purposes under acceptable accounting principles (e.g., the IFRS), or would be required to do so if equity interests in any of the entities were traded on a public securities exchange, the trading on which requires the use of acceptable accounting principles.
 Digital content is defined to mean a digitally encoded text, video, image or sound recording, computer software or any other thing that is digitally encoded and electronically transmittable but does not include a financial instrument which, in turn, is defined to include shares of a corporation, an interest in a partnership, a note, a bond, or other evidence of indebtedness, etc.
 The DSTA specifically excludes the provision of payment services relating to the electronic transfer of funds, advances, granting of credit and loans and facilitating the supply of financial instruments.