Most taxes aim to generate revenue for short-term government spending (usually within one year of the taxable event). A well-designed modern tax will usually also involve a withholding mechanism: think, for example, of the payroll deduction or the input tax credit system in a typical VAT, such as Canada’s GST. The digital services tax as set out in the Notice of Ways and Means Motion of December 14, 20211 (the “Summer time“), deviates from these principles in an interesting way. This briefing note offers some observations on the DST and addresses the question of who will bear the economic cost of this tax if it is finally implemented.
The basics of DST
DST is offered at 3% of a taxpayer’s digital service revenue, which in turn is made up of four categories: online marketplace service revenue, online advertising service revenue, social media and user data income. There are two relevant thresholds: to enter the scope, a taxpayer must reach two income thresholds: group income greater than 750 million euros,
and Canadian digital services revenue of over CAD 20,000,000 in one year. It is proposed that the tax apply to domestic and foreign businesses, provided they have Canadian users.
It is proposed that the DST will only apply on January 1, 2024. If it enters into force on that date, then the tax is payable for the period from January 1, 2022 until the effective date, c that is, there is effectively a catch up on the tax burden. The reason is that Canada has embarked on the OECD process to come up with a multilateral solution to tax digital businesses, i.e. the first pillar (or maybe the second pillar).2 Indeed, in its press release, the federal government notes that it has a “strong preference for a multilateral approach” and that the DST will only be imposed if an agreement is not found on the first pillar.3
The aim of DST is therefore not to generate short-term income. Indeed, if Canada succeeds in achieving its stated goal of seeking a multilateral solution, then it may never receive revenue through DST. Why, then, publish a bill? Other commentators, more attentive than this author to the U.S.-Canada negotiations on trade issues, have suggested that the daylight saving time announcement should be seen in the context of a ongoing trade discussion between these countries.4
As noted above, it is proposed that the DST apply to foreign and domestic companies. But there is no obvious mechanism in the draft bill for Canada to demand payment from a non-Canadian business that is subject to RST. Since the DST is an entirely separate tax from the Part I tax under the Income Tax Act, the draft CSD bill includes enforcement and collection provisions, but none directly addresses how to apply a tax to a non-Canadian business. the Income Tax Act has various mechanisms, such as the section 116 withholding tax on the sale of Canadian real estate (the obligation being placed on the buyer, rather than the non-resident seller, to ensure ease of collection). But there doesn’t seem to be a similar approach taken with DST.
Canada may assume that the types of taxpayers who will be subject to RST will comply as part of good corporate governance or to avoid enforcement action in their jurisdiction of residence (possibly under the mutual assistance provision of an applicable bilateral tax treaty). Or, Canada may assume that the burden of daylight saving time will be borne by the end users of digital services.
Effective incidence: who will pay the DST?
France introduced a tax on digital services in 2019, also at the rate of 3% on a tax base of revenues from digital services.5 Netflix increased its tariffs in France in 2019. This testifies to a truism of any taxation for which a company is the formal taxpayer: the effective burden cannot be borne by the company and is shared (to a certain extent) between shareholders, employees and customers. .
The added difficulty with digital businesses is that they are largely indifferent as to where their next customer is: having established a platform and content, Netflix probably doesn’t care whether their next new customer is French or German. Thus, if France introduces a tax on digital services, the logic for Netflix is to pass it immediately on to its French customers, to equalize the after-tax return of its shareholders from the acquisition of this customer (compared to a German viewer ). It all depends, of course, on the elasticity of demand for streaming services in France (and elsewhere), but in times of pandemic and reduced in-person socialization, many digital businesses thrive.
DST is an odd tax. Canada hopes this will not be necessary, does not want to collect any tax revenue until 2024 at the earliest (but could then look back to 2022 and 2023), and has no clear way to collect it from foreign companies. If it is imposed, it is very likely that it will be fully borne by Canadian users of digital services. The federal government should focus on the additional GST from digital sales in Canada,6 which is a better tax: it started to generate income (from July 2021) and has a simpler collection mechanism.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.