Canada’s Digital Services Tax Plan Likely to Meet Many Obstacles

Canada is preparing to implement a digital services tax that has been framed as a backstop to the OECD’s Pillar One. The revised DST legislation included in bill C-59 was introduced in Parliament Nov. 28. We expect the bill to be enacted into law in 2024.

The digital services tax plan likely will encounter political and administrative obstacles. The US opposes the DST and might not timely ratify the Organization for Economic Cooperation and Development/G20 Inclusive Framework’s multilateral convention to implement Amount A of Pillar One. Businesses that must prepare for the DST and Pillar One face several practical hurdles.

Once enacted, Canada’s DST is to apply retroactively to in-scope revenue from Jan. 1, 2022, despite significant concerns raised during a prior comment period. The first DST payment, based on in-scope revenue from 2022 to 2024, would be due mid-2025.

However, the revised DST legislation allows the Canadian government the flexibility to amend when the DST will apply and the applicable rate—pending discussions with the US and other jurisdictions.

The DST is structured as a 3% tax on revenue over CA$20 million (about $14.8 million) from digital services that rely on the engagement, data, and content contributions of Canadian users. Large businesses that provide digital services to Canadian users should prepare for a prospective (and possibly retroactive) DST liability.

The implementation reflects a troubling trend of the current Canadian federal government to propose legislation that applies retroactively. See, for example, recent changes to the goods and services tax and harmonized sales tax rules for certain financial services that apply retroactively to 1990—despite significant concerns over breaching the rule of law raised by the Canadian Bar Association.

Taxpayers couldn’t have properly prepared for the DST—such as setting up systems to collect the required information—when the proposed rules were subject to changes. Rather than remove the retroactivity, the government simply added an election to compute the tax liability for early years (2022 and 2023) using data obtained in 2024.

The revised DST legislation in bill C-59 gives the government flexibility to make material changes without needing to amend the legislation in Parliament.

Specifically, the executive branch of the government can do the following through regulations: postpone the effective date of the DST, eliminate the retroactivity by setting the DST rate at 0% for the earlier years, and change the DST rate for the earlier years from the current 3% rate.

Although the Inclusive Framework still aims to implement Pillar One by 2025, it faces significant political challenges. The framework in October released a draft multilateral convention to implement Amount A of Pillar One. Article 48 of the multilateral convention provides it won’t come into force unless contracting states representing at least 600 points have ratified the convention.

Because the US represents 486 of the total 999 available points, as listed in Annex I of the convention, the 600-point target can’t be met without the US. Although the US Treasury Department has sought input from the public on the convention, the agreement appears unlikely to receive the political support needed to be ratified in a timely manner.

The US has also opposed DSTs, which it argues disproportionately affect US-based multinationals, and has threatened retaliatory tariffs. Canada has indicated that it plans to introduce a DST despite US pressure, based on statements in the government’s 2023 fall economic statement and at the time of bill C-59’s introduction.

Most Inclusive Framework members agreed to pause any new DSTs to allow for more talks. Because Canada and other countries have made very little effort to coordinate DSTs or other measures outside of the two-pillar project, a failure to reach a global agreement on Pillar One may result in a patchwork of conflicting and overlapping unilateral measures with increased trade disputes and uncertainty.

While the political challenges of Pillar One remain unresolved, taxpayers also face technical and practical difficulties in preparing for Pillar One or the Canadian DST.

In theory, the guidance accompanying the multilateral convention on Amount A (spanning 900 pages) released in October should allow companies to run models and calculations to more accurately determine the potential impact of Pillar One.

But in practice, Pillar One has become unduly complicated and administratively burdensome. Complex revenue sourcing rules and formulas will fundamentally change the international tax framework that, at this point, are largely theoretical and haven’t been tested.

The DST legislation in bill C-59 is a significant step in Canada’s efforts to tax the digital economy, but it isn’t the final word. The government has left room for alignment with an evolving multilateral process. And the DST legislation acknowledges the importance of international cooperation and coordination.

Large businesses that provide digital services to Canadian users should closely monitor the developments and implications of the DST legislation and the Inclusive Framework, and they will have to assess potential exposure and compliance obligations under both the DST and any future Pillar One rules.

It is unfortunate that Canada has so far refused to amend the DST to address some of its many flaws, including its retroactivity, the double taxation caused by its lack of creditability, and the failure to coordinate with other countries. However, we hope that the pressure exerted on Canada from the US and others may eventually convince Canada to revisit its DST positions.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Patrick Marley is co-chair of Osler, Hoskin & Harcourt’s national tax group and former president of the International Fiscal Association’s Canadian branch.

Kaitlin Gray is an associate with the tax group at Osler, Hoskin & Harcourt, focused on tax controversy and international tax.

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