The impact of Canada’s new Digital Services Tax Act on businesses

September 9, 2024

Canada’s Digital Services Tax Act (“DSTA”) impacts both Canadian and foreign large businesses with global consolidated revenues of at least €750M, while earning digital services revenue in Canada. A business that meets the minimum thresholds will be required to pay a 3% Digital Services Tax (“DST”) in respect of revenues earned as of January 1, 2022, on their taxable Canadian digital services revenue in excess of C$20M.

Introduction

The Organization for Economic Co-operation and Development (“OECD”) has been concerned over the last few years that current tax systems do not properly tax multinationals on the revenues generated from the digital economy. To ensure that the largest and most profitable global corporations, including large digital corporations, pay their fair share of tax in the jurisdictions where their users and customers are located, the OECD has proposed the implementation of the Pillar One Amount A (“Pillar One”) global tax.

In its 2020 Federal Fall Economic Statement on November 30, 2020, the Canadian government first announced its proposed DST as its interim solution to Pillar One.

In October 2021, Canada and other members of the OECD/G20 Inclusive Framework, agreed to pause the implementation of any new DST until the end of 2023. This was intended to give time for Pillar One negotiations to conclude. However, given that Pillar One did not enter into force by the end of 2023, the Canadian government decided to move forward with enacting a DST; its unilateral interim solution to the delayed Pillar One objective.

The DSTA was then introduced into the Canadian legislative process on November 30, 2023, as part of Bill C-59. Bill C-59 was finally enacted on June 20, 2024, and Canada’s DSTA came into force by Order in Council on June 28, 2024. The purpose of the Canadian DSTA is to ensure that digital businesses that monetize the data and content of Canadian users are paying their fair share, and that Canada is not at a disadvantage relative to other countries. Namely, that digital services revenues earned in Canada by both Canadian and foreign businesses are subject to Canadian federal taxation.

The DST is estimated to increase Canadian federal revenues by approximately C$7.2B over five years, with a significant portion expected to be paid by US businesses.

Overview of the DSTA in Canada

The DSTA impacts large Canadian and foreign businesses, including corporations, trusts and partnerships, that are part of a corporate group^[1] with:

Global revenue from all sources of at least €750M in the fiscal year ended in the previous calendar year; and
Canadian digital services revenue from providing online marketplace services, online advertising, social media services and or the monetizing of user data exceeding C$20M in the calendar year.

The DST is calculated at 3% of taxable digital services revenues derived from Canadian users exceeding C$20M (or approximately US$15M). The DST applies retroactively to revenues earned as of January 1, 2022.

Since the first draft of the DSTA released on August 4, 2023, an important change made to the legislation was moving the thresholds regarding global revenue, in-scope revenue and registration from the DSTA to the DST Regulations to provide the Canada Revenue Agency (“CRA”) with greater flexibility in adjusting the thresholds over time.

Key DST Concepts/Terms

The following DST concepts/terms are fundamental to the determination of in-scope revenues subject to the DST as further discussed in the sections that follow:

Anti-cascading rule: This rule would ensure that the same revenue would not be taxed several times.
Digital content: Any content (other than a financial instrument) that is digitally encoded and electronically transmittable, including digitally encoded text, video, image or sound recording, and computer software.
Digital interface: An electronic medium through which data or digital content is collected, viewed, consumed, delivered or interacted with. A website and an application are specifically included.
Online marketplace: A digital interface that allows users to interact with other users and facilitates the supply of property or services, including digital content, between those users.
Online search engine: A digital interface that allows users to search the digital content of multiple unrelated websites via the Web.
Social media platform: A digital interface which mainly allows users to find and interact with other users or with digital content generated by other users.
User located in Canada: A user is considered to be located in Canada if it is reasonable to conclude, based on data available to the taxpayer in the normal course of its business, that the user is in Canada. Methods to determine if the user is located in Canada can include the following: the real-time location (e.g., device geolocation), address on file for the user, the area code of the phone number, IP address, financial institution address, etc.

In-Scope Revenues Subject to the DST

There are four different categories of Canadian-sourced revenues that qualify as digital services revenue in Canada:

Online marketplace services revenue;
Online advertising services revenue;
Social media services revenue; and
User data revenue.

Each of these categories are discussed in greater detail below.

Online Marketplace Services Revenue
Included Revenue	Calculation of Revenue	Exclusion(s)	Example
Revenue earned from providing an online marketplace to facilitate transactions between sellers and buyers. Activities include: · Providing access or use of the online marketplace (e.g., subscription fees, pay-per-use fees) or facilitating a transaction between sellers and buyers (e.g., transaction commissions). · Providing premium services relating to the online marketplace.	Revenues are calculated based on the following methods: Transactional Method: · 100% of the revenue earned from facilitating the supply of a service in physical form performed in Canada (e.g., accommodations, transportation) would be considered sourced in Canada. · Revenue earned from facilitating a transaction between users: – if both users are located in Canada, the revenue would be considered entirely sourced in Canada. – If one user is located in Canada, 50% of the revenue would be considered sourced in Canada. Non-Transactional Method: · Revenue earned from online marketplace services that cannot be traced would be considered sourced in Canada based on the percentage of the participants of the transaction that are located in Canada.	Activities/revenue excluded from the definition of “online marketplace services revenue” include: · Storage or shipping services. · Sale of goods and services by a single supplier (i.e., selling one’s own inventory, online marketplace by an entity in a consolidated group from another entity in the same group). · Trading in financial instruments and commodities.	An advertising company operates a digital platform to connect publishers of advertising content with marketers. The company operating the platform received a commission from advertising facilitated by the platform. The platform would be considered an “online marketplace” per the DSTA. Due to an exclusion provision (i.e., anti-cascading rule) included in the DSTA, the fees are exclusively considered “online marketplace services revenue”, otherwise it could have also been considered “online advertising services revenue”.

Online Advertising Services Revenue
Included Revenue	Calculation of Revenue	Exclusion(s)	Example
Revenue earned from facilitating the delivery of online advertisement and providing the space for online advertisement. Activities include: · Services of placing online advertisement targeted and based on data collected from users of various online interfaces (e.g., online marketplaces and social media, internet search engines, digital content streaming services, online communications services).	Revenues are calculated based on the following methods: Tracing Method · Revenue earned can be traced to the display of an advertisement to a specific user who is located in Canada. Formula Method · · · Revenue earned from the display of an advertisement that cannot be traced would be considered sourced in Canada based on the percentage of users located in Canada who are subject to the advertisement.	Activities/revenue excluded from the definition of “online advertising services revenue” include: · Revenue that qualifies as “online marketplace services revenue”. · Revenue earned from online advertising services by an entity in a consolidated group from another entity in the same group.	A social media platform allows marketers to use the users’ data in order to target advertisement at users. The marketer will pay the platform a fee for view and clicks on an advertisement. This revenue would be considered “online advertising services revenue” per the DSTA. To prevent taxation on the same revenue multiple times in the hands of different entities, the definition excludes the portion of revenue that is paid from another entity and would be considered online advertising services revenue for the other entity (i.e., “anti-cascading rules”).

Social Media Services Revenue
Included Revenue	Calculation of Revenue	Exclusion(s)	Example
Revenue earned from providing a social media platform facilitating interactions between users, or between users and user-generated content. Activities include: · Provision of access to, or use of, the social media platform, premium services, and the facilitation of specific interactions between users, or between users and user-generated content.	Revenues are calculated based on the following method: · Revenue sourced in Canada would be based on a formulaic approach that calculates the percentage of the platform’s users (e.g., social media accounts) that are located in Canada.	Activities/revenue excluded from the definition of “social media services revenue” include: Revenue that qualifies as “online marketplace services revenue” or “online advertising services revenue”. · Platform with the sole purpose of providing private communication services (e.g., voice calls, video call, instant messaging, emails). · Revenue earned from social media services by an entity in a consolidated group from another entity in the same group.	A website allows users to connect with friends and access content posted by those friends. There is a premium fee for an add-free version of the website. This fee would be considered a “social media services revenue” per the DSTA.

User Data Revenue
Included Revenue	Calculation of Revenue	Exclusion(s)	Example
Revenue earned from the sale or licensing of data collected about the users of an online marketplace, an online search engine, or a social media platform.	Revenues are calculated based on the following methods: · Revenue that can be traced to the user data of a single user who is located in Canada would be considered entirely sourced in Canada. · Revenue that originates from a set of data from different users would be considered sourced in Canada based on the percentage of users located in Canada.	Activities/revenue excluded from the definition of “user data revenue” include: · Revenue that qualifies as “online marketplace services revenue”, “online advertising services revenue”, or “social media services revenue. · Revenue earned from user data by an entity in a consolidated group from another entity in the same group.	A social media platform is collecting data from its users and selling the data to a third party. The revenue from the sale of the data would be considered “user data revenue” per the DSTA. Since it does not relate to a specific targeted advertisement, it is not considered “online advertising services revenue”.

DST Administration / Compliance Obligations

Affected businesses that meet the various global, registration and in-scope revenue thresholds would have to register with the CRA by January 31, 2025, and where applicable, file their first DST return(s) and pay any related taxes by June 30, 2025 (for the 2022 to 2024 years), or else they could face penalties and interest, as further discussed below.

We expect the CRA to issue additional administrative guidance on DST compliance in the following months.

Registration

An entity or consolidated group of which an entity is a member that earned over €750M in global revenue in the previous calendar year, and with over C$10M of Canadian digital services revenue are required to register and will have to do so by January 31, 2025.

Failure to register by the January 31, 2025 deadline could lead to a penalty of $20,000. An entity that has not met the DST registration threshold in the prior three years will have the ability to de-register from the DST.

DST Registration for multiple entities within a Consolidated Group

A taxpayer would share the C$10M registration revenue threshold with entities that are part of a consolidated group while the taxpayer is part of the group. To simplify and streamline the registration process, an election can be made for a specific year for members of a consolidated group to register through a single entity.

Example – Multiple entities/groups:

Entities A, B and C are members of a consolidated group that consistently earns consolidated revenue above the €750M threshold. In 2026, entity A earned C$10M of Canadian digital services revenue, entity B earned C$100K of Canadian digital services revenue, and entity C did not earn Canadian digital services revenue. Entity A and entity B would both be required to register on January 31, 2027, since they both earned Canadian digital services revenue and surpass the threshold as a consolidated group. Entity C does not have to register since it did not earn any Canadian digital services revenue.

Since the registration threshold is C$10M, the consolidated group surpassed the threshold in 2026 with C$10.1M.

Annual Returns and Payments

An entity or consolidated group of which an entity is a member of that earned over €750M in global revenue in the previous calendar year while earning over C$20M of Canadian digital services revenue, are required to file DST returns and make payments of their DST liability. The deadline to file DST returns and make payments are based on the calendar year and are due on June 30^th of the following calendar year.

The first payment will be due June 30, 2025, and will include payments, if applicable, for years 2022 to 2024 due to the retroactive application of the DST to January 1, 2022.

Failure to file the DST return and pay the tax before the June 30 deadline would result in a 5% penalty applicable on the unpaid DST plus 1% penalty of such unpaid DST times the number of months the required filing and payment will have been outstanding, up to a maximum of 12 months (maximum penalty of 17% when requirements are a year or more past due).

Businesses can elect to simplify the calculation of their Canadian digital services revenue for their 2022 and 2023 calendar years by using a formula intended to approximate the in-scope revenue based on an affected taxpayer’s Canadian digital services revenue from 2024, subject to certain conditions.

DST Returns and Payments for various entities within a Consolidated Group

Similar to the DST registration, a taxpayer would need to share the C$20M deduction (i.e., first C$20M of Canadian digital services revenue is exempted from DST) with entities that are part of a consolidated group at the same time that the taxpayer is part of the group. An election can however be made for a specific year for members of a consolidated group to report the DST through a single entity.

The taxpayers that are part of the group would share a pro-rata portion of the first C$20M of Canadian digital services revenue exemption amongst themselves. The portion that a particular taxpayer would be entitled to would generally depend on the amount of its Canadian-sourced in-scope revenue earned throughout the calendar year as compared to the Canadian-sourced in-scope revenue of the other taxpayers in the group.

Key Considerations for Canadian and Foreign Corporations

It is anticipated that Pillar One will be implemented in the near future, and at that time, countries will be expected to eliminate their local DST to prevent double taxation on businesses’ income.

Until such time, the Canadian DST will likely remain in place, forcing Canadian and foreign businesses to be prepared. Businesses will have to ensure they are ready to deal with the impacts associated with the DST; both from an internal and external perspective.

The Canadian DST has many unintended consequences that are expected to impact various sectors of the Canadian economy including potential inflationary pressures on Canadian consumers, potential harm to Canadian innovation, and impediments to Canada’s relationship with international trading partners.

Global DSTs

Currently, around half of the European country members of the OECD have already proposed or implemented unilateral DSTs. In addition to these OECD countries, Argentina, Brazil, India, Indonesia, Kenya, Nigeria and Vietnam are among various non-OECD countries with proposed or existing DSTs with additional measures likely to come.

A consensus has been reached amongst agreeing DST countries that the relative costs and efforts of implementing these local DSTs have been relatively low. For example, the UK implemented its DST at an approximate cost of £6.3 million (€7.25 million) and lived a smooth implementation process with relatively limited DST tax avoidance observations. The UK indicated that this likely resulted from the fact that businesses considered that the reputational risk associated with avoiding the DST outweighed any potential gains associated with its overall costs. Similarly, and in comparison, Canada estimated that the initial implementation costs of its DST would be around C$24M over two years and C$4M per year after that for its administration.

One downside of having local DSTs in multiple jurisdictions is that their differing calculation methods and digital revenue scoping could ultimately lead to double taxation, as different jurisdictions may tax the same type of revenue earned by a single taxpayer. For example, Poland and Denmark apply a DST on streaming services, while Austria and Hungary apply a DST on digital advertising. The impact of this on businesses will need to be monitored.

The ultimate question is whether the DSTs are more likely than not to disappear in the short term. The future of DSTs will likely depend on the following critical factors: (i) the progress vis-a-vis the adoption of Pillar One and (ii) the position the US takes on both DSTs and Pillar One (in consideration with the commercial and international trading approaches/retaliatory measures the US is willing to take against agreeing DST countries).

In October 2021, Canada and other members of the OECD/G20 Inclusive Framework, committed not to impose any newly enacted DSTs before the end of 2023 as previously discussed. Despite intensive negotiations and the extended deadline of June 30, 2024, the OECD did not achieve consensus on Pillar One, and therefore members party to the 2021 Agreement agreed to a further one-year standstill to the end of 2024 for the implementation of any new DSTs. This commitment did not however impose any obligation on countries with pre-existing DSTs.

At the end of 2021, the US government entered into a Unilateral Measures Compromise Agreement with Spain, France, Italy, Austria and the UK to ensure that these countries (that already had domestic DSTs in place) would withdraw their domestic DSTs once Pillar One takes effect (“2021 Agreement”)^[2]^{,^[3]}. As a result, the US government agreed to stop its planned trade actions against these countries. In the meantime, these DST-imposing European countries would continue to levy the tax but have agreed that any tax liabilities from the DST incurred within their jurisdictions would be credited against the future tax obligations resulting from the implementation of Pillar One. This 2021 Agreement was extended following the further delay in the implementation of Pillar One. The US has however made it clear that it will protect the interests of US businesses until such a consensus is reached.

The US Response

The global DSTs, whether that of Canada or European countries, are expected to primarily impact large US technology-based companies including Meta, Amazon, Google and Apple. The US government has already received increased pressure for a formal response which could include retaliatory trade measures with added tariffs on various products and potentially have impacts beyond the digital services industry.

Regardless of a formal response from the US and or other governments, it is expected that targeted businesses will pass on new DST costs to consumers, including Canadians, and as such, digital services subject to DST are likely to see their cost increases passed on in the form of higher user fees. For example, as of October 1, 2024, Google will be imposing a 2.5 percent Canada DST fee on its customer invoices/statements for ads served in Canada. Google notes that these fees are being added to cover part of the cost of complying with DST legislation in Canada. This response by Google is no different than its response to other jurisdiction-specific surcharges (e.g., UK DST, Austria DST); DST costs are considered as an integral part of the cost of doing business when an ad is served in these jurisdictions.

It remains however to be seen whether the US government will act on its retaliatory measures, and if so, which industries might be affected by additional tariffs. It would not be unreasonable to expect the US to react in a similar manner to how it reacted to comparable taxes from other countries in the past. We can likely expect the use of tariffs to attempt to make up for what is perceived to be lost revenue. The Canadian government has stated that it is actively engaging with the US regarding the DST but also notes that the US has been explicitly tolerating the pre-2022 DSTs in at least seven other countries (e.g., Austria, France, India, Italy, Spain, Turkey and the UK).

Impact on Canadian and Foreign Businesses

The DST liability that businesses could be facing, including retroactive amounts to 2022, would be incurred on top of the current significant corporate income tax and regulatory fees that such companies already have to pay. Canadian businesses, unlike foreign businesses not subject to Canadian corporate income tax (i.e., on the same revenues on which DST is applicable), will potentially be subject to double taxation as the DST outlays are not eligible for a credit against Canadian income tax payable. Even if no credit would be available for DST paid to offset the corresponding corporate income tax payable on the same revenues, a deduction when computing net income for tax purposes could potentially be available to Canadian taxpayers. The determination of the deductibility of the DST is based on the same principles as with other non-income taxes (i.e., deductible if incurred for the purposes of earning income), as further discussed below.

The DSTA mandates that taxpayers (Canadian and foreign) that are part of a consolidated group are to share a pro-rata portion of the C$20M deduction, and any DST liabilities on revenues in excess of this C$20M deduction would also be expected to be shared in a similar manner. However, from a practical standpoint, it is unclear where and who within the supply chain would ultimately bear the cost. As such, the presence of DST makes it crucial for businesses to examine their supply chain and address issues with their suppliers and customers. For example, a Canadian subsidiary of a non-resident parent that is a member of a large global group may be expected to bear the full DST liability otherwise payable to the Canadian government by any other group member. In such cases, Canadian taxpayers would likely also need to consider the impact of such payments from a transfer pricing perspective.

In addition to the DST, online streaming services will also be subject to the new Online Streaming Act which amended the Broadcasting Act that requires the Canadian Radio-television and Telecommunications Commission (“CRTC”) to modernize the Canadian broadcasting framework and ensure that online streaming services make meaningful contributions to Canadian and Indigenous content. The CRTC is requiring online streaming services to contribute 5% of their Canadian revenues to support the Canadian broadcasting system. These obligations will start in the 2024-2025 broadcast year and will provide an estimated C$200 million per year in new funding while weighing down on Canadian’s tax and overall government type contributions’ burden. This will put added financial pressure on Canadian online streaming businesses.

Accounting and Income Tax Treatment

The accounting norms ASC740 and IAS 12 dictate how businesses should account for “taxes based on income” under US GAAP or IFRS. Although the term “taxes based on income” is not defined clearly in each of these respective accounting frameworks, it is our interpretation that the reporting obligation relates to taxes on the net income rather than on a gross basis.

Typically, DSTs are not considered to be income (profits) taxes, online sales taxes, nor VATs. They are generally a tax on gross revenues occurring outside of any treaties. Similarly, since the Canadian DST is applied on the gross revenue stream, such DST would most likely not be considered as “taxes based on income” for purposes of US GAAP and IFRS reporting.

Since DST would not be considered an income tax, any DST liability payments made by a taxpayer would not be eligible for a credit against its Canadian income tax payable for the year. However, as with other non-income taxes (similar to property taxes and payroll taxes), any DST liability payments would be considered a deductible outlay for tax purposes if such expense was incurred for the purpose of earning income.

Next Steps / DST Readiness to Comply

As a result of the enacted DSTA, where its application is retroactive to Canadian digital revenues earned as of January 1, 2022, Canadian and foreign businesses (part of a consolidated group or not) should be proactive in determining whether they will be affected by this new “gross revenues” tax, and if so, should put a plan into place to ensure they comply with the new rules, including:

Calculating the global consolidated revenues to determine whether such group meet the DST Global revenue threshold (€750M).
Reviewing all the revenue streams of the entities that are part of the group to determine whether revenues earned fall into any of the four categories of in‑scope DST revenues.
Determining whether “in scope entities” of a consolidated group can elect to simplify the calculation of their Canadian digital services revenue for their 2022 and 2023 calendar years by using a formula intended to approximate the in-scope revenue based on an affected taxpayer’s Canadian digital services revenue from 2024.
Registering for DST on or before January 31, 2025, where Canadian digital services revenue earned by a taxpayer or a group of taxpayers within a consolidated group exceeds the threshold of C$10M in any of the 2022 to 2024 calendar years.
Preparing and filing DST returns on or before June 30 of the calendar year following the calendar year for which the DST applied and accrued, where Canadian digital services revenue earned by a taxpayer or a group of taxpayers within a consolidated group exceeds the threshold of C$20M in the calendar year.
Paying any tax payable for a calendar year by the due date to avoid penalties and interest, where the first payment will be due June 30, 2025, and will include payments for years 2022 to 2024, where applicable.

We encourage taxpayers to discuss potential DST questions, implications and or concerns with their Andersen tax advisor.

Andersen Canada Contacts

DST Resources:

For further information on the DST, please refer to the CRA’s DSTA and explanatory notes https://www.canada.ca/en/department-finance/news/2021/12/digital-services-tax-act.html

[1] The thresholds should be evaluated based on the consolidated results of a corporate group should the taxpayer be part of such a group.

[2] The US entered into a similar agreement with Turkey in November 2022.

[3] This position to withdraw their domestic DST until Pillar One takes effect is similar to that of Canada.