Digital Services Tax Act
This backgrounder provides a high-level overview of the draft legislative proposals for the Digital Services Tax Act (Act) and invites input from stakeholders. For more detail, please refer to the draft legislative proposals.
The proposed Act would implement the Digital Services Tax (DST) announced in the 2020 Fall Economic Statement, further details of which were presented in Budget 2021. Annex 7 to the Budget set out the policy intention, described the main features of the proposed tax, and invited input from stakeholders.
The government has a strong preference for a multilateral approach to addressing the tax challenges arising from today’s digital economy. Therefore, the DST was proposed from the outset as an interim measure, to apply until an acceptable multilateral approach comes into effect. In international negotiations, 137 members of the OECD/G20 Inclusive Framework agreed to an October 8, 2021 Statement on a two-pillar plan for international tax reform. The Statement was subsequently endorsed by G20 Leaders and Finance Ministers. Canada is working with international partners to bring the multilateral agreement into effect.
In the interim, to protect the interests of Canadians, the government is moving forward with legislation for the DST. Consistent with the Statement, the DST would not be imposed earlier than January 1, 2024, and only if the treaty implementing the Pillar One tax regime under the multilateral approach has not come into force. In that event, the DST would be payable as of the year that it comes into force in respect of revenues earned as of January 1, 2022. The government hopes that the timely implementation of the new international system will make this unnecessary.
The DST would apply at a rate of 3 per cent on certain revenue earned by large businesses from certain digital services reliant on the engagement, data and content contributions of Canadian users, as well as on certain sales or licensing of Canadian user data.
The DST would apply to large businesses, both foreign and domestic, that meet both of two revenue thresholds. If a taxpayer is a member of a consolidated group, these thresholds would be calculated on a group basis.
- Total Revenue Threshold – If a taxpayer or, if applicable, its consolidated group, earns total revenue from all sources of €750,000,000 or more in a fiscal year of the taxpayer or group that ends in a particular calendar year, the taxpayer or group would meet this threshold for the subsequent calendar year. Additionally, if a taxpayer joins a group that meets the €750,000,000 threshold, the taxpayer would meet this threshold as of the date of joining the group.
- Canadian In-Scope Revenue Threshold - A taxpayer would meet this threshold for a calendar year if the taxpayer (or the taxpayer’s consolidated group, if applicable) earns greater than $20,000,000 of Canadian in-scope revenue in the calendar year.
Four categories of in-scope revenue are proposed:
- Online marketplace services revenue;
- Online advertising services revenue;
- Social media services revenue; and,
- User data revenue.
Online marketplace services revenue would consist of revenue earned from providing an online marketplace that helps match sellers of goods and services with potential buyers. This would include revenue earned from the provision of access to, or use of, the online marketplace, commissions from facilitating supplies between users of the online marketplace, and revenue from providing premium services relating to the online marketplace. It would not, however, include revenue from providing storage or shipping services at a reasonable rate of compensation. Certain business would be excluded from the definition of an “online marketplace”, such as certain financial service providers.
Online advertising services revenue would consist of revenue earned from services aimed at the placing of online targeted advertisements. This would include revenue earned from facilitating the delivery of an online targeted advertisement and revenue earned from providing digital space for an online targeted advertisement. However, an anti-cascading rule would ensure that the same revenue would not be taxed several times as it is paid from one entity in the online advertising industry to another.
Social media services revenue would consist of revenue earned from providing a social media platform that facilitates interactions between users, or between users and user-generated content. This would include revenue earned from the 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. It would not include revenue from providing private communication services (e.g., video calls, voice calls, emails and instant messaging) if the sole purpose of the platform is to provide such services.
User data revenue would consist of revenue earned from the sale or licensing of data gathered from users of an online marketplace, a social media platform, or an online search engine. User data revenue would be in-scope to the extent that it is earned from user data that was collected by the taxpayer or, if applicable, by another member of the taxpayer’s consolidated group.
Sourcing to Canada
The DST would only apply to in-scope revenue associated with users in Canada. Revenue sourcing principles would vary according to the nature of the revenue.
Online marketplace services revenue would be sourced using one of three methods, depending on how the revenue is earned. First, if revenue is earned from facilitating the supply of a service delivered in physical form, such as the provision of transportation or accommodations, and the service is performed in Canada, the revenue from facilitating that specific transaction would be entirely sourced to Canada. Second, if revenue is associated with facilitating a particular transaction between users, other than a service delivered in physical form, sourcing to Canada would depend on where those users are located. If both users are located in Canada, all the revenue associated with facilitating that transaction would be sourced to Canada. If only one user is located in Canada, 50 percent of the revenue associated with facilitating that transaction would be sourced to Canada. Finally, if online marketplace services revenue cannot be traced to a specific transaction, the revenue would be sourced to Canada based on a formulaic approach that calculates the percentage of the marketplace’s transaction participants that are located in Canada.
Online advertising services revenue would be sourced based on one of two methods, depending on how the revenue is earned. If revenue can be traced to the display of an advertisement to a specific user, and that user is located in Canada, the revenue would be entirely sourced to Canada. If revenue cannot be traced to specific users, the revenue would be sourced to Canada based on a formulaic approach that calculates the percentage of users to which the advertisement was displayed that are located in Canada.
Social media services revenue would be sourced using only one method: a formulaic approach that calculates the percentage of the platform’s users that are located in Canada.
User data revenue would be sourced based on one of two methods. If revenue can be traced to the user data of a single user, and that user is located in Canada, the revenue would be entirely sourced to Canada. If revenue relates to a set of data that was collected from multiple users, revenue would be sourced to Canada based on the percentage of those users that are located in Canada.
Whether a user is located in Canada or outside Canada would be determined based on a taxpayer’s available data with respect to the user. This could include the billing, delivery or shipping address, or phone number area code, most recently provided by the user, global satellite positioning data, or Internet Protocol address data. If, based on this data, it is reasonable to conclude that the user is located in Canada, that user would be considered to be located in Canada.
The method of determining a user’s location is dependent on the kind of revenue for which the determination is made. In most cases, user location is where the user is normally located (i.e., their usual or ordinary location). This concept extends over a period of time and typically would not result in a user who visits Canada only for a short period, such as during a vacation, from being considered located in Canada. By exception, if the revenue is online advertising services revenue in respect of an advertisement targeted based on real-time location, the user’s location would be determined at the particular time the advertisement is displayed. Similarly, if the revenue is from the sale of user data that was sold based on the real-time location of users, the user’s location would be determined at the particular time the data is collected.
The DST would apply to in-scope revenue sourced to Canada only to the extent that it exceeds a $20,000,000 deduction. This deduction would be shared amongst members of a consolidated group based on a formula.
In essence, a taxpayer would share the $20,000,000 deduction with entities that are part of a consolidated group at the same time that the taxpayer is part of the group. If there are changes in the membership of the group, the year would be split into intervals, such that each interval is a period with no changes in the group’s membership. The taxpayers that are part of the group during each of those intervals would then share a pro-rata portion of the $20,000,000 amongst themselves. The portion that a particular taxpayer would be entitled to for an interval 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 during that interval. At no time would a single taxpayer, or a single consolidated group, be entitled to more than a $20,000,000 deduction for a calendar year.
Given the group-level threshold calculations and group-wide sharing of the $20,000,000 deduction, certain administrative rules would be included in the Act to simplify compliance and enforcement.
Members of consolidated groups would be allowed to designate an entity in the group to fulfill their filing obligations, pay the DST liability, and otherwise comply with the administrative requirements of the Act.
The Act would include a joint liability provision whereby each entity in a consolidated group would be jointly and severally liable for DST payable by any other group member.
The Act would require registration by certain taxpayers that meet two thresholds. To assist enforcement, the Canadian in-scope revenue threshold for registration would be $10,000,000 rather than $20,000,000 (the threshold for tax liability) although the €750,000,000 total revenue threshold would be the same. These thresholds would operate in the same manner as the thresholds for liability, including calculation at the group level, if applicable. If a taxpayer or, if applicable, the taxpayer’s consolidated group, meets these thresholds for a calendar year, that taxpayer must register by January 31 of the following year.
The Act would also require that annual tax returns be filed by taxpayers that meet the €750,000,000 total revenue threshold and the $20,000,000 Canadian in-scope revenue threshold (i.e., the thresholds for liability). DST returns would be due on or before June 30 of the calendar year following the calendar year for which the return would be required to be filed. Any tax payable for that calendar year would also be due by that date.
Penalties and interest would apply where taxpayers do not comply with the requirements of the Act. For more detail on these and additional administrative powers and requirements, please refer to the legislative proposals. It is intended that the final legislation will include additional provisions on bankruptcy and certain other administrative issues.
Treatment for Income Tax Purposes
As with other non-income taxes, the deductibility of the DST liability of an entity in computing taxable income for Canadian income tax purposes would be determined based on general principles – e.g., whether it is incurred for the purpose of earning the entity’s income. DST liability would not be eligible for a credit against Canadian income tax payable.
Have Your Say
Interested parties are invited to provide comments on the proposed Act.
Please send your comments to DST-TSN@fin.gc.ca by February 22, 2022. Written correspondence related to these consultations can also be mailed to:
DST Act Consultation
Tax Policy Branch
Department of Finance Canada
90 Elgin Street
The government will take into account feedback received in this consultation in finalizing the legislation, prior to its inclusion in a bill for introduction in Parliament. Explanatory notes for parts 1 to 4 of the proposed Act are available.
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