IBX-Jakarta. Canada is getting ready to put into effect a digital services tax that has been positioned as a safeguard for the OECD’s Pillar One. The updated DST legislation, included in bill C-59, was presented in Parliament on November 28. We anticipate the bill will become law in 2024.
The digital services tax strategy will probably face political and administrative challenges. The US opposes the DST and might not promptly approve the Organization for Economic Cooperation and Development/G20 Inclusive Framework’s multilateral convention for implementing Amount A of Pillar One. Businesses preparing for the DST and Pillar One encounter various practical obstacles.
Upon enactment, Canada’s DST will retroactively apply to revenue falling within scope from January 1, 2022, despite considerable concerns voiced during an earlier comment period. The initial DST payment, calculated from revenue between 2022 and 2024, is expected around mid-2025.
Nevertheless, the revised DST legislation grants the Canadian government the flexibility to alter when the DST takes effect and the applicable rate—subject to discussions with the US and other jurisdictions.
The DST is designed as a 3% levy on revenue exceeding CA$20 million (about $14.8 million) from digital services reliant on engagement, data, and content contributions of Canadian users. Major businesses providing digital services to Canadian users need to brace themselves for a potential (and possibly retrospective) DST obligation.
This implementation showcases a concerning trend by the current Canadian federal government to propose laws with retroactive application. For instance, recent changes to goods and services tax and harmonized sales tax rules for certain financial services apply retroactively to 1990—despite significant concerns raised by the Canadian Bar Association regarding rule of law breaches.
Taxpayers couldn’t have adequately prepared for the DST—like setting up systems to gather necessary information—when the proposed rules were subject to change. Rather than eliminating the retroactivity, the government added an option to compute tax liability for early years (2022 and 2023) using data collected in 2024.
The revised DST legislation in bill C-59 grants the government the freedom to make substantial changes without requiring parliamentary amendments.
Precisely, the government’s executive branch can, through regulations, delay the DST’s effective date, nullify retroactivity by setting a 0% DST rate for earlier years, and alter the earlier years’ DST rate from the current 3%.
While the Inclusive Framework still aims for Pillar One implementation by 2025, it faces significant political hurdles. The framework released a draft multilateral convention in October to implement Amount A of Pillar One. Article 48 states the convention won’t take effect unless states representing at least 600 points have ratified it.
Given the US holds 486 of the total 999 points listed in Annex I of the convention, the 600-point target can’t be met without US support. Despite the US Treasury Department seeking public input on the convention, it seems unlikely to receive the political backing needed for timely ratification.
The US has also opposed DSTs, claiming they disproportionately affect US-based multinationals, and has threatened retaliatory tariffs. Canada has indicated its intent to introduce a DST despite US pressure, as stated in the government’s 2023 fall economic statement and during bill C-59’s introduction.
While most Inclusive Framework members agreed to halt new DSTs for further discussions, the lack of effort by Canada and other countries to coordinate DSTs or other measures outside the two-pillar project might lead to conflicting and overlapping unilateral measures. This could result in increased trade disputes and uncertainty if a global agreement on Pillar One isn’t reached. While the political hurdles of Pillar One persist, taxpayers also encounter technical and practical challenges in preparing for Pillar One or the Canadian DST.
In theory, the 900-page guidance accompanying the multilateral convention on Amount A released in October should help companies model and calculate the potential impact of Pillar One more accurately. However, Pillar One has become excessively complex and burdensome to administer. Elaborate revenue sourcing rules and formulas will fundamentally alter the international tax framework, which, at this stage, remains largely theoretical and untested.
The DST legislation in bill C-59 marks a significant move in Canada’s attempts to tax the digital economy but isn’t the final decision. The government has allowed for alignment with an evolving multilateral process and acknowledges the importance of international cooperation.
Major businesses providing digital services to Canadian users should vigilantly track the developments and implications of the DST legislation and the Inclusive Framework. They will need to evaluate potential exposure and compliance responsibilities under both the DST and any future Pillar One rules.
It’s regrettable that Canada has thus far declined to amend the DST to address its numerous flaws, including retroactivity, the lack of creditability leading to double taxation, and the failure to coordinate with other countries. However, there’s hope that pressure from the US and other nations may eventually prompt Canada to reconsider its DST positions.