Beginning January 1, 2024, with retroactive effect to taxation years beginning January 1, 2022, certain large Canadian and non-Canadian businesses will need to prepare for the imposition of a 3% Canadian Digital Services Tax (DST) on their “in-scope” digital services revenues earned from customers located in Canada. The Canadian government reconfirmed its intention on July 12, 2023, to continue with its previously stated timing.
The DST was proposed as a backstop to global and multilateral efforts to agree to implement the Pillar One proposals from the Organization for Economic Co-operation and Development (OECD). Pillar One, of which a DST may play a crucial role, aims to (among other goals) impose tax on digital services provided by large multinational corporations based on the location of their customers. Work continues at the international level in the development and refinement of Pillar One, but several countries, including Canada, have indicated their willingness to proceed with a unilateral imposition of a DST until such time that Pillar One becomes adopted.
Draft DST legislation was released August 4, 2023, and is a revision of draft legislation first released in December 2021. The government intends that this legislation be passed such that the DST will come into force January 1, 2024, with retroactive application to revenues earned as of January 1, 2022.
Definitions
The DST is intended to apply to large Canadian and non-Canadian multinational corporations earning revenues from customers located in Canada. The test for this is based on two thresholds defined in Part I of the Digital Services Tax Act (the “DSTA”), as detailed below. Both thresholds must be met for the DST to apply.
Total revenue threshold
This threshold is met if a taxpayer, or the consolidated group of which it is a member, earned revenues from all sources totaling €750,000,000 or more in in the immediately preceding reporting calendar year.
Canadian in-scope revenue threshold
This threshold is met if a taxpayer, or the consolidated group of which it is a member, earned Canadian in-scope revenues totaling CAD 20,000,000 or more in the calendar year. In-scope revenues are revenues from digital services, and specifically revenues from these four categories:
This revenue stream includes revenues earned from the provision of an online marketplace where vendors can list their products for sale to customers. An online marketplace must be 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.
This would include services such as that of an online marketplace that specializes in connecting property owners with tourists who wish to rent the property owners’ apartments for short periods of time, or an online marketplace that specializes in connecting drivers with passengers for specific trips.
However, services of digital interface with a single supplier, such as the website of a traditional retailer that sells its products directly to customers, would not be an online marketplace. Certain financial services are also excluded.
The revenues include marketplace access fees, listing fees, commissions, and other similar amounts. Online marketplace services revenue generally does not include fulfilment, storage, and shipping revenues.
This revenue stream includes revenues earned from the placement of targeted online advertisements and the provision of digital space for such advertisements. The legislation provides relief where such revenues are derived from several entities in the online advertisement industry, such that the tax is levied only once.
This revenue stream includes revenues earned from the provision of access or use of a social media platform, premium services and optional enhancements to basic functionality, and the facilitation of interaction between users and between users and user-generated content. This does not include private communication services including video calls, voice calls, emails, and instant messaging if the sole purpose of the platform is to provide private communication services.
This revenue stream includes revenues earned from the sale or licensing of data gathered from users of online marketplaces, social media platforms, and online search engines. Where user data is collected by one entity in a corporate group and the sale of that data is recognized in another entity, such revenue remains in-scope.
Application of the DST
Where the two revenue thresholds are met, the DST applies at a rate of 3% of Canadian in-scope revenues. Different sourcing principles are required to be used depending on the nature of the revenues earned.
Online marketplace services revenue
- Revenues relating to the provision of physical services in Canada would be sourced entirely to Canada.
- Revenues relating to facilitation of other services depend on the location of the users of the marketplace – if both the vendor and purchaser are in Canada, revenues are solely sourced to Canada. If one is located outside Canada, 50% of the value of the transaction is sourced to Canada.
- Revenues that cannot be traced to specific transactions - users would be sourced to Canada based on an overall percentage of the marketplace’s transaction participants in Canada.
Online advertising services revenue
- Revenues from the display of an advertisement that can be traced to a specific user in Canada would be entirely sourced to Canada.
- Revenues that cannot be traced to specific users in Canada would be sourced to Canada based on an overall percentage of users to which the advertisement was displayed that are in Canada.
Social media services revenue
- Revenues from social media services are solely sourced based on the percentage of a platform’s user base that is in Canada.
Canadian user data revenue
- Revenues that can be traced to the user data of a single user in Canada would be sourced to Canada.
- Revenues that relate to a set of data that was collected from multiple users would be sourced to Canada based on the percentage of those users that are in Canada.
Whether a user is located in or outside Canada depends on the data collected by the taxpayer, including billing addresses, ship-to addresses, phone numbers, postal codes, IP data, global navigation satellite systems data, etc. If it is reasonable to conclude that a user is physically located in Canada, the DSTA considers that user to be located in Canada.
Administration
The DST applies to Canadian in-scope revenues to the extent that those revenues exceed a base $20,000,000 deduction. Where a taxpayer is part of a consolidated group of entities, this $20,000,000 deduction is allocated among the group members proportionately with their shares of total Canadian-sourced in-scope revenues earned by the consolidated group.
Members of consolidated groups may be allowed to designate a single entity within the group to file on behalf of the group and pay any DST liability on behalf of the group. Members would be considered jointly and severally liable for the DST obligations of the group.
To assist with enforcement and monitoring, the threshold for Canadian in-scope revenues required for registration is $10,000,000, rather than the $20,000,000 threshold where tax becomes payable. This $10,000,000 registration threshold applies similarly as above for consolidated groups, though no DST return appears to be required where Canadian in-scope revenues for the year exceed $10,000,000 but do not exceed $20,000,000. Registration is nevertheless required on or before January 31 of the subsequent calendar year. Returns are due on June 30 of the calendar year subsequent to the year for which the return is to be filed.
Whether DST paid or payable is deductible for Canadian income tax purposes is subject to general deductibility principles in the Income Tax Act, and whether such an outlay or expense is incurred for the purposes of earning income.
Looking forward and how BDO can help
If the Canadian federal government proceeds as indicated, DST returns may be required for the 2022, 2023, and 2024 calendar years, with those returns and payments potentially due on June 30, 2025. Large multinational corporations with significant sales from customers in Canada will need to review their obligations with consideration to the following requirements:
- Businesses will need to review their financial records/systems to identify and allocate their Canadian revenues between the various categories of Canadian in-scope revenue. While tax is triggered on in-scope revenues in excess of $20,000,000, registration is triggered on in-scope revenues in excess of $10,000,000.
- If the revenue threshold(s) are met, registration is required on or before January 31 of the subsequent calendar year. As such, registration may be required for affected corporations prior to January 31, 2025. Penalties for failure to register are $20,000 per year.
- If the revenue threshold(s) are met, returns are required on or before June 30 of the subsequent calendar year. As such, filing and remittance of returns may be required for large corporations by June 30, 2025. Penalties for failure to file can reach as high as 17% based on the duration of non-compliance.
Contact us or one of the BDO advisors below to learn how we can help
Frederick Wong, Senior Manager, Indirect Tax
Brian Morcombe, Partner, Indirect Tax Practice Leader
The information in this publication is current as of October 13, 2023.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.