The U.S. government has warned Canada that it may impose trade sanctions if it goes ahead with its plan to tax digital services provided by foreign companies such as Netflix, Amazon and Spotify. The U.S. Trade Representative (USTR) said on Friday that Canada’s proposed digital services tax (DST) is “unreasonable, discriminatory and burdensome” and could harm U.S. interests and workers1.
Canada’s DST proposal
Canada announced its intention to introduce a DST in its 2020 Fall Economic Statement, and provided further details in its 2021 budget. The DST would apply at a rate of 3% 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 data2. The DST would apply to both foreign and domestic businesses that meet two revenue thresholds: a global revenue of €750 million or more, and a Canadian in-scope revenue of $20 million or more2. The DST is expected to raise $3.4 billion over five years, starting from 20223.
Canada said that the DST is an interim measure, until an acceptable multilateral approach to address the tax challenges arising from the digitalization of the economy is implemented. Canada is part of the OECD/G20 Inclusive Framework that agreed on a two-pillar plan for international tax reform on October 8, 20214. The plan aims to ensure that multinational enterprises pay a fair share of tax wherever they operate and create value, and to reduce tax uncertainty and disputes4. However, Canada said that it will not impose the DST earlier than January 1, 2024, and only if the treaty implementing the Pillar One tax regime under the multilateral approach has not come into force2.
U.S. response and potential actions
The U.S. has been opposed to unilateral digital taxes imposed by other countries on U.S.-based tech companies, arguing that they are discriminatory and inconsistent with international tax principles. The USTR has initiated investigations under Section 301 of the Trade Act of 1974 into the DSTs or similar measures adopted or under consideration by 10 jurisdictions, including Canada5. Section 301 allows the U.S. to take trade action against foreign countries that violate trade agreements or engage in unfair trade practices that affect U.S. commerce.
On Friday, the USTR released its report on Canada’s DST proposal, concluding that it violates international tax standards, discriminates against U.S. companies, and contravenes Canada’s commitments under the USMCA trade agreement1. The USTR also announced that it will pursue trade remedies against Canada if it implements the DST, such as imposing tariffs or other trade restrictions1. The USTR said that it will announce a proposed action list and hold a public hearing in January 20221.
Implications and reactions
The U.S. threat of trade retaliation could escalate trade tensions between the two countries, which are already at odds over other issues such as softwood lumber, dairy products, and aluminum and steel tariffs. The trade dispute could also affect the bilateral relationship and cooperation on other matters of mutual interest, such as climate change, border security, and COVID-19 recovery.
Canada has defended its DST proposal as a fair and necessary measure to ensure that digital businesses pay their fair share of tax in Canada, where they generate significant value and profits from Canadian users. Canada has also reiterated its preference for a multilateral solution to the digital tax challenge, and its commitment to work with the U.S. and other partners to implement the OECD/G20 agreement as soon as possible.
Some experts have suggested that Canada should delay or suspend its DST plan until the multilateral agreement is finalized and ratified, to avoid a trade conflict with its largest trading partner. Others have argued that Canada should stand firm on its DST plan, as it is consistent with its sovereign right to tax economic activities within its jurisdiction, and as a bargaining chip to secure a better deal under the multilateral agreement.