The Digital Services Tax Will Not be Good for Canada

On a cool day in early October 1997, government ministers, heads of international organizations, business leaders, and labour representatives gathered in Ottawa for an OECD conference on how best to promote and regulate electronic commerce. There, they agreed that when it comes to taxing online goods and services, the most important factors were neutrality, efficiency, certainty and simplicity, effectiveness and fairness, and flexibility. A few decades later, Canada's federal government has introduced the Digital Services Tax (DST), which is neither neutral, simple, nor flexible. The DST places a tax on the revenues derived from providing digital services to Canadians by large, mostly U.S. firms, and is modelled after similar taxes implemented by other countries, including France and the United Kingdom. Deputy Prime Minister Freeland said in a press conference that the DST would add sorely needed spending power to federal coffers at a time when there is a "crying need for investment". So would imposing a 90 percent tax on every Canadian with a last name starting with "F," but that doesn't make it sound policy. The DST violates longstanding international tax treaties and norms and invites retaliation. Will it then be fair for the U.S. to turn around and impose a maple syrup tax (MST) on the revenues of all Canadian producers of maple syrup that sell in the United States? After all, what's good for the goose is good for the gander.

Leaving aside the issues of a cross-border tax transfer, what was not mentioned were the harmful effects the DST will have on Canadian businesses, startups, and consumers. As ITIF noted previously, the DST will "not only lead to reduced services or increased prices for digital services in Canada, but also surely lead to a retaliatory response by the U.S. government."

Much of the DST cost will be largely borne by Canadian businesses and the downstream customers of those businesses. This is because the DST is a tax on revenue instead of profits. For instance, if a Canadian cybersecurity company is trying to drum up additional business by placing advertising on LinkedIn or Instagram, the majority of the DST will likely be paid for by them, rather than by Microsoft or Meta, due to the price elasticity of demand. Indeed, the Montreal Economic Institute found that France's introduction of what was then known as the GAFA (Google, Apple, Facebook, Amazon) Tax resulted in prices that "went up by two percent for clients of Google and by three percent for clients of Apple and Amazon". If the government is serious about increasing digital adoption and boosting innovation, then it makes little sense for taxes to be levied upon the very firms that are using digital services and attempting to reach broader audiences.

Similarly, the DST is unprecedented in that it is designed to be a revenue tax and is retroactive to 2019, which means that companies will need to spend a great deal of resources on designing systems to capture data retroactively and forward-looking on specific revenue streams. There are real opportunity costs to imposing compliance burdens on companies, whether that is in the form of increased costs or a reduction of availability of services to Canadians.

Part of the justification provided by the Deputy Prime Minister as to why Canada is moving forward with the DST is that since other countries in Europe are doing it, Canada should follow suit, free from retaliation from the United States. But two wrongs don't make a right. Moreover, what this argument misses is that Canada derives about 75 percent of its exports from our southern neighbour and 56 percent of our imports. In contrast, countries like France and Italy do not have the United States as their largest trading partner. As such, Canada levying a tax on U.S. companies would most likely result in retaliatory measures (which the U.S. Trade Representative has threatened other DST-implementing countries with) that would damage more than half of our trade. However, Hungary, for example, which also implemented a DST, would stand to damage four percent of its exports and two percent of its imports to the United States. Straining trade relations with the United States in advance of the potential re-election of a U.S. president that has already taken an antagonistic approach to Canada-U.S. trade relations in the past could have serious consequences for Canadian businesses and consumers that rely on the free import and export of goods across the border (which is virtually every single Canadian and Canadian business).

By continuing down the current path, Canada will inadvertently be taxing the 1 in 20 companies that are effectively adopting digital technologies, disadvantaging them relative to their offline peers. That is most certainly not the approach that Canada should take. Instead, Canada should drop the DST and continue to push forward with the OECD's multilateral approach of addressing base erosion and profit shifting.