Canada’s digital services tax and USTR’s opposition

What is the BEPS agreement and why is the USTR accusing Canada of going against it?

The story so far: The Office of the U.S. Trade Representative (USTR) has protested against Canada’s decision to impose a digital services tax of 3% on large companies that sell various services in Canada. Companies with a total annual revenue of at least $850 million and profits of at least $16 million will be taxed by the Canadian government under the new rules. USTR has argued that the new tax particularly targets large U.S. technology businesses and has stated that it would look into ways available under existing bilateral and other trade agreements to retaliate against Canada’s actions.

The question of how to tax large multinational corporations (MNCs) that have their business spread across countries has been a bone of contention among governments. Many MNCs draw a large share of their revenue and profits from outside their home countries, yet they pay most of their taxes in their home country. These include large technology companies such as Facebook, Apple, and Google which do business in developing countries like India and China but pay most taxes in the US or in tax shelters such as Ireland. Many governments have tried to tax at least a part of the profits of these MNCs.

In a meeting of the Organization for Economic Cooperation and Development in October last year, a total of 136 countries including Canada and the United States came to an agreement on how to tax large MNCs. They agreed, under what is known as the OECD/G20 Base Erosion and Profit Shifting (BEPS) project, that large MNCs will have to pay tax on a certain portion of their profits to the government of the foreign country where they do business. To be particular, companies will have to allocate 25% of the residual profits, which is defined as profits exceeding 10% of revenue, as profits earned in the foreign country and pay tax on these profits. Other than this, the countries also agreed to impose a minimum corporate tax rate of at least 15% on corporations with revenues and profits above a certain threshold level. This was seen as a way to bring an end to tax competition which adversely affected the tax revenues of governments. So, Canada’s new digital services tax basically comes at a time when governments are trying to implement new ground rules on how to tax companies and share revenues.

USTR has argued that Canada’s digital services tax goes against the spirit and the text of the BEPS agreement signed by 136 countries in October last year. It was agreed last year that the signatory countries would not impose new unilateral taxes that work against the spirit of the BEPS agreement. Countries were instead supposed to work together on the swift implementation of the BEPS rules.

Canada has contested that the digital services tax will not come into effect if the BEPS framework is implemented on time (by the end of 2023). It has also assured the United States that it is committed to cooperating with other governments to implement the BEPS framework. It should be noted that in case there is a delay in the implementation of the BEPS agreement that was framed last year, then companies will have to pay the digital service tax from 2024 on all their accumulated profits since 2022.

The dispute over Canada’s digital services tax is seen as a prelude to the various other problems that are likely to arise as governments across the world try to implement the BEPS agreement. Each government would want to maximise its share of taxes and some may even disagree on the appropriate tax rate that maximises overall revenue collection, so more disputes might be in store. Some also see Canada’s decision as a sign that there may be doubts over the timely implementation of the BEPS framework.