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The effort over many years to curb multinational corporations' use of tax havens got a lift in October when more than 130 countries agreed to a global tax overhaul imposing a 15 percent minimum tax on certain enterprises. But now Canada is threatening to violate that accord by proposing a tax on international digital services, despite an agreement among the signatories in October to forego such a tax for at least two years.
Digital services taxes (DSTs) are a longstanding proposal by France, Italy, Britain, and other countries to tax technology behemoths like Google, Amazon, and Facebook for the services they provide in those countries. DST proponents continue to insist on such taxes, at least as a fallback. However, the United States strongly objects to such taxes because they invariably discriminate against US tech firms and violate both World Trade Organization (WTO) rules and bilateral tax treaties. In response to French, Italian, British, and other DSTs, the Trump administration proposed retaliatory tariffs under Section 301 of the Trade Act of 1974 and considered retaliatory tax measures permitted by Section 891 of the Internal Revenue Code.
The threat of a trade war over the issue was defused by the global tax deal signed in October 2021 under the auspices of the Organization for Economic Cooperation and Development (OECD), the club of the world's industrial democracies. As part of that deal, President Joseph R. Biden Jr. conditionally withdrew threatened Section 301 tariffs in exchange for a two-year moratorium, expiring in December 2023, on new DSTs and provisional tax credits for existing DSTs. The bargain, codified in the OECD agreement in October, calls for home countries to attribute, for tax purposes, a portion of earnings of their large corporations to foreign countries where goods or services are consumed rather than the traditional practice of attributing all earnings to the home country. Implementation of the agreement will require national legislation, most importantly by the US Congress.
Meanwhile, the OECD agreement states "[n]o newly enacted Digital Services Taxes or other relevant similar measures will be imposed on any company from 8 October 2021 and until the earlier of 31 December 2023 or the coming into force of the [Multilateral Convention which embodies the agreement]."
Disregarding this crucial DST moratorium, on October 8, 2021, the Canadian deputy prime minister and minister of finance Chrystia Freeland proposed a new DST taking effect on January 1, 2022. The DST would enter into force on January 1, 2024, if the Multilateral Convention has not been implemented. Most importantly, the Canadian DST would then apply retroactively to all earnings after January 1, 2022.
The motivation for Canada's action is not clear, but the government would stand to gain at least some revenue from it, though no estimates have been provided on the amount. As it happens, European countries that had previously enacted DSTs will provisionally collect revenues in 2022 and 2023. Canada proposes to collect those revenues only retroactively, which would seem to be less burdensome on the tech companies. Canada, however, had pledged not to impose a DST and is now violating that commitment. Canada may also be preparing for US non-compliance in the event that the US Congress does not pass new tax base attribution rules necessary to satisfy the OECD accord. However, given close US-Canada relations, Minister Freeland should have the grace to postpone DST collections until 2024.
Alternatively, Canada's DST may be intended as retaliation for the Biden administration's Build Back Better Act, which provides tax credits for US-made electric vehicles (EVs). On December 10, 2021, Finance Minister Freeland joined with the Minister of International Trade, Mary Ng, in sending a letter to US lawmakers, threatening to launch a dispute settlement process under the United States–Mexico–Canada trade agreement of 2020 (USMCA) and apply tariffs on US exports if the EV tax credits are passed by the Senate with a Buy America requirement. Digital services taxes are another tool the Canadians have at their disposal to pressure the US Congress to broaden EV credits to at least cover Canada and Mexico.
Like the French DST and others, the Canadian DST would probably discriminate against US digital companies. All affected firms would need to begin tracking revenues attributable to Canada starting in January 2022 and set aside funds for potential future tax liabilities. This provision violates the OECD agreement and the Canada-US bilateral income tax treaty. If, as seems likely, the DST discriminates against US firms, it will also violate WTO rules.
President Biden must no doubt maintain good relations with Prime Minister Justin Trudeau, but the Canadian tax threat cannot go unanswered. If the Biden administration quietly accepts the proposed Canadian legislation, other countries will emulate the retroactive Canadian DST. Recently, US Trade Representative Katherine Tai persuaded India to modify its DST legislation and provide a tax credit to affected US firms. The Biden administration cannot be less insistent with Canada than with India.
If quiet diplomacy does not prevail, Ambassador Tai should publish a list of potential Section 301 tariffs against sensitive imports from Canada, such as beer and maple syrup. By one means or another, Canada should be deterred from discriminating against US digital firms and violating its international agreements.
