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Among the many perplexing questions raised by the OECD’s two-pillar project on global tax policy, one mystery is why the government of Canada has broken ranks with other major players in the Inclusive Framework on Base Erosion and Profit Shifting—by announcing its intention to proceed unilaterally with a digital services tax.
The tax could take effect as early as the start of next year and would apply retroactively to the start of 2022. By doing this, Canadians would almost certainly provoke the US to impose retaliatory trade sanctions, causing significant economic pain in Canada.
The pain would be felt most acutely in provinces such as Quebec, where exports to the US of products such as aluminum and paper are crucial to the local economy. Meanwhile, businesses throughout Canada are seeking to increase their exports to the US in areas such as clean energy.
But the digital services tax threatens the US-Canada trade relationship. A bipartisan group of US legislators issued a letter to the US Treasury Secretary and the US Trade Representative on Sept. 19, urging that pressure be placed on Canada not to proceed with the digital services tax, as doing so could have “significant consequences.”
Extension Agreement
The Organization for Economic Cooperation and Development’s Inclusive Framework on July 12 issued its outcome statement on the two-pillar solution that addresses the tax challenges from digitalization of the economy.
The 138 Inclusive Framework members that signed the statement agreed to extend the current moratorium on new digital services taxes, due to expire at the end of this year—if at least 30 jurisdictions accounted for at least 60% of the parent companies of in-scope multinational entities and signed the multilateral convention before the end of 2023. The members also agreed to extend this commitment to Dec. 31, 2025, “assuming sufficient progress has been made by that date towards the entry into force of the multilateral convention.”
Despite the opposition of Republicans in Congress to the two-pillar deal, the US is expected to sign the multilateral convention. At least 60% of the parent companies of the in-scope multinational entities are thought to be US companies, so it’s likely that the ban on new digital services taxes will extend at least to 2025 and perhaps longer.
Canada, a member of the Inclusive Framework’s steering group, refused to sign the outcome statement, on the basis that it couldn’t agree to the ban on introducing new digital services taxes. The four other countries that didn’t sign—Russia, Belarus, Pakistan, and Sri Lanka—have been outliers throughout the negotiations on the two pillars at the OECD. Canada, in contrast, has been one of the leaders of the multilateral process.
Soon after the outcome statement was announced, the Canadian government unveiled the details of its proposed digital services tax legislation, which would be retroactive to Jan. 1, 2022.
‘Stick in the Eye’
The US Trade Representative’s office made clear that if Canada proceeds, the US will look at retaliatory trade sanctions, which would most likely take the form of tariffs on specified Canadian imports. This would be consistent with the USTR’s actions against France and other countries that implemented digital services taxes in 2019 and 2020.
Why would the Canadian government be willing to poke the digital-service-tax stick into the eye of the US economic beast? The move is puzzling, particularly in light of previous tension with the US on trade in aluminum and lumber and recent wins on renewable energy agreements between the two trading partners.
The rationale asserted by Finance Minister Chrystia Freeland was that further delay in implementing a digital services tax would put Canada at a disadvantage relative to countries that already have such taxes. It’s not readily apparent that digital services taxes in countries such as the UK and France have had any deleterious effect on the Canadian economy. Freeland’s statement seems to suggest that the other countries are somehow eating Canada’s lunch, but this clearly isn’t the case.
US trade sanctions would be damaging to the Canadian economy, particularly to Canadian provinces that rely heavily on important economic ties to the US and are actively seeking to expand US trade. Proceeding with digital services tax implementation at this point would almost certainly be more detrimental than beneficial to Canada—a classic case of shooting oneself in the foot.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Jefferson VanderWolk is partner at Squire Patton Boggs and was head of the tax treaty, transfer pricing, and financial transactions division at the OECD Center for Tax Policy and Administration.
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