U.S. Challenges Canada’s Digital Services Tax Act Under CUSMA

Posted on November 19th, 2024 in Cross-border Tax, Domestic Tax

Executive summary

The US Trade Representative has initiated consultations with Canada over the Digital Services Tax Act (DSTA) under the CUSMA trade agreement. The DSTA, effective from June 28, 2024, retroactively applies to revenues from Jan. 1, 2022, and imposes a 3% tax on digital services revenue from large corporations. The US claims the DSTA discriminates against American companies by favoring Canadian firms, citing revenue thresholds that disproportionately impact US digital service providers. The consultations aim to address these concerns and seek a resolution.

The US Trade Representative has requested consultations with Canada regarding the Digital Services Tax Act (DSTA) under the Canada-United States-Mexico (CUSMA) trade agreement. These consultations could result in amendments or a potential suspension of the legislation.

Background on the Digital Services Tax Act

The DSTA is intended as an interim measure as the OECD works towards a multilateral solution to tax challenges arising from the digitalization of the economy. The Act came into force on June 28, 2024, but applies retroactively to revenues earned on or after Jan. 1, 2022. 

The DSTA imposes a 3% tax on Canadian digital services revenue. In general, digital services revenue is comprised of revenue from the following sources:

• Online marketplaces that help match sellers of goods and services with potential buyers, whether or not the platform facilitates completion of the sale
• Social media platforms that facilitate interaction between users, or between users and user-generated content
• Online advertising that targets based on data gathered from users of a digital interface, including online marketplaces, social media platforms, internet search engines, digital content streaming services, and online communications services
• The sale or licensing of data gathered from users of an online interface

The DSTA applies to large corporations, both foreign and Canadian, that satisfies two revenue thresholds. If a taxpayer is a member of a consolidated group, these thresholds would be calculated on a group basis.

• Total revenue threshold – at least €750 million in a fiscal year of the taxpayer or group that ends in the immediately preceding calendar year; and
• Canadian in-scope revenue threshold – at least CAD$20 million of Canadian digital services revenue.

US Trade Representative’s challenge of the DSTA

The CUSMA requires member states to give suppliers and investors from the other member states no less favourable treatment in like circumstances than domestic suppliers and investors. The US Trade Representative alleges the DSTA targets US companies and discriminates against US companies in favour of Canadian companies.

Though the consultation request does not give the US Trade Representative’s reasoning for this determination, the Computer & Communications Industry Association (CCIA) argues the DSTA revenue thresholds create a discriminatory effect. The CCIA, while also citing a 2019 report by the Congressional Research Service (CRS), argues that the high minimum revenue thresholds of the DSTA would capture many US digital services providers while excluding most Canadian competitors.

This is not the first trade dispute the US has initiated regarding a digital services tax. In 2019, France signed into law a 3% tax on revenues from digital services provided in France. The legislation had similar revenue thresholds as the DSTA. Among other support for their position, the US found the revenue thresholds excluded many non-US based companies while capturing US-based company groups. The US announced retaliatory tariffs against French products, but later suspended application of these tariffs. This was first due to France delaying imposition of the digital tax, and later, to coordinate a US response to similar legislation being introduced in other countries.

Through the CUSMA consultation, the US and Canada will attempt to find a mutually satisfactory resolution. This could result in amendments to, or even the suspension of, the DSTA.  Should the US and Canada be unable to reach a resolution through consultation, the US can request conveying of a panel. The panel will determine whether the DSTA is inconsistent with Canada’s CUSMA obligations. If the panel finds in favour of the US, the countries will again attempt to reach a satisfactory resolution. Failing a resolution, the US will be permitted to suspend providing CUSMA benefits (such as non-application of tariffs and no favourable treatment of domestic suppliers) to equivalent effect as the DSTA’s infringement. The complaining party would be required to prioritize suspending benefits in the same sector first, if practicable. 

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This article originally appeared on 2024-10-07 and is available online at https://rsmcanada.com/insights/tax-alerts/2024/us-disputes-digital-services-tax-act.html. 

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