The Mechanics of Canada’s New Digital Services Tax

By Zvi Halpern-Shavim, Jeffrey Shafer, Elena Balkos and Joshua Zung

April 24, 2024

Canada’s long-anticipated Digital Services Tax Act (Act) was introduced into Parliament on November 30, 2023 as part of Bill C-59. While our previous Blakes Bulletin: 2023 August 4 Draft Legislation: Selected Tax Measures and Blakes Bulletin: 2021 Federal Budget - Selected Tax Measures provided an overview of the digital services tax (DST), we now aim to provide more detail on how affected taxpayers should compute their 3% DST liability as we inch towards an implementation date.

Most recently, the 2024 federal budget reaffirmed the government’s intention to proceed with implementation this year, but no further details were provided. Although the Act is not yet in force, the DST payable in the first year retroactively includes DST for revenue earned as of January 1, 2022, thus imposing tax on an additional two years. While the rate of tax for 2022–2023 is to be set by regulation and could be different from the 3% applicable going forward, the government has not explicitly indicated that it is considering this option (and the draft regulation included in Bill C-59 provides for a 3% rate for those periods as well).

Total Revenue Threshold – €750-million

The first criterion to be subject to the DST is that the revenue of the taxpayer or the consolidated group of which the taxpayer is a constituent entity (taxpayer’s consolidated group) must be at least €750-million during a fiscal year that ended in the immediate preceding calendar year.

Generally, a consolidated group is a group of entities that are required to use consolidated financial statements under acceptable accounting principles, or that would be required to do so if the equity of the ultimate parent of the group were traded on a public securities exchange that requires acceptable accounting principles.

Canadian Digital Services Revenue – C$20-million

The second criterion to be subject to the DST is that the taxpayer or consolidated group must have Canadian digital services revenue (DSR) that exceeds C$20-million annually.

Canadian DSR is the sum of four components:

Canadian online marketplace services revenue
Canadian online advertising services revenue
Canadian social media services revenue
Canadian user data revenue

Whether revenue is to be included in any of these components is not the most intuitive exercise, and each component has sub-components or must be attributable to Canada to be included. We describe each of the categories in more detail below.

1. Online Marketplace Services Revenue

An “online marketplace” is defined as a digital interface that allows users to interact with other users and facilitates the supply of property or services, including digital content, between those users. An online marketplace does not include:

Digital interfaces with a single supplier of such property or services (such as a retailer that sells its products directly to customers), or
Digital interfaces whose main purpose is to provide payment services by facilitating the electronic transfer of funds; make advances, grant credit or lend money; or facilitate the supply of financial instruments (such as credit card processors, credit providers and investment trading platforms)

“Online marketplace services revenue” includes revenue from:

The provision of access to, or the use of, the online marketplace (such as subscription fees or pay-per-use fees)
Commissions and other fees from the facilitation of a supply between the users and from services ancillary to the supply (such as transaction commissions and payment service fees)
The provision of premium services, preferential listing services (such as listings for goods and services that are for sale on the online marketplace, but not advertisements that link to third party websites) and other optional enhancements to the basic function, or changes to the standard commercial terms, of the services provided in respect of the online marketplace (such as revenue from loyalty reward programs or from the provision of access to special deals)

Excluded are reasonable amounts of revenue from the provision of storage or shipping services, as well as revenue earned from another member of the taxpayer’s consolidated group.

Attributable to Canada?

The taxpayer must then determine the amount of online market services revenue considered to be attributable to Canada (Canadian online marketplace services revenue). To make this determination, taxpayers must classify their online marketplace services revenue into the following three categories.

First Category: Revenue from Supply of Services in Canada

The first category of Canadian online marketplace services revenue is revenue in respect of a supply between users of an online marketplace of a service that is:

Physically performed and received in Canada
In respect of real property situated in Canada, or
In respect of tangible personal property that is normally situated in Canada and that is situated in Canada at the time the service is performed

This category of online marketplace services revenue is 100% included in Canadian online marketplace services revenue.

Second Category: Revenue from Supply of Property and Certain Services

The second category of Canadian online marketplace services revenue consists primarily of online marketplace services revenue in respect of a supply of property between users of an online marketplace. This category also includes revenue from services that are physically performed and received in different countries and services performed in respect of tangible personal property that is situated in a different country from where it is normally situated. The revenue is allocated as follows:

If the supplier and purchaser are both located in Canada at the time of the supply, 100% of the revenue for that supply is included in Canadian online marketplace services revenue.
If only one of the supplier or purchaser is located in Canada at the time of the supply, then 50% of the revenue for that supply is included in Canadian online marketplace services revenue.
There is no inclusion if the supplier and purchaser are both located outside Canada at the time of the supply.

For purposes of computing Canadian online marketplace services revenue, the location of a user is not determined based on real-time location but rather on where he or she is normally located at that time. The taxpayer must determine user location reasonably based on information about the user (such as residential or shipping addresses, telephone area codes, satellite systems or IP addresses).

Third Category: Non-Transactional Revenue

The third category of Canadian online marketplace services revenue is revenue that is not in respect of a supply between users (non-transactional revenue). This includes subscription fees for the use of an online marketplace. Because this category of revenue is not dependent on an actual supply between users, the Act uses a proxy formula to determine the amount of non-transactional revenue that is considered to be attributable to Canada.

The formula first requires a calculation of global non-transactional revenue for the taxpayer and other members of the taxpayer’s consolidated group as follows.

Global non-transactional revenue x G/H, where:

G is the total number of users, for each supply between users of the online marketplace in the calendar year, that are located in Canada at the time of the supply
H is the total number of users, for each supply between users of the online marketplace in the calendar year, that have a determinable location at the time of the supply

The result must be included in Canadian online marketplace services revenue.

This formula is somewhat unintuitive because it uses information about marketplace transactions (and specifically, the locations of parties to the transactions) to calculate the taxable Canadian non-transactional revenue.

For example, suppose 100 sales between users occur on an online marketplace in the year, and the online marketplace can determine the location of both users for 90 of the sales and the location of only 1 user for another 8 of the sales; it cannot determine the location of either user for 2 of the sales.

Suppose further that 5 of the 100 sales take place between users that are both located in Canada, and another 10 of the sales involve a user that is located in Canada and a user that is not located in Canada.

In this scenario, G equals 20, since there are 2 users for each of the 5 sales that take place between users that are located in Canada (2 * 5 = 10) and 1 user for each of the 10 sales that take place between a user that is located in Canada and a user that is not located in Canada (1 * 10 = 10). H equals 188, since there are 2 users that are of determinable location for 90 sales (90 * 2 = 180) and 1 user that is of determinable location for 8 sales (1 * 8 = 8). In this scenario, the ratio would compute to 20 / 188, which is approximately 10.6%.

Thus, 10.6% of the company’s global non-transactional revenue is subject to the 3% DST.

2. Online Advertising Services Revenue

“Online advertising services revenue” consists of revenue from the facilitation through a digital interface of the delivery of an online targeted advertisement and revenue from the supply of digital space for an online targeted advertisement.

An “online targeted advertisement” is advertisement (including any content that is prominently placed for the purpose of promotion) that consists of digital content, is placed on or transmitted through a digital interface, and is targeted at users based on any part of the user data associated with the users. For example, this can include advertisements based on a user’s age, gender, location, browser history or purchase history.

A contextual advertisement that is not targeted to users based on user data associated with the users, but rather is matched with particular content on the digital interface, would not be considered an online targeted advertisement.

Online advertising services revenue excludes any revenue stream for online marketplace services revenue (to avoid double counting). As with online marketplace services revenue, it does not include revenue earned from another member of the taxpayer’s consolidated group. Lastly, online advertising services revenue does not include amounts of revenue paid by the taxpayer or a member of the taxpayer’s consolidated group to another entity in respect of the online targeted advertisement that would otherwise be online advertising services revenue of the other entity.

For example, suppose a company hires an “advertising server” to deliver targeted advertisements on various websites, and the advertising server remits a portion of the fee to the website owner for each time the advertisement is displayed on the website. The remitted portion is excluded from the advertising server’s online advertising services revenue and is included in the website owner’s online advertising services revenue.

To determine the amount of online advertising services revenue considered to be attributable to Canada (Canadian online advertising services revenue), taxpayers must classify their online advertising services revenue into two categories.

Attributable to Canada?

First Category: Specific Display or Interaction Revenue

The first category of Canadian online advertising services revenue consists of revenue directly attributable to an instance of a display of an online targeted advertisement to a user, or an instance of a user’s interaction with an online targeted advertisement, if the user is located in Canada at the time of display or interaction. 100% of this revenue is included in Canadian online advertising services revenue.

For example, if a search engine receives a fee each time an advertisement is displayed to a user located in Ottawa, this fee is fully included in Canadian online advertising services revenue.

For purposes of computing Canadian online advertising services revenue, the location of a user is determined based on real-time location.

Second Category: Non-Display Revenue

The second category of Canadian online advertising services revenue consists of revenue not directly attributable to an instance of a display to, or an interaction, by a user of determinable location (non-display revenue). This includes lump-sum revenue for displaying an advertisement to many users.

As with the non-transactional revenue category of Canadian online marketplace services revenue, the Act uses a proxy formula to determine the amount of non-display revenue that is considered to be attributable to Canada. However, unlike the calculation of non-transactional revenue, which uses a single ratio for the calendar year, the calculation of non-display revenue requires determining multiple ratios, one for each online targeted advertisement.

The formula first requires a calculation of non-display revenue for each online targeted advertisement multiplied by a ratio, D/E, where:

D is the number of times during the calendar year that the online targeted advertisement is displayed to a user located in Canada
E is the number of times during the calendar year that the advertisement is displayed to a user that has a determinable location

The non-display revenue for each online targeted advertisement, prorated as described above, is then added together to determine the total amount of non-display revenue that must be included in Canadian online advertising services revenue.

3. Social Media Services Revenue

“Social media services revenue” consists of revenue from:

The provision of access to, or the use of, a social media platform (such as subscription fees or pay-per-use fees)
The provision of premium services and other optional enhancements (such as premium membership fees)
The facilitation of an interaction between users or between a user and digital content generated by other users on the social media platform (such as fees for seeing restricted-access content)

For this purpose, a “social media platform” is a digital interface with a main purpose to allow users to find and interact with other users or with digital content generated by other users. Since a user is generally defined as an individual or entity that interacts with a digital interface, excluding the operator of the digital interface or the operator’s consolidated group, revenue from content generated by a social media platform would not be included in social media services revenue.

Social media services revenue excludes any of the revenue streams for online marketplace services revenue or online advertising services revenue. It does not include revenue earned from another member of the taxpayer’s consolidated group. Social media services revenue also does not include revenue from the provision of private communication services (e.g., video calling, voice calling, email or instant messaging) if the sole purpose of the platform is to provide those services.

The calculation of Canadian social media services revenue is similar to the calculation of non-display revenue described above. First, a taxpayer must compute its social media services revenue for each social media platform multiplied by a ratio, B/C, where:

B is the total number of social media accounts in respect of the social media platform that are accessed (i.e., logged in to) at any time during the calendar year by a user located in Canada
C is the total number of social media accounts that are accessed during the calendar year by a user that has a determinable location

The social media services revenue from each social media platform, prorated as described above, is then added together to determine the total amount of Canadian social media services revenue.

For purposes of computing Canadian social media services revenue, the location of a user is not determined based on real-time location but rather on where he or she is normally located at that time.

4. User Data Revenue

The final component relates to user data revenue, which is revenue from the sale of user data or the granting of access to the user data, if the data was collected by the taxpayer or a member of the taxpayer’s consolidated group from an online marketplace, a social media platform or an online search engine. “User data” is defined broadly to mean representations, in any form, of information or concepts generated by or collected from a user’s interaction with a digital interface.

User data revenue also similarly excludes revenues from all the other taxable revenue streams, and it does not include revenue earned from another member of the taxpayer’s consolidated group.

To determine the amount of user data revenue considered to be attributable to Canada (Canadian user data revenue), taxpayers must classify their user data revenue into two categories.

Attributable to Canada?

First Category: Individual User Revenue

The first category of Canadian user data revenue consists of revenue in respect of a single user located in Canada at the time the data is collected. This category arises only where the value of user data can be determined on an individual basis. This revenue is 100% included in Canadian user data revenue.

For purposes of computing Canadian user data revenue, the location of a user is determined based on real-time location.

Second Category: Non-Individual Revenue

The second category of Canadian user data revenue consists of revenue in respect of a set of user data of multiple users where the value of the data of specific users in the set is unknown.

To compute the amount of Canadian user data revenue under this category, a taxpayer must first compute the amount of its user data revenue not in respect of the user data of a single user of determinable location (non-individual revenue) multiplied by a ratio, D/E, where:

D is the number of users in the set that are located in Canada at the time the user data is collected
E is the number of users in the set that have a determinable location at the time the user data is collected

The non-individual revenue for each set, prorated as described above, is then added together to determine the total amount of non-individual revenue included in Canadian user data revenue.

Administration of DST

Only amounts of Canadian DSR in excess of C$20-million or, if multiple entities in the taxpayer’s consolidated group have Canadian DSR, a prorated amount based on the proportion of the group’s Canadian DSR that was earned by the taxpayer are subject to the DST. The annual DST returns and payment are due by June 30 of the following calendar year.

While the taxable threshold is C$20-million of Canadian DSR, registration is required where the taxpayer’s (or taxpayer’s consolidated group’s) Canadian DSR exceeds C$10-million. Taxpayers that meet the registration threshold must apply to register by January 31 following the implementation year.

Members of a consolidated group may elect to report the DST through one entity. If this election is made for a particular year, the designated entity must handle DST compliance on behalf of the electing members for that year.

For further information, please contact: