Canada's tax on digital services must be settled with the US

The battle over Canada's controversial digital services tax could escalate this week as the deadline approaches for the Biden administration to decide whether to move forward with dispute arbitration amid the threat of retaliation from Donald Trump's new administration.

On August 30, United States Trade Representative (USTR) Katherine Tai filed an official complaint under the Canada-United States-Mexico Agreement (CUSMA), arguing that the three percent tax on Canada implemented over the summer unfairly discriminates against American companies.

The move began a 75-day consultation period that ends this week. But with President Joe Biden's administration in a paralyzed position, it's not clear whether Tai will escalate the dispute by asking an arbitration panel to decide whether the Canadian tax actually violates CUSMA.

The USTR's other option is to shelve this complaint for the time being, and leave it to the new Trump administration to pick up and prosecute it – which could pose even more risk to Canada.

“The first Trump administration was very clear about taxes on digital services. They believed that taxes on digital services were a very clear indication that a country was specifically targeting the US and US companies. It will be 'with us and against us'.” scenario,” says John Dickerman, the Washington-based policy vice-president of the Business Council of Canada.

“I think there will be very little room for negotiations on daylight saving time.”

When Tai initiated the CUSMA dispute with Canada, the USTR statement also made clear that it supported US Treasury Secretary Janet Yellen's participation in talks between OECD and G20 countries to reach a multilateral agreement on the would continue to support taxing large global technology companies.

Those countries have pursued such an agreement to prevent digital companies from pitting competing jurisdictions against each other and organizing themselves to minimize or avoid taxation.

However, Dickerman said these discussions could be disregarded under Trump. “Multilateral solutions are not as attractive as bilateral solutions would be,” he said.

Business groups have previously warned

Canada's DST applies to companies that generate more than $20 million in annual revenue from Canadian sales of online advertising, social media and streaming services or data storage. This does not apply to small start-ups. It is triggered when a tech giant's annual turnover exceeds a set international threshold of more than 750 million euros ($1.1 billion Cdn).

The risk of direct tariff retaliation from the US is one of the main reasons for groups like the Canadian Chamber of Commerce has fought against the introduction of Canadian Daylight Saving Time from the beginning.

Before the results of last week's election were even known, Ontario Premier Doug Ford called for a suspension of the tax, based on what he said he heard about how “furious” Americans were about it.

If Americans had elected more Democrats to Congress last week, there might have been more patience and even more support for participating in the multilateral process that Yellen and Treasury Secretary Chrystia Freeland were trying to steer toward a treaty.

Populist voices calling for downsizing or breaking up some of these companies — or at least paying their fair share of taxes to fund social services — received some traction before the election. That could explain why the Biden administration did not spend much of its capital defending the trade interests of US big tech, to the frustration of more hawkish voices in Congress.

However, the incoming Trump administration has quite close ties with tech giants like Elon Musk.

“Several of the top digital executives reached out to Trump during the election,” noted trade lawyer Mark Warner of Toronto and New York. He said he doesn't think this bodes well for the Canada Revenue Agency after the inauguration.

“The digital stuff is easy for people to understand because it's like, 'Wait a minute, the only businesses [Canada is] Hits are big American companies,” Warner added.

“Whatever the logic of it and how it's defined, it's just easy to frame an issue that way… 'You say you're our best friend. You're going after our big corporations. What is this?' “

Despite previous threats of retaliation from the US, Freeland's office has taken note of the way France, the United Kingdom and Italy collect taxes on digital services.

WATCH: Freeland defends taxing foreign tech giants

Freeland defends taxing foreign technology giants such as Netflix, Google and Amazon

Finance Minister Chrystia Freeland is defending a controversial new tax on foreign technology giants such as Netflix, Google and Amazon. She says it will generate billions in revenue, but experts say consumers will end up paying more.

“Meanwhile, some of the world's largest companies are not paying their fair share in Canada, despite doing business and making huge profits in Canada. That is wrong and puts Canada at a significant comparative disadvantage,” Freeland's spokesperson Katherine Cuplinskas said. CBC News.

“Our preference has always been a multilateral solution,” she said, noting that Canada has already made “important concessions” in an effort to reach an international deal, including delaying the introduction of its own tax.

“We look forward to working again with President Trump and his administration on important issues on both sides of the border.”

Although the Trudeau government hoped the DST would generate more than $7 billion over the first five years, it may have to concede this windfall to avoid punitive measures once Trump is in charge.

That could disappoint progressives like the New Democrats, who have argued for years that big corporations should pay their fair share — but fears of even greater economic damage may now have to grab the attention of minds in Ottawa.

Trump's former national security adviser Robert C. O'Brien wrote recently that “allies seeking to constrain the US economically should be reminded that our global technological leadership, including in the digital services market, is a national security issue for the US”

Even if the Biden administration uses the remaining weeks to refer this dispute to a CUSMA arbitration process, it is not clear that Canada will be able to defend its tax against claims that it is squeezing U.S. companies.

“Canada may have a safe haven beneath it [CUSMA] cultural exception,” says Elizabeth Trujillo of the University of Houston Law Center. She admittedly wonders whether the language Canada fought for in that deal — to protect its right to subsidize and support its own arts and media industries — could also be applied in this case. “arguable whether it is really a cultural exception.”

With the World Trade Organization also struggling to oversee the ever-expanding digital economy, Trujillo said this will certainly be an issue if CUSMA comes up with a mandatory review, if not a full renegotiation, in 2026.

“It's already tense over these issues,” she said.