What are the challenges of taxing the digital economy?

In 2019, France announced the implementation of a 3% digital tax on large multinational corporations in the technology sector.

France's decision has inspired several other countries, such as Australia, to establish similar taxes in order to reign in these tech giants, which benefit from outdated tax legislation. In 2020, Canada joined in, announcing a digital tax that will come into effect in 2022.

These new regulations have disrupted relationships between governments and tech giants and prompted the OECD to create a framework for international tax rules for digital industries.

What are the main challenges related to digital taxation? How are these issues perceived in Canada and internationally? Find out in this article.

The digital tax challenges addressed by the OECD

The growing importance of digital technology in the international economy is creating taxation challenges throughout the world.

As world leaders become increasingly concerned about the consequences of the current outdated regulations, the Organisation for Economic Co-operation and Development (OECD) has entered into consultations with G20 countries.

The goal of these consultations is to negotiate new international tax regulations in order to find a long-term solution to the fiscal challenges posed by the digital economy.

In 2019, the OECD developed a two-pillar approach that seems to provide a good basis for a future agreement, although discussions have unfortunately been delayed due to the COVID-19 pandemic.

Here is an overview of the two pillars that form the basis of the negotiations.

Pillar One: nexus and changes to the allocation of taxing rights

Pillar One of the OECD plan would introduce new nexus rules. In other words, these regulations would determine where tax should be paid.

It would also make significant changes to the way taxing rights are distributed among countries.

These measures are designed to ensure that the major players in the digital world, including the Big Five (Google, Amazon, Facebook, Apple and Microsoft), pay their business taxes in locations where they conduct a significant amount of business. This would apply even to companies that do not have a physical presence in those locations.

Pillar Two: addressing challenges related to tax base erosion

Pillar Two of the project aims to implement a new global minimum tax. This tax would be used to help countries address unresolved problems related to tax base erosion and multinational corporations shifting their profits.

What impacts might the digital tax have in Canada?

At the end of 2020, the Canadian government announced its intention to tax large digital companies by 3% as of January 1, 2022. With this new tax, tech giants would pay the same sales tax as other Canadian companies.

The new tax would remain in effect until the OECD reaches a consensus on new international rules for digital taxation.

The decision has sparked debate about the consequences of taxing these large companies.

Here are a few of the points raised regarding Canada’s digital tax.

Fairer taxation for Canadian businesses

The main reason Ottawa has created its own digital tax is that foreign tech multinationals are currently exempt from existing tax laws.

Current regulations allow the Big Five to avoid collecting the Goods and Services Tax and the Harmonized Sales Tax (GST/HST). This has a direct impact on consumers, who must pay the sales tax themselves.

By introducing this new legislation, the government expects to increase federal revenue by approximately CAD 3.4 billion over five years. The tax would only apply to large digital companies and would restore fairer taxation for Canadian businesses.

The New Democratic Party, however, is outraged by projections. “Just $3.4 billion over 5 years! This is clearly nothing like the 15% [tax rate] other companies have.” According to the NDP, this level of taxation will not be enough to restore fair fiscal balance.

Digital tax pitfalls to avoid

Some economic experts argue that a digital tax could have a significant impact on the country's economy.

After analyzing the French digital tax, some economists have concluded that a similar tax could be detrimental to Canadian consumers and businesses.

They believe that a digital tax could reduce the profitability of the businesses, which in turn might reduce the projections of government revenue, as happened in France.

They also argue that the new tax could slow the development of smaller digital companies, which would affect the Canadian economy.

The tax might discourage small businesses and leave big tech to fill the gap.

Digital tax: a conversation worth having

There are many complex issues related to digital tax. The digital world is constantly changing and has evolved more quickly than ever during the COVID-19 pandemic.

Although the OECD's discussions on digital tax regulations have been delayed, it is essential that the organization takes as much time as necessary to find the best solution to the problem while taking our current economy into account.

What do you think about Canada’s new digital tax?

For more information about corporate tax in Canada, check out the “corporate tax” section of T2inc’s blog.