How a Brewing Digital Trade Dispute Could Impact Manufacturers

In this video from The Franklin Partnership, contributing author Omar Nashashibi explains how a trade dispute related to taxes is brewing between the U.S. and Canada.

U.S. & Canada Digital Services Taxes Dispute

Background

Canada is once again back in the spotlight regarding both a tax and trade dispute related to Organization for Economic Cooperation and Development, or OECD, Base Erosion and Profit Shifting tax agreements with Pillars 1 and 2.

Canada recently restated that its Digital Services Tax will take effect on January 1, 2024, if the countries party to OECD tax talks do not reach a deal on the two-pillar tax framework. This, in turn, could lead the U.S. to respond with tariffs on Canadian products and other action taken under U.S. domestic laws.

Digital Services Taxes on multinationals are a mix of gross receipts taxes and transaction taxes that apply on everything from digital advertising, operation of online marketplaces, internet purchases, and the sale of data collected from users, among other transactions, depending on the country. As part of the OECD talks, most countries agreed to eliminate their Digital Services Taxes due to redundancy.

Who Wants a Bite of the Apple

As of June 2023, 143 countries signed onto the OECD domestic tax Base Erosion and Profit Shifting agreement, known as BEPS. The OECD agreement calls for two Pillars. Pillar One applies to the biggest and most profitable multinationals and re-allocates part of their profit to the countries where they sell their products and provide their services, or simply put, where their consumers are. The primary target of digital services taxes is the Facebook, Amazon, Apple, Netflix, and Google (FAANG) community selling cross-border.  Under Pillar Two, multinationals with over $800 million would be required to pay minimum tax of 15% on income arising in each jurisdiction in which it operates.

The OECD estimates that Pillar One could reallocate the taxing rights on roughly $200 billion of profit to jurisdictions each year. The Pillar Two global minimum tax of 15% is estimated to generate around $150 billion in additional global tax revenues annually.

Congressional Concerns

Congressional Republicans continue to raise objections to the agreement, saying it cede U.S. authority over taxes to other countries. In September, Republicans on the House Ways & Means Committee denounced the OECD’s tax negotiations, saying the committee would not cede its authority to shape U.S. tax law. These are just some of the obstacles in the way of a global minimum tax.

As part of these agreements, many countries agreed to eliminate the types of Digital Services Taxes I mentioned earlier, and under an agreement reached over the summer, most OECD economies agreed to extend a moratorium on digital services taxes through the end of 2024, essentially waiting until after the U.S. elections. Not Canada, and this brings us to the issue that impacts manufacturers and distributors of all sizes.

Canada has said that it will move forward with the digital services tax, which U.S. officials say clearly targets American companies, retroactively to 2022. This is where the U.S. Congress comes in. The top Democrat and Republican on the Senate Finance Committee sent a letter to the Biden administration calling on them to “apply the requisite response immediately, if and when Canada may adopt its proposed Digital Services Tax.”

In September, nearly all members of the House Ways & Means Committee demanded that the administration take action to ensure Canada does not implement the tax.

Many here in Washington, including in the Biden administration, believe that Canada’s tax would warrant action under the new NAFTA. The USMCA dispute mechanism could be an avenue but members of Congress could call for some type of retaliatory action, in the form of tariffs or taxes, that could affect cross border trade.

This is one of those tax and trade issues that is colliding with a lot of politics and creating uneasiness both on Capitol Hill and in the business community.

How Congress Could Strike Back

In February 2022, the Office of the U.S. Trade Representative said that Canada’s tax could result in Section 301 tariffs on imports from Canada. This Section 301 tariff is the same law used to impose tariffs on Chinese imports that are still in place five years since being first imposed. It would not surprise anyone to see a tariff list that targets politics of political and economic importance to Canada, while also seeking to protect some U.S. industry ahead of the 2024 election. 

There is definitely pressure from Congress as we approach the January 1^st deadline for when Canada said it would impose the tax, retroactive to 2022. Although implementation of some of the Base Erosion and Profit Shifting agreement items can be done through regulation, others would require legislation or treaty amendments, which must be approved by the Senate. And for the main foundations of BEPS, we are hearing that there seems little to no chance that the U.S. Congress will move on Pillars 1 and 2 prior to the end of the year, let alone before next November’s elections.

And that is the holdup on the OECD agreement, what happens with the U.S. elections in November 2024. Meanwhile, the Canadians are not willing to wait that long with their Digital Service Tax slated to take effect on January 1^st. And if that happens, the U.S. will likely retaliate, which puts manufacturers and distributors on both sides of the border in the middle of a simmering trade battle.

Action:  Close Monitoring

While not grabbing many headlines outside of Washington, D.C., in trade circles, this issue is quickly moving up the ladder of concern to cause disruption if one side or the other does not back down.