The Contention between Unilateralism and Multilateralism in International Taxation
Written by Opeyemi Bello
The proliferation of the Digital Services Tax (DST) continues to spark the debate over whether unilateralism or multilateralism more effectively addresses the tax challenges posed by the digitalized economy. The DST is an initiative that some countries adopt as a unilateral measure to tax specific revenues of eligible taxpayers instead of their net profits. The OECD Inclusive Framework – a group of 148 countries – promotes multilateralism and proposes a multilateral instrument to address the digital tax challenges (the ‘Convention).[1] The Convention differs from the DST in its approach to taxation. While the DST focuses on revenue—applying to eligible businesses once they reach a specific revenue threshold—the Convention upholds the traditional principle of taxing net profit. This indicates that under the Convention, a tax obligation arises only when the eligible taxpayer has generated a taxable profit, along with certain factors that are beyond the scope of this piece.[2]
The Convention requires the removal of all DSTs;[3] yet, several countries involved in the OECD Inclusive Framework—who also helped design the Convention—have opted for DSTs as a unilateral solution to the same issues the Convention aims to address.[4] Of particular concern is that some G7 countries, including Italy, the UK, and France, have chosen to implement DSTs.[5] Given their leadership in global economic governance generally[6] and their foundational role in initiating and advancing the Inclusive Framework’s work on the Convention,[7] the G7 countries are supposed to provide leadership in discouraging other countries from pursuing unilateralism. The G7 countries should set an example in supporting multilateralism to establish a cooperative global tax system, which they claim to support.[8] Their preference for DSTs, whether temporary or not, could encourage other countries to follow suit, potentially leading to uncoordinated approaches to the challenges of digital taxation.[9]
Contrary to the Convention, Canada has now joined the other G7 countries by enacting its Digital Service Tax Act (‘Act’) in June 2024.[10] This decision has faced criticism from the US, which argues that the Act discriminates against its multinational companies (MNCs).[11] The Act not only contradicts the Convention but also has a broader scope than the Convention, potentially applying to more taxpayers and likely generating more revenue than the Convention. Should Canada be criticized for adopting this unilateral measure? No. In the ensuing paragraph, I argue that neither Canada nor the other G7 countries with DSTs should face criticism for implementing these taxes even though they are positioned to provide leadership in supporting multilateralism.
Given that the Act is the latest DST introduced by a G7 country, I adopt it to argue two issues. First, I explore how DSTs diverge from the Convention’s framework and expand their scope to include more taxpayers, potentially increasing revenue. Second, I examine how the growing trend of implementing DSTs may lead to a fragmented and polarized international tax system. In my conclusion, I emphasize the importance of international tax institutions in preventing such polarization within the global tax landscape.
This piece does not provide a detailed analysis of the Act’s tax framework, design, and application. Instead, it uses the Act as a case study for DSTs and addresses some of its relevant aspects. The aim is to demonstrate how the Act can include more taxpayers than the Convention and how it may impact multilateralism, which the OECD claims is a solution to the challenges posed by digital taxation. Since most DSTs share similar structures to some extent, the analysis presented here is also applicable to other DSTs.
A. Countries’ Taxing Rights over Economic Activities within their Jurisdictions
Every country has the right to impose taxes on incomes generated from economic activities conducted within its borders, regardless of whether domestic or foreign companies carry out these activities. This taxing authority is widely accepted and is utilized by many countries, including Canada, to generate the revenue necessary for providing public goods and funding other government expenditures.[12] However, exercising the right to tax in the digitalized economy is problematic, particularly on incomes of MNCs that are neither headquartered nor have subsidiaries (Non-resident MNCs) in the country imposing the tax.
For example, in Canada, Non-resident MNCs must have a substantial degree of connection based on their physical activities (described as permanent establishment ‘PE’ when a tax treaty is in force or a list of activities stated in s. 253 Income Tax Act) in the country before incomes attributable to their PEs can be subject to tax. According to the Income Tax Act[13] and Canada’s network of bilateral tax treaties[14], the PE – and activities in s. 253 – is defined as having a physical presence, such as maintaining a branch, an office, a factory, or a workshop. However, the rise of the digitalized economy provides Non-resident MNCs with strategic ways to operate without this physical presence, thereby avoiding taxation in Canada. Since they are incorporated in Canada, MNCs headquartered in or with subsidiaries in Canada already meet the connection requirements necessary for exercising taxing rights. Therefore, taxing their incomes in the digitalized economy will not encounter as many challenges as those posed by Non-resident MNCs.
The Convention utilizes the significant economic presence test, which relies on various economic factors, including Non-resident MNCs’ revenues, to determine the necessary degree of connection or nexus that market jurisdictions should have before they can exercise their taxing rights.[15] The Act also uses economic factors to determine the nexus that triggers taxation of income arising from the digitalized economy. Canada’s commitment to the OECD’s Inclusive Framework suggests that implementing the Act may be a temporary measure designed to generate revenue from activities within its jurisdiction. However, this temporary measure could have enduring effects, given that the Act’s scope applies to more taxpayers than those covered by the Convention and can potentially generate more revenue. The Act’s potential benefits may encourage the government to retain it, but that retention can frustrate implementation of the Convention.
The Act applies to four specific categories of services: online marketplace services, online advertising services, social media services, and the sale of user data.[16] In contrast, the Convention encompasses these services as well as other businesses, such as transport, intangible property, and immovable property, which are not included in the Act.[17]Although the Convention covers a broader range of services, this does not necessarily mean it will generate more revenue. This is because the Convention applies to a smaller number of taxpayers compared to the Act (I provide more details below). Additionally, businesses falling under the Convention can still be regulated by the existing tax regime, as it is impossible to operate such businesses without a physical presence.[18] For instance, engaging in international transport by Non-resident MNCs—whether by shipping or aviation—requires a definite physical presence in Canada. Article 8 of Canada’s network of tax treaties can, therefore, regulate the taxation of incomes arising from those activities.[19]
To determine which is more attractive, the focus should be on the number of taxpayers to whom each of the two instruments can apply. A comparison between the Act and the Convention highlights at least four key differences that indicate the Act applies to a larger number of taxpayers, potentially generating more revenue than the Convention.
i. Lowering the Eligibility Criteria
Both the Act and the Convention adopt a common approach of using revenue tests to determine Non-resident MNCs’ nexus but differ on the revenue threshold. An MNC with a global revenue equal to or exceeding the threshold of EUR 750 million (approximately $1.1 billion) and generating at least $20 million in revenue through its digital-enabled business in Canada is subject to taxation under the Act.[20] This revenue threshold is much lower than the global revenue threshold test of EUR 20 billion and the in-scope revenue threshold test of EUR 1 million set by the Convention.[21] The Act’s lower threshold indicates that the Act will also apply to Canadian MNCs or even domestic companies that meet the threshold. Reuven Avi-Yonah[22] and Wei Cui[23] argue that the Act applies equally to both Canadian and non-Canadian MNCs, which counters the critiques from the US regarding the discriminatory nature of the Act. In addition to Cui’s and Avi-Yonah’s arguments, the lower threshold also expands the Act’s tax net, applying to a broader category of companies compared to the Convention, which can potentially generate more revenue than the Convention.
Furthermore, the Act does not consider MNC’s profitability when determining its eligibility to pay tax.[24] Under the Convention, the MNC must have a profitability ratio of at least 10% before it is eligible to pay tax.[25] This means that MNCs that would have been exempted under the Convention because their profitability is below 10% will be taxable under the Act. The Act targets many taxpayers by lowering the revenue threshold and dispensing with the profitability requirement. The Act’s requirement to tax their revenue at 3% – subject to the prescribed deduction of $10 million – is reasonable considering the potentially large number of taxpayers to whom it applies.
ii. Income Measurement
Taxpayers’ revenues generated from their users and consumers in Canada play a key role in determining their eligibility under both the Convention and the Act. An innovative feature of the Convention and the Act is their utilization of technological tools such as internet protocol and device geolocation to track the revenues generated from digital-enabled businesses, such as advertising services. The technological mechanisms identify the locations where users reside based on their device data.[26] The main difference between the two instruments is that the Convention permits MNCs to use other reliable indicators to trace their revenues to jurisdictions where those revenues arise, whereas the Act does not provide this kind of flexibility.[27] The Act restricts the indicators taxpayers can use to those explicitly mentioned in section 11, which can reasonably indicate that users are located in Canada.[28] The Act establishes a closed framework by restricting revenue tracing mechanisms to specific methods. This allows the tax authority to closely monitor revenue tracking and accurately assess the actual revenue generated in Canada. This is particularly important for determining whether registration of the MNCs under the Act is mandatory.[29] In contrast, taxpayers can leverage Convention’s flexibility by using other reliable indicators to achieve different outcomes, potentially resulting in revenues that are lower than those generated by other indicators or lower revenues that may render them non-taxable.
iii. Residual v. Routine Profits
The Convention divides the profits of eligible MNCs into two categories: routine profits and residual profits.[30] It assumes that residual profits are generated in market jurisdictions and allocates 25% of these residual profits to those jurisdictions.[31] Unlike the Convention, the Act does not categorize profits into routine and residual. It adopts a revenue-based system, making all revenues sourced or traced to Canada taxable, with a fixed deduction of $20 million.[32] Since the residual profit under the Convention represents a smaller portion of the MNCs’ adjusted profits, the revenue-based tax system established by the Act will likely generate more revenue than the Convention. This further supports the rationale for the Act’s modest 3% tax rate, as it applies to a large revenue pool.
iv. Proactive Registration Requirements
Efficient tax collection often begins with accurately registering taxpayers and monitoring their businesses for audit and compliance purposes. The Act mandates compulsory registration for taxpayers who meet the eligibility criteria explained above and those who meet the global revenue threshold but have in-scope revenue of $10 million.[33] This requirement helps expand the taxpayer database, capturing those who are immediately taxable and those potentially taxable. In cases where there is a conflict about a taxpayer’s eligibility for registration, the tax authority has the authority to make a definitive determination and register the taxpayer if it believes it is registrable.[34] The possible rationale for registering taxpayers who are not immediately subject to tax—due to their in-scope revenue being $10 million—is to monitor their activities closely. This way, authorities can identify the precise moment these taxpayers reach the eligibility threshold. This strategy reflects the government’s proactive approach and vigilance in ensuring that no tax revenue is lost.
B. The Impact of DST’s Trend on International Tax Cooperation
Considering the above points, the Act appears more appealing as it encompasses a broader range of taxpayers, which could lead to increased revenue. Should Canada be criticized for unilaterally enacting the Act? The tax sovereignty theory, which states that every country has an inalienable right to design its tax policies according to its preferences, justifies all the DSTs, including the Act, and their stricter measures.[35] This theory rests on the understanding that taxation is closely linked to national sovereignty; therefore, any external restrictions on a country’s tax policy effectively undermine its sovereignty.[36]
However, the historical developments of the International Tax System (ITS) have demonstrated that some degree of cooperation—and sometimes compromise—is necessary to create an optimal tax system that supports the growing demands of the global economy.[37] The OECD’s involvement in coordinating the negotiations of the Convention reflects this understanding of the importance of cooperation, especially in today’s digitalized economy, which is experiencing unprecedented levels of economic integration among countries. Canada is participating in the OECD’s project and supports the Convention, which specifically calls for the removal of all DSTs.[38] Beyond contradicting the Convention, the DSTs generally have at least three significant implications for the Convention specifically and international tax cooperation generally.
i. Domestication of Convention
The Convention is a multilateral tax treaty that requires domestic implementation in the respective signing countries to be effective. For example, implementing the Convention in Canada requires its enactment as a domestic law.[39] Canada’s finance minister has stated that one of the reasons for the Act is to allow the government to collect tax revenues from MNCs that are not paying their fair share of taxes due to the challenges posed by the digitalized economy.[40] The fundamental question the Parliament and other interested stakeholders may raise during the domestication process is: will the Convention generate an equal or higher revenue than the Act? Given the tightening of the Act and its broad scope, it is unrealistic to expect that the Convention will ensure greater revenue than the Act. Likely, a negative assessment suggesting that the Convention will generate less revenue will not convince the Parliament to proceed with its domestication. Non-domestication of the Act ends its enforcement in Canada, and this could have broader implications for other countries and the ITS.
ii. Likely Impact on the International Tax System
Canada is the fourth G7 country to implement a DST. Given the G7’s significant role and influence in the Convention negotiations,[41] I expect that G7 members would not act contrary to it. While the positions of the other G7 countries may raise some concerns, Canada’s Act is particularly concerning because it was enacted when the Convention had evolved into a treaty and was ready to be signed. Retaining the Act because it can potentially guarantee more revenue than the Convention or is more simplified than the Convention can encourage other countries to choose DST over the Convention or motivate countries with DSTs to retain them. Institutions that promote developing countries’ interests, like the ATAF and the South Centre, are already considering policy options between DST and Convention for developing countries, and the G7 countries’ positions might significantly influence their choice.[42] If this trend continues, it could jeopardize the implementation of the Convention before it even begins. The OECD has invested considerable efforts in developing the Convention, with nearly a decade of extensive negotiations and technical design culminating in a draft multilateral treaty that is close to completion.[43] Failure to successfully implement the Convention will undermine countries’ trust and confidence in similar global tax cooperation efforts, whether led by the OECD or the UN.
iii. Effect on the Low-and-middle Income Countries (LMICs)
Lastly, the increasing trend toward unilateralism in the proliferation of DSTs and the possible abandonment of the Convention will significantly impact the LMICs. The effective implementation of any DST depends heavily on the technological advancement of the country enforcing it. For example, the Act’s provision that the tax authority has the final decision in determining the registrability of businesses indicates that the government has the technological capability to monitor activities within its digital space, including transactions involving cryptocurrencies. Monitoring various types of digital financial transactions is crucial to ensuring that revenues generated in Canada meet the required thresholds. While developed countries like Canada may face fewer challenges in enforcing the Act, LMICs are often not well-equipped to cope with the strategies the MNCs can use to leverage technology to structure their operations and shift profits to jurisdictions with low or no taxes.
Though not explicitly stated in its international tax policy, Kim Brooks finds that Canada appears to be sensitive to the LMICs’ position in negotiating bilateral tax treaties.[44] Canada adopts an approach that allows the LMICs to earn some revenue in commercial tractions involving the treaty partners but does not use such an approach for its equally comparable developed countries.[45] This commendable compromise favouring the LMICs could be undermined if the trend of unilateralism persists.
C. The Buck Stops with International Tax Institutions
The Act and the DST trend, in general, reaffirm the widely acknowledged principle that every country has exclusive rights to design its tax policies according to its preferences. The idea behind the ITS is not to create a new tax at the global level, but rather to design a framework that coordinates and harmonizes the various national taxes to promote an efficient global economy.[46] One important question is what role international tax institutions should play in this process. The primary function should be to prevent uncoordinated approaches and persuade countries to prioritize cooperation and, in some instances, compromise for countries in need. Unilateral tax policies were effective only before the global trade boom and the era of economic integration of the 19th and 20th centuries. If the economic interdependence of the 20th century highlighted the need for tax cooperation, the current digitalized economy demands even greater collaboration, as its level of economic integration surpasses that of the previous century. Just as no single country could dictate the ITS framework in the 20th century, no country today can unilaterally compel others to engage in tax cooperation. The responsibility for promoting tax cooperation among nations rests primarily with the international institution coordinating the ITS. This institution should aim to create a supportive environment, while developed countries like Canada should take the lead in prioritizing the achievement of an effective ITS.
Given the absence of a purposively created international tax institution, the OECD should continue to assume the leadership role given its historical contribution to global tax governance and its ability to fill the lacuna created by the exit of the League of Nations and the UN in the 1940s and 1950s, respectively.[47] The OECD should recognize that its leadership in the ITS is not only to promote the economic development of its member states but also to provide an enabling environment for the quick implementation of an inclusive and fair global approach to digital tax problems. Failing to do so may create an opportunity for the UN to reclaim its leading role, provided the UN can successfully advance its ongoing work on establishing a truly inclusive forum for international tax cooperation.[48]
[1] OECD, The Multilateral Convention to Implement Convention of Pillar One: The Two Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy, available online at https://www.oecd.org/tax/beps/multilateral-convention-to-implement-amount-a-of-pillar-one.pdf (‘Convention’). For a list of members of the Inclusive Framework, see https://www.oecd.org/en/topics/base-erosion-and-profit-shifting-beps.html.
[2] This piece briefly examines some eligibility criteria to compare the Convention with the Act.
[3] OECD Convention, supra note 1.
[4] Ibid. See Annex A.
[5] Wei Cui, ‘The Canadian Digital Services Tax’ in C. Eliffe, ed, International Tax at Crossroads. (Cheltenham: Edward Elgar, 2023) 245 at 253.
[6] Smith Gordon, G7 to G8 to G20: Evolution in Global Governance (Waterloo, Ontario: Centre for International Governance Innovation, 2011) 4-6.
[7] Wei Cui, “New Puzzles in International Tax Agreement” (2022) 75:2 Tax L Rev 201 at 205.
[8] G7 Finance Minister and Central Bank Governors Meeting Communique, May 13, 2023, online: https://www.mof.go.jp/policy/international_policy/convention/g7/g7_20230513_2.pdf
[9] The differing approaches of the Convention and the DST highlight why the two systems cannot coexist and support the Convention’s demand for the elimination of all DSTs.
[10] Digital Services Tax Act, SC 2024, c15, s. 96.
[11] Cui, ‘The Canadian Digital Services Tax’ supra note 4 at 252; Reuven S. Avi-Yonah, ‘Much Ado: Why the United States Should Calm Down About DSTs’ (2023) Tax Notes Int’l 903.
[12] Elsbeth Heaman, “The Politics of Fairness: Income Tax in Canada Before 1917” in Kim Brooks, ed, The Quest for Tax Reform Continues the Royal Commission on Taxation Fifty Years Later (Toronto: Carswell, 2013) at 15; Irving Brecher, Monetary and Fiscal Thought and Policy in Canada, 1919 -1939 (Toronto: University of Toronto Press, 1957) at 48; J. Harvey Perry, Taxes, Tariffs, & Subsidies: A History of Canadian Fiscal Development Volume 1 (Toronto: the University of Toronto Press, 1955) at 140; Richard Bird et al. ‘Looking Back To Look Ahead: Critical Themes, Milestones and Future Directions’ in Jinyan Li, J. Scott Wilkie & Larry F. Chapman, eds, Income Tax at 100 Years (Toronto: Canadian Tax Foundation, 2016) 25:1. For a different perspective of underlying motives for Canada’s first income tax see Colin Campbell & Robert Raizenne, A History of Canadian Income Tax: The Income War Tax Act, 1917 – 1948 (Toronto: Canadian Tax Foundation, 2022).at 26 – 36.
[13] See Income Tax Act R.S.C. 1985, c. 1 (5th Supp.), ss. 2, 3 and 253.
[14] For example, see Article 5 on permanent establishment in the tax treaty between Canada and the United Kingdom. See Convention Between the Government of Canada and the Government of the United Kingdom of Great Britain and Northern Ireland, September 8, 1978 (entered into force on different dates in 1976 for different taxes). See https://www.canada.ca/en/department-finance/programs/tax-policy/tax-treaties/country/united-kingdom-convention-consolidated-1978-1980-1985.html. Similar provisions are contained in its treaties with other countries.
[15] OECD Convention, supra note 1.
[16] See sections 13 – 19 of the Act.
[17] See Annex D of the Convention.
[18] For instance, section 6 of Annex D indicates that the address of the immovable property corresponds to the jurisdiction where the revenue is generated. This suggests that the business depends on the physical presence of the immovable property.
[19] See Article 8 of Canada – UK Tax Treaty, supra note 14.
[20] S. 10 of the Act.
[21] Reuven Avi-Yonah, Young Ran (Christine) Kim & Karen Sam, ‘A New Framework for Digital Taxation’ (2022) 63:2 Harv Int’l LJ 279 at 294. The in-scope requirement of EUR 1 million applies to larger jurisdictions, defined as those with a GDP of more than EUR 40 billion. For smaller jurisdictions, the revenue threshold is set at EUR 250,000.
[22] Ibid at 282. Further see Reuven S. Avi-Yonah, ‘Should Digital Services Taxes Be Creditable’? (2024) 113:11 Intl Tax Note 1469.
[23] Wei Cui, ‘The Digital Services Tax A Conceptual Defense’ (2019) 73:1 Tax L Rev 69.
[24] S. 10 of the Act.
[25] Reuven Avi-Yonah ‘A New Framework for Digital Taxation’ supra note 21.
[26] See Article 7 and Annex D of Convention.
[27] See Article 6(3)(b)(ii) of Convention. Taxpayers may use indicators beyond those in Article 7 and Annex D, as long as they can demonstrate their reliability and obtain acceptance from the certainty review panel.
[28] S. 11 of the Act.
[29] See section 41 of the Act. This section vests the tax authority’s power to determine whether a taxpayer should register under the Act. The effective way to exercise this power is to use revenue generated by the taxpayer to determine if it has reached the required threshold.
[30] Reuven Avi-Yonah ‘A New Framework for Digital Taxation’ supra note 21.
[31] Ibid.
[32] S. 24 of the Act.
[33] Section 41 of the Act; Section 5 of the Digital Services Tax Regulations.
[34] Section 44 of the Act.
[35] Diane Ring, “Democracy, Sovereignty and Tax Competition: The Role of Tax Sovereignty in Shaping Tax Cooperation” (2009) 9:5 Fla Tax Rev 555 at 561 – 563.
[36] Ibid
[37] Allison Christians, “Networks, Norms, and National Tax Policy” (2010) 9:1 Wash U Global Stud L Rev 1 at 11.
[38] OECD Convention, supra note 1.
[39] Laura Barnett, Canada’s Approach to The Treaty Making Process (Ottawa: Library of Parliament, 2021) 2 -3.
[40] Janyce McGregor, Canada’s Digital Services Tax Set for a Reckoning with U.S’ CBC News, November 13, 2024, available online: https://www.cbc.ca/news/politics/tuesday-dst-deadline-trump-1.7380857
[41] Wei Cui, “New Puzzles in International Tax Agreement” (2022) 75:2 Tax L Rev 201 at 205.
[42] Vladimir Starkov & Alexis Jin, “A Toss Up? Comparing Tax Revenue from the Convention and Digital Service Tax Regimes for Developing Countries” (2024) South Centre, African Tax Administration Forum and West Africa Tax Administration Forum Research Paper 199 online: https://www.southcentre.int/wp-content/uploads/2024/05/RP199_A-Toss-Up_EN.pdf
[43] Reuven Avi-Yonah ‘A New Framework for Digital Taxation’ supra note 21.
[44] Kim Brooks, “Canada’s Evolving Tax Treaty Policy toward Low-Income Countries” in Arthur J. Cockfield, ed, Globalization and its Tax Discontents: Tax Policy and International Investment (Toronto: University of Toronto Press, 2010)) 189 at 196 – 199.
[45] Ibid.
[46] W.H. Coates, “League of Nations Report on Double Taxation Submitted to the Financial Committee by Professors Bruins, Einaudi, Seligman, and Sir Josiah Stamp” (1924) 87:1, J. Royal Statistical Society 99.
[47] Michael Lennard, ‘The Purpose and Current Status of the United Nations Tax Work’ (January/February 2008) Asia-Pacific Tax Bulletin 23.
[48] Sol Picciotto, “The Design of a UN Framework Convention on International Tax Cooperation.” (2024) Available at SSRN.
The views and opinions expressed in the blogs and case reporter are the views of their authors, and do not represent the views of the Desautels Centre for Private Enterprise and the Law, the Faculty of Law, or the University of Manitoba. Academic Members of the University of Manitoba are entitled to academic freedom in the context of a respectful working and learning environment.