Canada’s 2021 budget includes proposals on digital taxes, profit shifting, interest deductibility

By Doug Connolly, MNE Tax

Canada’s Budget 2021, presented by Finance Minister Chrystia Freeland on April 19, proposes several significant tax measures affecting multinational enterprises, including international tax provisions on interest deductibility and hybrid mismatch arrangements. The budget also adopts a digital services tax proposal outlined late last year and announces upcoming consultations on transfer pricing rules and mandatory disclosure rules.

Many of the tax provisions are included as revenue raisers, offsetting some significant spending measures, including a national childcare plan, continued pandemic relief, and green economy provisions. Other revenue raisers in the budget include a tax on certain luxury goods like yachts, private planes, and expensive cars, and a tax on mostly vacant residential property owned by non-resident foreigners. The budget also proposes a federal minimum wage of CAD 15 (approximately USD 12), indexed for inflation.

The budget is Prime Minister Justin Trudeau’s first budget in two years. No budget was presented in 2020 due to the Covid-19 pandemic.

Digital services tax

The budget tax proposals in general emphasize a goal that “everyone pays their fair share,” and it specifically applies this credo to digital corporations. The government previously announced its intention to move ahead with a digital services tax in its 2020 Fall Economic Statement. The budget adopts and builds on that proposal.

The government says it is committed to continuing work on a multilateral approach to cross-border digital taxation and remains hopeful for the planned mid-2021 consensus solution. However, failing multilateral agreement this year on an acceptable alternative, the government intends to move forward with implementing a digital services tax applicable as of January 2, 2022. The tax would apply until an acceptable multilateral agreement is reached.

The proposed digital services tax would apply only to large businesses with gross revenue of at least 750 million euros (approximately USD 900 million). The tax would apply at a rate of three percent on revenue from digital services that rely on data and content contributions from Canadian users.

Interest deductibility

The government noted that Canada is the only G7 country that has yet to implement measures to limit excessive interest deductions by large companies, explaining that some companies use such excessive interest deductions to reduce the taxes that they pay in Canada.

The budget proposals would limit the amount of interest that certain businesses can deduct starting in 2023. The limit would be set at 40 percent of the company’s earnings in the first year of application and 30 percent thereafter. Exceptions would apply for small businesses and other circumstances representing low risk of tax evasion.

The government expects to release draft legislation on the proposal this summer.

Hybrid mismatch arrangements

Hybrid mismatch arrangements involve efforts by multinational enterprises to avoid paying taxes by exploiting differences in how two countries’ tax laws treat certain business entities or financial instruments.

The budget proposes introducing measures to eliminate the tax benefits of such transactions. The measures are proposed to be implemented starting July 1, 2022.

Transfer pricing

The government said that concerns have arisen about the application of Canada’s transfer pricing rules in light of the Federal Court of Appeal’s Cameco decision. The government believes that the case highlights shortcomings in the transfer pricing rules that can enable inappropriate shifting of corporate income out of Canada.

Accordingly, the budget announces plans to issue a consultation document requesting comments regarding changes to the transfer pricing rules.

Mandatory disclosure rules

The government also seeks to enhance the Canada Revenue Agency’s ability to timely obtain information on arrangements that involve aggressive tax planning. Building on OECD base erosion and profit shifting (BEPS) recommendations, the budget announces the launch of a public consultation on mandatory disclosure rules.

The proposed changes in the consultation will include a new requirement for certain corporations to report uncertain tax treatments, revised rules on reportable transactions, and a new requirement to report “notifiable transactions.”