The series on digital tax policy issues has touched on various tax measures that target consumers: digital sales tax, Netflix tax, Internet access taxes, and digital device taxes. The series returns with a post examining a business-focused tax proposal, namely lobbying efforts to amend the Income Tax Act to change the rules on advertising deductions in the hope of shifting ad spending to Canadian media organizations.

The challenges faced by local media companies is well-known as the industry faces significant declines in revenues and layoffs. Several groups have focused on tax reform as a potential solution, lobbying for a change to the Income Tax Act that would render advertising purchased on foreign Internet-based media no longer tax deductible. Section 19 of the Income Tax Act limits tax deductions for advertising with provisions designed to favour Canadian media organizations. However, since there are no restrictions on deductions for advertising on foreign websites, proponents of reform argue that that this favours foreign sites and ad networks such as those run by Google and Facebook. They maintain that reforms to treat advertising on foreign sites as non-deductible would shift advertising back to Canadian organizations by making online advertising more expensive.

For example, according to a Friends of Canadian Broadcasting report such a change would dramatically change the Canadian media landscape:

For Canadian media, it could be the single greatest factor in reversing revenue declines and ensuring viability for Canadian local print, TV and radio operations – and their contributions to Canadian culture, news and democracy. Hundreds of millions of dollars could move back from foreign to Canadian owned-and-controlled media companies – stabilizing and growing their revenues, and allowing these companies to reverse job cuts and re-invest in Canadian content, including journalism. 

Specifically, the suggested re-interpretation of the advertising tax deductibility provisions of the ITA would, we estimate, result in on the order of 50% – 80% of current internet advertising expenditures being deemed nondeductible. Conservatively estimating that 10% of these now non-deductible foreign internet advertising expenditures shift back to Canadian media, this would represent an influx of $250 to $450 million annually in incremental advertising revenue.

The Friends of Canadian Broadcasting report was the impetus for a Senate study on the issue earlier this year. Despite being a hearing seemingly designed to arrive at a recommendation for reform and general support from industry witnesses, the committee stopped short of recommending reform, instead opting for further study:

The Committee recommends that the Government of Canada study the tax deductibility of foreign Internet advertising and publish a report providing its position on the matter. The report should indicate if the government intends to take actions to extend section 19 of the Income Tax Act to Internet advertising; if it does, the government should indicate the best way to do so.

Why back away from recommending reform?  The short answer is that the proposal will harm Canadian businesses but do little to help Canadian media organizations.

First, the hope that advertisers will move away from digital advertising by making it more expensive by eliminating tax deductions misunderstands the very nature of digital advertising. Simply put, digital advertising is a function of audience. Given that more and more people are shifting their viewing and media consumption habits from offline to digital, advertisers are unsurprisingly following their audience (this is true for both the private sector and government, who occasionally get criticized for social media based advertising, as if advertising were merely a subsidy program as opposed to expenditures designed to communicate to the public).

That is a challenging marketplace shift for traditional media since there is far more competition for digital ad dollars. The combination of increased supply of potential ad space and real-time bidding that ensures market demand based pricing unsurprisingly leads to lower revenues for digital ads. Moreover, digital advertising offers metrics – click-through rates and actual views – that are more efficient in identifying advertising effectiveness. Lower prices and more effective advertising means that a change in the tax code is unlikely to result in a meaningful shift in advertising venues. Rather, it will simply make the digital advertising more expensive and leave Canadian business less competitive in the digital marketplace.

Second, the proposal misunderstands the complexity associated with digital advertising. A considerable portion of digital advertising with companies such as Google involves a revenue share between Google and the site where the advertising appears. In other words, the advertising often appears on the same Canadian sites that would purportedly benefit from the reform. That revenue initially goes to Google, which then sends the majority back to the site or media organization. For that form of advertising, Google is simply matching advertisers and websites, while collecting a commission for providing the service. If advertising through the Google or Facebook network alone were enough to disqualify the advertising from tax deductibility, Canadian sites would be harmed in the process.

In cases where the advertising is on a foreign site – think YouTube – there may also be important Canadian connections. For example, the Globe and Mail posts videos on Youtube and generates a revenue share for the advertising that appears alongside the video. That is part of how Canadian media is trying to monetize its content, yet the policy would discourage such advertising by making it more expensive. The problem with Canadian content on foreign sites also crops up for Canadian artists and smaller media organizations, who may similarly use foreign sites as important sources of distribution and advertising revenue.

The harm extends to Canadian businesses seeking to reach larger audiences through digital advertising. When asked about the issue during the Senate hearing, an official with Canada Revenue Agency warned that the policy would have limited impact on advertising practices but would harm Canadian businesses:

Estimates provided by the Friends of Canadian Broadcasting indicate that roughly 10 per cent of foreign Internet advertising expenditures would shift back to Canada and that their proposal would increase the tax burden on Canadian businesses by more than $1 billion. This suggests the measure would likely not change firms’ behaviour to a significant degree. As such, it seems it would mainly result in a tax increase on Canadian businesses. In this context, it is not clear that in itself the measure would represent a complete solution to the problem facing Canadian media.

There is a reasonable debate to be had over the dominance of Google and Facebook in the digital advertising sector and over how to fund important investigative journalism. However, cutting the flow of dollars to large Internet companies through income tax reform – particularly where that money often boomerangs back to Canada – will do little to actually help Canadian media organizations seeking to attract digital ad dollars, Canadian artists searching for new revenues online, or Canadians businesses trying to grow through digital advertising.