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The e-product I'm selling is set at $23. I need to charge tax to Canadian residents and the percentage varies with each province and territory. I do not want to add the tax onto the $23, however - I want to just calculate it myself later. But I need to somehow keep track of where my buyers are from. Is there a way for them to select their country or province of residence when they buy? Their address doesn't show up in my PayPal transaction log. Thanks!

You could enable Shipping/Buyer's Address, which would require buyers to enter their country/postcode in the cart and would trigger collection of a street address during checkout; however, this could confuse or even deter buyers who don't expect to have anything actually shipped to them.

If you might reconsider having our cart calculate Canadian GST/PST/HST for each buyer's order, this help page provides helpful tips for setting that up:
http://www.e-junkie.com/ej/tips.tax.canadian.htm

For the first option, is there a place on the pre-payment page where I can explain why their address is necessary?

For the second option, can I set it up so that the buyer still only pays $23, but the taxes are subtracted from that? (Meaning, I pay the tax from whatever profit is made, instead of having it tacked on for Canadian buyers to pay on top of the $23.) If so, is the tax calculated before or after PayPal fees?

There is no place on the pre-payment page that you can edit and include text about why their address is required. You could add this to your website itself, or you can customize the shopping cart to include the text at the bottom of the cart, by the checkout button:
http://www.e-junkie.com/ej/help.custom-cart.htm

As for the second option, it would not be possible to make sure that with tax the amount will always be exactly $23 since different provinces will have different rates. If you are set on having the total with tax be $23 for all users then you would not want to use the second method. If you did decide to use it, sales tax would be calculated before PayPal's fees.