Controlling for excessive interest and financing expenses limitation

  • May 26, 2023

The federal government previously signalled its intention to limit the deductibility of interest and other financing costs to address concerns over base erosion and profit shifting, also known as BEPS. The 2021 federal budget proposed to make changes to the excessive interest and financing expenses limitation regime, or EIFEL, to align it with its BEPS goals. The Joint Committee on Taxation of The Canadian Bar Association and Chartered Professional Accountants of Canada has a comprehensive and exhaustive list of concerns over the EIFEL regime, the most noteworthy among which are summarized below. 

The definition of “excluded entity” should be replaced with a requirement that no non-resident person, alone or with other non-arm’s length non-resident persons, own more than 50% of the votes or more than 75% of the value, either directly or indirectly through intervening corporations, trusts or partnerships, of the taxpayer or an eligible group entity in respect of the taxpayer, at any time in the particular year. This would better align with how the Organization for Economic Cooperation and Development, or OECD, defines entities that pose significant BEPS risks. 

Under the proposed EIFEL regime, interest which is not deductible under proposed section 18.2 becomes restrictive interest and financing expense, or RIFE. This means it can be carried forward and be used to offset future income in some situations. The Joint Committee recommends that where not otherwise dealt with in the EIFEL regime, RIFE should be treated “in a manner consistent with non-capital loss carry forwards.” 

When it comes to a Canadian branch of a foreign entity and a Canadian subsidiary within the same corporate group, the Joint Committee recommends amending EIFEL rules “to allow capacity transfers between Canadian corporation and Canadian branches of foreign corporations that are part of the same overall group (i.e., common control).” 

Definition of exempt interest and financing expenses

The current definition requires that a borrower entered into an agreement with a public authority to design, build and finance, or to design, build, finance, maintain and operate, real or immovable property owned by a public sector authority. The Joint Committee says it’s unclear why the definition requires the property to be owned by a public sector authority, “as it would result in seeming inconsistencies between borrowers who are engaged by a public sector authority to design, build, finance, maintain and operate an infrastructure project in one province that owns the underlying property, whereas in other provinces the EIFEL rules would apply to the borrower as a private entity – particularly a not-for-profit entity – owns the underlying property.” This requirement should be removed.

Issues related to foreign affiliates

The Joint Committee also presented a list of concerns with how EIFEL rules interact with the foreign affiliate regime. This second list is not meant to be exhaustive, as it is likely that many issues will arise in the coming months or year as the tax community becomes more familiar with EIFEL rules and their application to real-life situations. 

One potential hurdle already identified is that as drafted, EIFEL rules may not apply to a “lower tier” partnership structure “in which a partnership is interposed between two controlled foreign affiliates.” The Joint Committee recommends clarifying the rules that cover this situation. 

Another recommendation would see greater consistency “between the treatment of foreign taxes incurred directly by a taxpayer and foreign taxes incurred by a controlled foreign affiliate of a taxpayer.” If, however, different outcomes are the intention, the Joint Committee suggests including an overview of the intended differences with the explanatory notes.