New EIFEL rules are in effect
What you need to know
To comply with international guidelines preventing the shifting of profits between low tax and high tax regimes, the Department of Finance introduced the Excessive Interest and Financing Expense Limitation (“EIFEL”) rules. The EIFEL will limit the deduction of interest and financing expenses to 30% of adjusted taxable income (“ATI”) which can generically be characterized as EBITDA as determined for Canadian tax purposes.
Interest and financing expenses will not include inter-group financing costs such as, for example, loans between a Canadian parent corporation and its Canadian subsidiary provided an election is made on a timely basis. Other items such as leasing costs, capitalized interest and loss carryforwards could be affected.
On the good news front, the EIFEL rules allow for the sharing of excess capacity within related and affiliated group members. This would be the case where one entity in the group has interest and financing costs in excess of the 30% limitation whereas another entity in the group has more than enough ATI to absorb that excess. This sharing of excess capacity will serve to mitigate the impact of these rules provided various prescribed forms and elections are filed on a timely basis.
The EIFEL rules will apply to taxation years of corporations and trusts commencing on or after October 1, 2023.
The rules will not apply to so called “Excluded Entities” that are defined as follows:
- Canadian Controlled Private Corporations[1], together with all associated corporations having a combined taxable capital of less than $50 million.
- Related or affiliated groups of entities having interest and financing expenses net of interest and financing revenues of less than $1 million.
- Canadian resident corporations and trusts together with all of their related and affiliated Canadian resident entities provided that they each meet all of the following conditions:
- At least 90% of their business, undertakings and activities are carried on in Canada.
- The carrying value, as determined under generally accepted accounting principles, of any foreign affiliate or its proportion of the fair market value of the assets of such foreign affiliate is not greater than $5 million.
- No corporation within the related or affiliated group has a related group of non-resident shareholders owning 25% or more of the votes or value of that entity.
- No trust within the related or affiliated group has a non-resident beneficiary or a related group of non-resident beneficiaries owning 25% or more of the interests of the trust.
- No partnership having more than 50% of its partnership units held by non-residents owns shares of corporations or interests in trusts that meet the 25% of votes and value test.
- At least 90% of all interest and financing expenses is not paid to non-arm’s length non-residents and tax-exempt entities.
As can be seen from the narrowness of these exceptions, Excluded Entity status may be difficult to achieve.
The rules are extremely complex and can have a significant impact on cash flows, especially for capital intensive industries. The high interest rates which are anticipated throughout 2024 will magnify the impact of these rules. Impacted taxpayers may wish to look for equity investment in lieu of financing. Of course, each taxpayer must gauge the impact of the EIFEL on their specific facts and circumstances. As with all tax changes, we recommend that you contact your advisors at Richter to determine how you might be affected and what steps might be taken to mitigate their effect.
[1] Italicized references are defined terms under the Income Tax Act, the explanations of which are beyond the scope of this article.