New CRA Limits on Interest and Financing Expenses
Here is information on the new CRA limits. On November 3rd, 2022, the Department of Finance released revised legislative proposals for the excessive interest and financing expense limitation rules (“EIFEL” rules). The revisions address public commentary on the previously proposed rules, which were released on February 4, 2022.
The rules are intended to align with Canadian foreign policy by joining the growing number of jurisdictions pledging to address Base Erosion and Profit Shifting (BEPS). The global effort has been prompted in large part by the Organization for Economic Co-operation and Development (“OECD”)’s Action 4 report, released in October 2015, as part of their BEPS Action Plan. The EIFEL rules are comprised of the new sections 18.2 and 18.21, as well as paragraph 12(1)(1.2), of the Income Tax Act (“ITA”).
The February 4th, “original” proposal sought to limit taxpayers’ interest and financing expenses to a fixed percentage of earnings before interest, taxes, depreciation, and amortization (“EBITDA”). A taxpayer’s EBITA refers to their “adjusted taxable income”, which is determined by their tax liability under Part I of the Act, rather than the amounts reported in their financial statements. The rules apply predominantly in the context of multinational enterprises and cross-border investments. However, they also apply to non-residents for tax purposes, and indirectly to partnerships.
What do the New Rules Do?
The EIFEL rules intend to limit the ability of taxpayers to deduct excessive interest and financing costs on their income tax returns. To achieve this, the rules limit net interest and financing deductions to a fixed ratio of 40% for taxation years beginning in 2023, and then 30% for the proceeding years. In certain circumstances, a higher percentage may be permitted, where requisite conditions are met, and where a group of corporations or trusts jointly elect into the “group ratio” rules for a given tax year. The group ratio is determined based on the amounts reported in the group’s audited consolidated financial statements, inclusive of adjustments where appropriate. It is important to note that the proposed EIFEL rules can apply in addition to other sections of the Income Tax Act, so it is important to consult the Act in full when considering related deductions and exceptions to them.
The revised proposed rules, released on November 3rd, 2022, have included some important changes. First, instead of commencing on January 1, 2023, the EIFEL rules will come into effect on October 1, 2023. This means that for tax years beginning on or after October 1, 2023, and before January 1, 2024, the fixed ratio of 40% will apply, reducing to 30% for tax years starting from January 2, 2024, onwards.
Who do the New CRA Limits Rules Apply To?
Another important revision relates to whom the rules apply. Under the original proposal, the EIFEL rules applied to any taxpayer that is not an “excluded entity” per s. 18.2(1) of the ITA. Under the revised proposal, “excluded entity” now refers to:
- A Canadian-controlled private corporation that, together with any associated corporations, has taxable capital employed in Canada of less than CA$50 million (increased from $15 million in the Initial EIFEL Proposals to align with the amended upper value of the phase-out range with respect to the small business deduction, as announced in the 2022 federal budget);
- A corporation or trust if, together with all other Canadian resident affiliated corporations or trusts (each an “eligible group entity,” as defined in proposed subsection 18.2(1)), the total net IFE of the group (including both interest and financing expenses plus exempt interest and financing expenses for this purpose) is not more than $1 million (increased from $250,000 in the Initial EIFEL Proposals);
- A taxpayer resident in Canada that meets the following conditions:
- The taxpayer and all eligible group entities carry on all or substantially all of their businesses, undertakings and activities in Canada;
- The group’s foreign holdings, if any, are de minimis — meaning the greater of the book cost of the foreign affiliate shares held by the group or the fair market value of the assets of all foreign affiliates held by the group does not exceed $5 million (this condition was added in the Revised EIFEL Proposals);
- No person or partnership is a specified shareholder or specified beneficiary (both as defined in subsection 18(5)) of the taxpayer, or any eligible group entity in respect of the taxpayer, that is not resident in Canada; or a partnership where more than 50% of the fair market value of the interests in the partnership is held by non-residents, and the property of the partnership includes more than 25% of the vote or value in the particular taxpayer or any eligible group entity (this condition was added in the Revised EIFEL Proposals);
- All or substantially all of the IFE of the taxpayer and each eligible group entity in respect of the taxpayer are paid or payable to persons or partnerships other than tax-indifferent investors (generally defined to mean non-residents of Canada and tax-exempt entities) that do not deal at arm’s length with the particular taxpayer or any eligible group entity.
There are also other proposed changes to the new CRA limits that relate to foreign affiliates, the definition of some interest and financing expenses and revenues, exemptions, and excluded interest, among others. Importantly, these new revisions may not be the final rules that will come into law. The Department of Finance invites all interested parties to provide comments on the revised EIFEL proposals by January 6, 2023. At current, it seems that the proposed EIFEL rules are still evolving, and taxpayers should pay attention to updates and revisions as they become available. For further review, the originally proposed EIFEL rules can be found here, and the proposed revisions to those rules can be found here.
If you have any questions about the new rules, give us a call today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions, you should consult a lawyer.