Introduction
Types of expenses limited by EIFEL
Foreign affiliates
Comment
Many corporations and trusts will be affected by proposed rules to limit the amount of interest and other financing expenses that businesses may deduct for Canadian income tax purposes. These proposals, known as the excessive interest and financing expenses limitation (EIFEL) rules, generally limit the amount of net interest and financing expenses that may be deducted by affected corporations and trusts. This article is the second of a five-part series explaining the changes, and how they will affect the Canadian tax sector, focusing specifically on the types of expenses limited by the EIFEL rules and how these rules apply to foreign affiliates.(1)
Types of expenses limited by EIFEL
The EIFEL rules may apply to limit the net amount of interest and financing expenses (IFE) otherwise deductible when computing a taxpayer's income. A taxpayer's net IFE is generally its IFE in excess of its interest and financing revenues (IFR). IFE generally includes interest and other deductible financing costs (including capitalised interest and financing expenses that are deducted as capital cost allowance [CCA] or resource expenditure pool claims), imputed interest and certain amounts economically equivalent to interest, among other amounts. A taxpayer that is a partner in a partnership must also include its share of the partnership's IFE. The rules also allow two taxable Canadian corporations to jointly elect for certain interest or lease financing amounts paid between them to be treated as "excluded interest", which is not included in the payor's IFE or payee's IFR, as applicable. This election is generally intended to allow for common loss consolidation transactions undertaken with Canadian corporate groups to remain unaffected by the EIFEL rules. Note that certain conditions must be met to qualify for the election.
The latest proposals now include specific provisions to clarify how the EIFEL rules apply for controlled foreign affiliates (CFA). Specifically, these proposals now require taxpayers to include, in their IFE and IFR, their share of a CFA's "relevant affiliate interest and financing expenses" and "relevant affiliate interest and financing revenue" that are taken into account in determining the CFA's foreign accrual property income (FAPI). The previous draft legislation did not specify how these amounts would be treated.
Finance's latest proposals make certain adjustments to the types of expenses that are considered IFE. In particular, the portion of CCA or certain resource expenditure pools that a taxpayer claims in the year that is attributable to previously capitalised interest and financing costs is now only considered IFE if it is incurred and capitalised after 4 February 2022. Similar rules also now apply for terminal losses realised in the year, any portion of which is attributable to previously capitalised interest and financing costs. Further, the proposals now reduce IFE by certain amounts received or receivable under or as a result of agreements or arrangements designed to hedge the cost of borrowing.
Finance also adds a new definition for "exempt IFE", which clarifies that IFE incurred as part of Canadian public-private partnership (P3) infrastructure projects that meet certain conditions, is not subject to the EIFEL rules. However, note that exempt IFE is still included for purposes of determining whether the $1 million de minimis exclusions is met (for further details, see "Finance revises interest expense limitation proposals: background and affected corporations and trusts").
The revised rules also allow more taxpayers to qualify for the excluded interest election and enhance the benefit of making the election. In particular, the election is now available for amounts paid or received by a partnership provided that, among other conditions, no partnership member is a natural person, a trust or a corporation that is not a taxable Canadian corporation. The election can now also be made for a lease financing amount. However, the election cannot be made where a payer is not a financial institution group entity, and the payee is a financial institution group entity.
These proposals provide that where a proportion of the taxpayer's interest and financing expenses are denied, the same proportion of a CFA's relevant affiliate interest and financing expenses are also denied in computing the CFA's FAPI. That is, there is no separate determination of denied interest when computing FAPI for a taxpayer's CFA.
Nadia Virani and Brian Ernewein assisted in the preparation of this article.
For further information on this topic please contact Sabrina Wong at KPMG Law by telephone (+1 416 777 8899) or email ([email protected]). The KPMG Law website can be accessed at www.kpmg.com.
This article was originally published by KPMG Canada
(1) For the first article in this series, see "Finance revises interest expense limitation proposals: background and affected corporations and trusts".