Understanding the Excessive Interest and Financing Expense Limitation (EIFEL) Regime – A game-changer for Canadian tax landscape

The Excessive Interest and Financing Expense Limitation (EIFEL) legislations aligns with international efforts to combat base erosion and profit shifting (BEPS)[1]. The EIFEL rules can restrict a Canadian taxpayers’ ability to deduct a portion of their net interest and financing expenses (IFE) for income tax purposes based on percentage of their “tax EBITDA.” It’s crucial for certain corporations and trusts to understand the potential impacts of the EIFEL rules on their business.

These changes are effective for taxation years starting on or after October 1, 2023. The EIFEL rules are expected to impact public corporations, large CCPCs, related groups with greater than $1 million of IFE, and foreign-controlled Canadian corporations.

Canadian taxpayers are required to file schedule 130 with their tax return to support the deductibility of their IFE. The Canada Revenue Agency (CRA) is preparing forms that will allow taxpayers to apply for EIFEL elections. These forms will be available soon.

In the meantime, if you need to file an election before the forms are available, you may send a letter containing the required information under the relevant election provision in the Income Tax Act. This letter must include the signatures of all taxpayers or partnerships who are party to the election.

Furthermore, an election, to be made after the EIFEL rules take effect, will allow taxpayers to include their three pre-EIFEL regime taxation years towards their IFE deduction capacity.

Limitation on deductibility of IFE:

An impacted taxpayer’s net IFE would generally be limited by a calculation that incorporates a certain “fixed ratio” of their adjusted taxable income, under the EIFEL rules. 

The fixed ratio is as follows (Adjusted Taxable Income Safe Harbour):

• 40% fixed ratio applicable for taxation years commencing on or after Oct 1, 2023 but before Jan 1, 2024.
• 30% fixed ratio for taxation year’s beginning on or after Jan 1, 2024.

In certain circumstances, an election may be available to use a “group ratio” (discussed below) instead of the fixed ratio. 

Safe Harbour Rules and Applicability:

The EIFEL rules will generally apply to corporations and trusts[2] unless they are an “excluded entities” exempt from the EIFEL rules. An excluded entity is a taxpayer that meets at least one of the following four conditions:

1. Canadian-controlled private corporation (“CCPC”) with less than $50 million of taxable capital employed in Canada, along with any associated corporations, if applicable.
2. The taxpayer’s along with eligible group entities have an aggregate net IFE of $1,000,000 or less. 
3. Canadian corporations and trusts (alone or as an eligible group entity) that carry on all or substantially all[3]of their businesses, undertakings, and activities in Canada. The following conditions must be met for this exclusion to be valid:

• • the greater of the book cost of shares or fair market value (FMV) of property of all foreign affiliate holdings is $5 million or less throughout the year;
  • no non-resident is a specified beneficiary or specified shareholder of any group member;
  • all or substantially all of any group member’s IFE is payable to persons or partnerships other than those that are non-arm’s length and “tax- indifferent” (i.e., generally includes entities exempt from tax and non-residents of Canada); and
  • no partnership with over 50% of the FMV of its interests held by non-residents own 25% or more of the FMV of the interests or the voting rights in any group member.

4. “Exempt IFE” related to certain Canadian public-private partnership infrastructure projects are exempt from most EIFEL rules.
5. A proposed amendment to “Exempt IFE” to include IFE incurred to build or acquire eligible purpose-build rental housing in Canada. This exemption from the EIFEL rules would generally apply to the same types of purpose-built rental housing projects that benefit from the accelerated CCA deduction described above under “Accelerated Capital Cost Allowance (CCA) – Housing.” This measure is proposed to be effective for taxation years beginning on or after October 1, 2023, and to be available only for expenses incurred before January 1, 2036, for arm’s length financing.

Other relieving measures:

Given that these rules will impact many corporations and trusts starting from their taxation years commencing on or after October 1, 2023 (unless the safe harbor rules are applicable), it is crucial to consider various significant elections as outlined below:

1. EIFEL Rules – Carry forward: Denied IFE may be carried forward indefinitely and becomes restricted interest and financing expenses.
2. Joint Election for Excluded Interest: Certain related or affiliated Canadian corporations can collectively elect under the new rules to exempt certain “excluded interest,” including specific lease financing payments made between them. The purpose of this election is to safeguard against adverse impacts of EIFEL on transactions commonly conducted within Canadian groups, allowing one group member’s losses to offset another’s income.[5]
3. Excess Capacity Transfer Election: Taxpayers have the option to transfer “cumulative unused excess capacity” between group members, enabling them to optimize their available deduction room in a given year.[6]
4. Election for Specified Pre-Regime Losses: Taxpayers may elect to designate certain pre-regime non-capital losses as “specified pre-regime losses.” This designation entails adding back a fixed 25% amount in respect of such losses when determining adjusted taxable income (ATI) in the year the loss is utilized. Essentially, the 25% serves as a proxy for adjustments made to arrive at ATI in computing those losses.[7]
5. Transitional Rules Election: Taxpayers may elect to apply a three-year carry forward of excess capacity determined for years preceding the introduction of the EIFEL regime. This pre-regime excess capacity would augment the cumulative unused excess capacity of applicable group members for the years when the new rules are in effect.[8]
6. Group Ratio Election: Taxpayers may elect to use a consolidated “group ratio” instead of the fixed 40% or 30% ratio in the formula restricting the deduction of financing expenses. This allows certain corporate groups to potentially benefit from greater deduction room, particularly if the group is highly leveraged. However, a corporate group that elects to use the group ratio method will be deemed not to have any excess capacity in that year.[9]
7. Foreign Accrual Property Loss (FAPL) Election: Taxpayers may elect to forgo claiming a foreign accrual property loss (FAPL) in a controlled foreign affiliate (CFA) to avoid including the CFA’s financing expenses in their own financing expenses.[10]

Calculation of Restricted Interest and Financing Expense (“RIFE”):

The core provision of EIFEL is a mechanical, multi-layered calculation that a taxpayer must work through to arrive at the “excessive” IFE for a taxation year. To determine the non-deductible amount of IFE, a taxpayer multiplies its IFE for the taxation year (except amounts incurred through a partnership[1]) by a complex formula to arrive at the non-deductible amount of IFE, if any.

A high-level summary of the formula can be found here.
(A – (B + C + D + E)) / F
where for the taxation year,
A = taxpayer’s IFE
B = taxpayer’s “adjusted taxable income” multiplied by the fixed ratio, or taxpayer’s allocated group ratio amount
C = taxpayer’s interest and financing revenues
D = taxpayer’s “received capacity”
E = taxpayer’s “absorbed capacity”
F = taxpayer’s IFE with possible adjustments

Overall, as mentioned above, this formula determines the percentage of a taxpayer’s total IFEs which are subject to denial. For example, if the above formula yields 0.2 or 20%, and the taxpayer has $100 of IFEs, they would be subject to a $20 interest restriction when calculating taxable income for the applicable taxation year. This will give the same result as (A-(B+C+D+E)) if the formula was modified as such.

The EIFEL rules are best illustrated with an example based on a simplified fact pattern. A Canadian resident corporation (Canco) carries on an active business in Canada and no related group entities. During its December 31, 2024 taxation year-end the following occurred:

Based on the preceding 3 years of Canco it does not have any unused excess capacity carry forwards. For purposes of this example Canco does not meet the definition of “excluded entity”.

Accordingly, Canco’s $8,000 of otherwise tax-deductible IFE will be reduced by 23.75% (or $1,900) from $8,000 to $6,100 as a result of the EIFEL rules. The $1,900 of denied interest and financing expenses can generally be carried forward by Canco and applied in any future taxation year.

Key Takeaways:

In summary, the EIFEL regime represents a significant shift in interest and financing expense deductibility. Key takeaways include:

• The EIFEL rules are mechanical in nature and apply broadly to all Canadian corporations and trusts, with exceptions for those meeting the safe harbor exemptions discussed above or already subject to 100% interest expense denial under thin capitalization rules.
• As a BEPS measure, EIFEL aims to prevent multinational entities from evading Canadian tax through disproportionately high financing leverage.
• Taxpayers who do not meet the definition of an excluded entity and are unable to restructure their corporate structure should consider modelling their non-deductible IFE.
• A corporation in an eligible group entity can transfer unused deduction room or “excess capacity” to another corporation of the eligible group entity. 
• Unused excess capacity can be carried forward for up to three taxation years to deduct interest and financing expenses in those years. 
• Net interest and financing expenses that are restricted as deductions can be carried forward indefinitely to be used against excess capacity in future years. 
• Taxpayers subject to EIFEL should meticulously assess their financing structures to mitigate potential impacts on tax outcomes. Failure to adapt may result in perpetual interest denial, particularly in cases where leverage or earnings remain unchanged.

Overall, the EIFEL regime necessitates careful evaluation and potential adjustments to financial strategies to navigate the evolving landscape of interest and financing expense deductibility.

Please note that this blog is intended to provide a general discussion on the applicability of EIFEL rules and does not constitute tax, legal, or accounting advice.

[1] BEPS refers to the Inclusive Framework on Base Erosion and Profit Shifting led by the OECD and the G20 group of nations. EIFEL is based on the objectives recommended under Action 4 of the BEPS project.

[2] Partnerships are also impacted on a look-through basis to the members of the partnerships. Excessive IFE incurred by a partnership is subject to a deemed income inclusion in the hands of the corporation and trust members, rather than being treated as a denied deduction at the partnership level.

[3] In this article, the phrase “all or substantially all” means 90% or more, the interpretation usually given by the CRA. 

[4]  For this purpose, the book cost of the shares of an affiliate is determined based on only the taxpayer’s (or the taxpayer’s group’s) ownership interest in the affiliate.)

[5] T2227 – Excluded Interest Election Under Subsection 18.2(1)

[6] T2226 – Election to Transfer Cumulative Unused Excess Capacity under Subsection 18.2(4)

[7] T2228 – Specified Pre-regime loss election under subsection 18.2(1)

[8] T2224 – Transitional Rules Election

[9] T2225 – Group Ratio Rules Election under subsection 18.21(2), and Fair Value Adjustments Election under subsection 18.21(4)

[10] T2229 – Election to forgo a foreign accrual property loss under clause 95(2)(f.11)(ii)(E)