Tax Insights: Bill C-59 ─ Excessive interest and financing expenses limitation (EIFEL) regime

Issue 2023-38

In brief

On November 30, 2023, the federal government tabled Bill C‑59,¹ which includes legislation to implement the excessive interest and financing expenses limitation (EIFEL) rules. The EIFEL rules are intended to restrict Canadian taxpayers’ net interest and financing expense deductions based upon a percentage of their “tax‑EBITDA.”

The legislation in Bill C‑59 includes some changes to the draft legislation that was released on August 4, 2023 (August 2023 release).

This Tax Insights summarizes the key changes to the rules since the August 2023 release. For information on previously released draft legislation, see our Tax Insights,² which discuss in more detail, the EIFEL mechanics and some of the concepts discussed within this Tax Insights.

In detail

“Excluded entity” definition

All corporations and trusts are subject to the EIFEL rules, unless they meet the conditions to be considered an excluded entity. Excluded entities are:

• Canadian‑controlled private corporations (CCPCs) whose taxable capital employed in Canada (together with any associated CCPCs) is less than $50 million
• groups of corporations or trusts with net group interest expenses in Canada (including net relevant foreign affiliate interest expenses) of $1 million or less, or
• certain groups that carry on “all or substantially all” of their business, if any, and their undertakings and activities, in Canada, if certain conditions are met

For the third excluded entity exception, Bill C‑59 has clarified the condition that the Canadian group cannot have foreign affiliates valued at more than $5 million. Clarifications to this condition were made to ensure that, if a group owns only a portion of a foreign affiliate, only its proportionate share of the foreign affiliate’s value is tested against the $5 million de minimis threshold. This $5 million threshold applies to the greater of:

• the balance sheet value of the stock of all of the foreign affiliates (determined under Canadian Generally Accepted Accounting Principles)
• the fair market value of all property of the foreign affiliates

PwC observes

This clarification helps ensure that, if a group owns less than 100% of the shares of a foreign affiliate whose value breaches the threshold, the group should still be able to satisfy the condition, as long as its proportionate share of the foreign affiliate does not breach the $5 million de minimis threshold. For example, if a group owns 10% of a foreign affiliate valued up to and including $50 million, it could still be able to meet this condition.

Interest and financing expenses and interest and financing revenues

The EIFEL rules generally limit the deductibility of net interest and financing expenses, because they provide for a percentage limitation on interest and financing expenses (IFE); however, there is a dollar-for-dollar increase in the deduction of IFE to the extent of the entity’s interest and financing revenues (IFR).

The amounts for IFE and IFR are determined through complex formulae, which include variables addressing gains and losses realized on debts (typically due to foreign currency fluctuations), and on hedges of debts. Specifically (as proposed in the previous draft of the rules):

• an allowable capital loss on a debt payable, or on a hedge of a debt payable, is generally added in computing IFE for the year in which the loss reduces taxable income (i.e. where a current year loss is offset against taxable capital gains, or where a net capital loss is brought forward or backward from another year)
• a taxable capital gain on a hedge of a debt payable is generally deducted in computing IFE
• a taxable capital gain on a debt receivable, or on a hedge of a debt receivable, is generally added in computing IFR, and
• an allowable capital loss on a hedge of a debt receivable is generally deducted in computing IFR for the year in which the loss reduces taxable income

Bill C-59 amends the IFE and IFR definitions, so that in addition to the items noted above:

• a taxable capital gain on a debt payable is also generally deducted in computing IFE, and
• an allowable capital loss on a debt receivable is also generally deducted in computing IFR for the year in which the loss reduces taxable income

These changes, when integrated into the existing proposed definitions, facilitate a symmetrical treatment for gains and losses on debt obligations and receivables.

PwC observes

The amendments to the IFE and IFR definitions appear to address a deficiency in the previous draft legislation relating to a one-sided treatment where, for:

• debts payable, losses were added to IFE, but gains were not added to IFR (or deducted from IFE), and
• debts receivable, gains were added to IFR, but losses were not added to IFE (or deducted from IFR)

These changes confirm that a foreign exchange gain or loss on repayment of a debt obligation (or receivable) will generally be relevant in computing IFE. Taxpayers with foreign currency loans should pay particularly close attention to this concept. When such loans reach their maturity, or are refinanced, there could be significant foreign currency movements that could ultimately lead to a large amount being included in the EIFEL calculation. Capital losses may contribute to restricted IFE (RIFE), which may be deducted in future years of excess capacity, but they could also prevent the deductibility of ordinary interest and financing expenses.

Financial institution group entities

The EIFEL rules impose certain restrictions on groups that include financial institutions, including limits on the transfer of cumulative unused excess capacity (CUEC) from financial institution group entities (FIGEs) to non‑FIGEs. This is because FIGEs are expected to generate significant IFR in their ordinary business operations.

The definition of a FIGE is amended in Bill C‑59 by adding an additional type of entity. A particular entity is now an FIGE if it is an eligible group entity of an entity that meets one of the other FIGE criteria (e.g. banks, credit unions, insurance corporations, etc.) and the particular entity “primarily engages in the business of providing portfolio management, investment advice, fund administration or fund management, including any services connected to those activities, in respect of real estate.”

PwC observes

This broadened definition brings certain real estate investment management entities that are related to FIGEs into the FIGE definition, and could:

• prevent these entities from sharing their CUEC with non‑FIGEs, and
• broaden the pool of other FIGEs to which FIGEs are able to transfer CUEC

For groups with financial institution entities, we recommend revisiting the classification of entities to ensure that any meeting this revised FIGE definition are appropriately factored into any group‑wide modelling.

Application of the EIFEL rules to controlled foreign affiliates

The EIFEL rules take into account certain IFE and IFR of a taxpayer’s controlled foreign affiliates, relating to amounts of IFE or IFR that are included in the controlled foreign affiliate’s computation of foreign accrual property income (FAPI) or its foreign accrual property loss (FAPL). These amounts are called relevant affiliate interest and financing expenses (RAIFE) and relevant affiliate interest and financing revenues (RAIFR). A single limitation proportion (proposed subsection 18.2(2) of the Income Tax Act [ITA]) is determined for the taxpayer, which includes the taxpayer’s proportionate share of the RAIFE and RAIFR of its controlled foreign affiliates. This same proportion is then applied to the controlled foreign affiliate’s RAIFE, giving rise to an interest denial which could increase the affiliate’s FAPI or decrease its FAPL.

RAIFE that creates a FAPL could make a taxpayer’s subsection 18.2(2) limitation proportion higher, even though there may be no immediate way to utilize the FAPL to reduce Canadian tax. The August 2023 release introduced a “FAPL election,” which allows taxpayers to elect to exclude these expenses from the subsection 18.2(2) computation, with the trade‑off being an exclusion of this amount from the FAPL.

Bill C‑59 contains some important ordering clarifications relating to the FAPL election, to ensure that this election can apply in advance of any EIFEL denial calculation relating to RAIFE, and allow a taxpayer to apply the FAPL election in advance of the relevant inter-affiliate interest (RIAI) rule (which removes certain interest amounts between two controlled foreign affiliates from the taxpayer’s EIFEL calculations).

PwC observes

The clarification that the “elected amount” can be determined before EIFEL is applied to a controlled foreign affiliate’s RAIFE is welcomed. Similarly, in cases where interest is paid between foreign affiliates and the creditor’s interest income is included in FAPI, the election to eliminate the FAPL on the debtor’s side of the loan could also be beneficial (as opposed to relying upon the RIAI rule, which may also remove the RAIFR side of the loan from the taxpayer’s EIFEL calculation).

Note that there are no adjustments to adjusted taxable income (ATI), specifically for Part I adjustments made in computing FAPI that is already included in taxable income, other than for interest and financing expenses and/or revenues which are included in RAIFE or RAIFR, respectively. For example, capital cost allowance (CCA) that is deducted in computing FAPI is not adjusted for when determining the resulting ATI arising from that FAPI.

Liquidations

The taxpayer’s ATI determination for a particular taxation year includes an add-back for a proportion of a non‑capital loss utilized in that year (i.e. a loss that is carried forward or backward from another year). The calculation of this proportion is complex and requires looking back to the year in which the loss arose to determine certain ATI‑adjusting items in that loss year.

Under the previous draft legislation, it was not clear whether these ATI adjustments could be applied in cases where a subsidiary has been wound‑up into a parent entity, and the parent deducts a carried‑forward loss of the subsidiary in computing its own taxable income.

Bill C‑59 introduces a new deeming rule, which essentially allows the above‑noted ATI adjustments to be made if a parent entity deducts a liquidated subsidiary's loss.

Concerns with the EIFEL rules that remain in Bill C-59

While Bill C‑59 makes certain clarifications and amendments, there are still issues within the legislation that will be complex for taxpayers to navigate in calculating their EIFEL position for each legal entity. In particular:

• The EIFEL rules as drafted can create an interest limitation for interest that is capitalized to depreciable property and then subsequently deducted as CCA. Proposed ITA subsection 18.2(3) deems such an amount to have been deducted in determining the undepreciated capital cost (UCC) balance (and similar pools for resource property), even though this deduction may be restricted due to the EIFEL rules. If there is a recapture of depreciation on the disposal of an asset in a later year, and related restricted interest amounts have not been fully recovered through the RIFE mechanism, the UCC would be understated, such that there would be an overstatement of the recapture. To remedy this, the Department of Finance should consider amendments to reduce the recapture (with a corresponding reduction in the RIFE balance) or allow a deduction of the RIFE balance related to the capitalized interest restricted under the EIFEL rules in respect of the disposed asset.
• The clarifications in respect of “capital losses,'' which are included in IFE, apply to include a capital loss in IFE in the year in which it is used to offset a capital gain. Where taxpayers have capital losses arising from various sources, it will be necessary to distinguish the portion relating to debts from those relating to other items. This could prove challenging, especially for capital losses carried forward from many years past. Unfortunately, the EIFEL rules do not contemplate a cutoff for pre‑EIFEL capital losses, nor do they contemplate granting a taxpayer the choice to deduct capital losses that are not related to debts (this could be helpful where a taxpayer has large amounts of capital loss carryforwards from different sources, which they do not expect to use).
  
  A legislated grandfathering date would also be useful. A similar approach was adopted in grandfathering capitalized interest paid or payable before February 4, 2022, which is included in a later CCA claim; or in the case of the “specified pre‑regime loss” election, which can apply to non‑capital losses arising in a taxation year ending before February 4, 2022.

• The utilization of non‑capital losses in calculating ATI for a taxation year to which the EIFEL rules apply remains particularly complex. This situation involves an add‑back adjustment to ATI, which requires a determination of various components in the loss year to calculate how much of the utilized non‑capital loss can be added back. This calculation is naturally circular due to the fact that a non-capital loss can be used to offset additional taxable income arising from an EIFEL restriction. However, due to this circular impact on the ATI determination, it will be necessary for taxpayers to recalculate the EIFEL limitation depending upon the final amount of non‑capital losses that are ultimately utilized in the EIFEL year. This creates complexity through iterative calculations to determine the optimal non‑capital loss required to be utilized to bring the additional taxable income from EIFEL down to nil.
• There are limited sector‑specific exceptions to the EIFEL rules, meaning that these rules apply to most corporations and trusts that cannot meet one of the excluded entity tests. We understand that highly‑leveraged businesses are expected to rely upon the group ratio rules as the main mitigation strategy to deduct higher levels of interest expenses, where a group’s proportion of external interest expenses to EBITDA exceeds the 30% fixed ratio. However, the application of the group ratio has challenges, in particular for private groups that do not have audited consolidated financial statements at the level of the ultimate parent (for these purposes, the ultimate parent of the group is determined based on the consolidation rules that would apply if the group were subject to International Financial Reporting Standards). Groups seeking to rely upon the group ratio as a mitigation strategy should ensure that they have analyzed the application of these rules, and that the appropriate consolidated audited financial statements will be prepared for the first year in which they intend to rely upon the group ratio rules.
  
  Other challenges also exist in applying the group ratio if certain group entities generate excess capacity from net IFR, absent the group ratio. This net IFR capacity would be inaccessible once the allocated group ratio amount is allocated under the group ratio rules, because this concept relies only upon an allocation of “ATI capacity.”

The takeaway

The EIFEL rules will be enacted when Bill C‑59 receives royal assent, which is expected to occur in early 2024. For taxpayers that are required to report quarterly, this could mean that the impact of the EIFEL rules needs to be addressed in advance of the first quarterly reporting due in 2024.

All taxpayers should consider the potential impact of these rules on their business and whether their existing financing structure is optimal following the introduction of an additional interest deduction limitation in Canada. The EIFEL changes in this latest legislation are limited, although the changes noted above should be considered and addressed in any prior analysis and/or modelling already undertaken.

All taxpayers should gain an understanding of these rules, so they can effectively plan for their wide‑reaching impact on existing and future financing commitments. Even if groups are not anticipating adverse tax consequences from these rules, the additional administrative burden to comply with the EIFEL prescribed forms and elections (which have not yet been released) is likely to significantly complicate the annual tax compliance cycle.

^{1. Bill C-59, An Act to implement certain provisions of the fall economic statement tabled in Parliament on November 21, 2023 and certain provisions of the budget tabled in Parliament on March 28, 2023 (first reading: November 30, 2023); for more information, see our Tax Insights “Bill C-59 introduces EIFEL, environmental incentives, digital services tax, GAAR changes and more.”}

^{2. For details on draft legislation released on February 4, 2022, November 3, 2022 and August 4, 2023, see our Tax Insights:
 - “Excessive interest and financing expenses limitation (EIFEL) regime”
 - “Updated legislation: Excessive interest and financing expenses limitation (EIFEL) regime”
 - “Updated legislation: Excessive interest and financing expenses limitation (EIFEL) regime (August 2023 release)”}