The “EIFEL” (Excessive Interest and Financing Expenses Limitation) regime is a set of rules first announced in Budget 2021 that seeks to deny interest and financing expenses in certain situations to certain corporations (and certain trusts).  The EIFEL regime does not apply to individuals or partnerships.

Broadly speaking, the limitations apply to larger corporations (or larger corporate groups) that have some level of either foreign ownership or foreign activity.   The Fall Economic Statement Implementation Act, 2023 included revised EIFEL rules for implementation which are effective now – i.e. for taxation years commencing after September 30, 2023.

Summary of EIFEL regime

The EIFEL rules restrict the deduction of interest and financing expenses (“IFE”) to:

• 40% of Adjusted Taxable Income (“ATI” or, essentially, tax-basis EBITDA) for taxation years beginning between October 1, 2023 and December 31, 2023
• 30% of ATI for taxation years beginning January 1, 2024 or later

Excluded Entities

There are three important exclusions which may apply to a specific taxpayer that will exclude the taxpayer from the application of the EIFEL regime include:

1. The ‘Small CCPC’ Exemption;
2. The ‘De Minimis’ Exemption; and
3. The ‘Domestic Entity’ Exemption.

First, the Small CCPC Exemption generally applies where the taxpayer is a Canadian Controlled Private Corporation with Taxable Capital of $50m or less between itself and its associated group.    This serves to generally exempt non-foreign-controlled private corporate groups of small to medium size from the application of the rules.    Many Canadian based owner-managed business will be able to make use of this exemption to avoid the application of EIFEL.

Secondly, the De Minimis Exception will exempt taxpayers/groups that have Interest and Financing Expenses (“IFE”) of $1m or less in the taxation year.   This is a significant number in that borrowings to each $1m or more of interest expenses would typically need to be more than $10,000,000.    As a result, taxpayers/groups with small to medium size interest and financing expenses will be to make use of this provision to avoid the application of EIFEL.    Note that this exemption will apply to both CCPC and non-CCPC taxpayers such as ‘Other Private Corporations.’

Thirdly, The Domestic Entity Exception will exempt taxpayers/groups that have met several conditions relating to the ownership and activities of the taxpayer, including:

• The taxpayer/group has no significant foreign activities or undertakings;
• The taxpayer/group has no significant foreign owners; and
• The taxpayer/group has no significant foreign affiliates.

Foreign affiliates where the greater of the GAAP-based financial statement values and the fair market values remains under $5m are not considered significant for this purpose, and simply owning an interest in a foreign affiliate with no other activities outside of Canada is not considered a significant foreign activity for this purpose.

Interest and Financing Expenses and Revenue

There are some nuances in the calculation of IFE.    Any expenses reasonably considered to be costs of funding the borrowing of the taxpayer or a related entity are included, and could include certain allowable capital losses to extent they are used in the year to offset taxable capital gains.

In addition, the presence of Interest and Financing Revenue (“IFR”) will increase a taxpayer’s ability to deduct IFE on a dollar-for-dollar basis.

Restricted Interest and Financing Expense and Capacity Elections

As noted above, EIFEL generally limits the deduction of interest expense in a year to a percentage of ATI.    Taxpayers/groups may, however, find themselves in situations where interest and financing expenses, or the capacity to deduct them change significantly from year to year.     As a result, the Act now requires the tracking of IFE that was denied because of the application of EIFEL, and this attribute is called Restricted Interest and Financing Expense (or “RIFE”).    Generally speaking, taxpayers/groups will be able to deduct RIFE in years where they have excess capacity.    As such, this is effectively a carryforward mechanism that allows for denied IFE to be deducted in future years if requirements are met.

Additionally, it’s important to note that where a corporation is a member of a group it may be possible to assign capacity from a member with excess capacity to a member with IFE to maximize the amount that is deductible.

Layering of Rules within the Act

Note that the EIFEL rules apply only to interest otherwise deductible within the Income Tax Act.   Certain interest limitation provisions, such as the thin-capitalization rules, and the general interest deductibility provisions, already serve to limit interest deductions in certain circumstances, and accordingly the EIFEL rules add another layer to the analysis of when interest is deductible.    Multiple analysis may be required in certain circumstances, particularly if thin-capitalization rules apply.

Summary

Although many clients will be able to benefit from the application of one of the three exemptions from the application of EIFEL, certain clients will have to contend with these complicated and somewhat punitive provisions that will serve to limit the deduction of interest, particularly where taxpayer/group income in a year is low or negative (as 30% or 40% of zero is zero).

If the EIFEL regime may apply to you, please consult either myself or your Melo LLP advisor to help you navigate the application of these rules.