On February 4, the federal government put forward draft legislation setting out the new Excessive Interest and Financing Expenses Limitation (EIFEL) regime. EIFEL is intended to prevent erosion of the Canadian tax base by limiting net interest and financing deductions of certain Canadian taxpayers generally to 30% of earnings before interest, taxes, depreciation and amortization (EBITDA). Rules would come into effect for tax years beginning on or after January 1, 2024, with a transitionary year at a 40% EBITDA rate for tax years starting January 1, 2023.
On April 28, Lawson Lundell submitted its comments on the draft legislation prior to the government's May 5 deadline. We restricted our submission to one key policy matter – Canada’s response to the OECD’s BEPS Action 4, Limitation on Interest Deductions. Our concerns for which we have outlined below.
- The Draft Legislation is overbroad: it does more than is necessary to implement the recommendations of Action 4, to the detriment of Canadian corporate borrowers and Canadian resident tax-exempt lenders.
- Action 4 is a base erosion measure. The EIFEL rules will generally apply to standalone Canadian-resident corporations and trusts where interest and financing expenses are payable to a “tax-indifferent investor," which includes a non-resident, as one might expect in the context of a base erosion rule, but also includes a tax-exempt resident lender. The predominant tax-exempt lenders in Canada are registered pension plans.
- No erosion of the Canadian tax base occurs when a registered pension plan (or a trust or partnership in which such plan invests) lends to a Canadian resident.
- We are unaware of any other proposal in other OECD countries to include, in the implementation of Action 4, a domestic thin capitalization rule.
- Combined with the low de minimis rules, we are concerned that the EIFEL rules as drafted will unnecessarily burden Canadian corporate borrowers, putting them at a disadvantage compared with other OECD countries.
- Canadian resident tax-exempt lenders would also be adversely impacted by EIFEL. Compared with Canadian taxable investors, a loan by a Canadian resident tax-exempt lender may be sufficient to cause the borrower to cease to be an “excluded entity” under EIFEL.
- Canada could meet its commitment to Action 4 by restricting the application of the EIFEL rules to debt owing to non-resident lenders. In our view, this would be a principled approach.
To read our submitted comments in full, click here.
Please contact a member of our Tax Group if you have any questions about the draft legislation or any other tax matters.
Gareth is a partner with our Tax Group. He brings more than 15 years of tax experience to the group having worked at Deloitte & Touche LLP, PricewaterhouseCoopers LLP and as the Director of Tax for a private real estate company.
Max has a taxation practice and assists in advising clients on:
- Income and sales taxation matters arising in connection with private equity funds and a variety of other transactions;
- Tax compliance issues affecting various types of ...
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