CANADA Law and Practice Contributed by: Scott Hyman, Anthony Spadaro and David Wilson, Davies Ward Phillips & Vineberg LLP
non-resident who owns 25% of a corporation measured in terms of voting power or fair market value, either alone or together with a group of non-arm’s length persons. For the purposes of the thin-capitalisation rules, the “debt” portion of the debt-to-equity ratio is calculated as the average of the greatest amount of the Canadian corporation’s outstanding debt owed to specified non-resident shareholders in each month of the year. The “equity” portion of the ratio is calculated as the sum of the following three amounts: • the unconsolidated retained earnings of the corporation at the beginning of the year; • the corporation’s average contributed surplus from specified non-resident shareholders at the beginning of each month of the year; and • the corporation’s average paid-up capital on shares owned by specified non-resident shareholders at the beginning of each month of the year. The thin-capitalisation rules also apply to trusts and in respect of the Canadian branch of a for- eign corporation or trust. There are also special rules for partnership borrowings and complex anti-avoidance rules to address back-to-back loans. Where the maximum debt-to-equity threshold is exceeded, the corporation’s deductible interest paid or payable to specified non-resident share- holders is reduced proportionately to the excess amount of debt owed to such shareholders. The amount of any non-deductible excess interest is also deemed to be a dividend paid by the corpo- ration to the specified non-resident sharehold- ers for withholding tax purposes. Accordingly, subject to the provisions of any applicable tax treaty, the excess interest will be subject to a
withholding tax of 25%, whereas it may other- wise be exempt from withholding tax. While not technically a thin-capitalisation rule, Canada’s “excessive interest and financ - ing expenses limitation” (EIFEL) rules limit the deduction of “interest and financing expenses” for Canadian income tax purposes of non- excluded entities. Entities excluded from the application of the rule generally include small Canadian controlled private corporations and groups with no or minimal activities or entities outside of Canada and no material foreign own- ership. The EIFEL regime implements the recom- mendations from the Organisation for Economic Co-operation and Development’s Action 4 report under the Base Erosion and Profit Shifting Action Plan. The EIFEL rules have two separate sets of pro- visions that determine the amount by which to restrict the deductibility of net interest and financing expenses. Under the default regime, the EIFEL legislation would generally limit the amount of net interest and financing expenses that may be deducted in computing a taxpayer’s income to no more than a fixed percentage of tax EBITDA. For taxation years beginning on or after 1 January 2024, the ratio is 30%, in line with OECD norms. The amendments also include an optional rule applicable to corporate groups. Essentially, where certain conditions are met and a group of corporations and/or trusts so elects, a higher “group ratio” may be applied in lieu of the fixed ratio rule. In certain cases, the group ratio rules can also apply to a single corporation or a purely Canadian group.
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