EIFEL tips and traps every business should know for 2025 and beyond

The new excessive interest and financing expense limitation (EIFEL) rules have been in effect for corporations and trusts with taxation years beginning on or after Oct. 1, 2023. For many corporations and trusts, these rules have been in effect starting in their 2024 taxation years. Any corporate and trust tax filings will need to address some possibly unintuitive EIFEL considerations, such as inadvertent business relationships resulting in additional compliance, iterative loss utilization calculations, as well as needing to consider the interest component of leases.

The new excessive interest and financing expense limitation (EIFEL) rules comprise a new set of Canadian tax legislation which restricts the ability to deduct interest expense for tax purposes. The stated purpose of these rules is to comply with recommendations put forth by the Organisation for Economic Co-operation and Development via Action 4 of their base erosion and profit shifting (BEPS) initiative.  Canada decided to implement many facets of Action 4, including the interest denial based on a taxable computation of earnings before deducting net interest expense, depreciation and amortization (EBITDA) and a group ratio rule to allow for interest denial considering a group of companies as a whole. The BEPS initiative, and Canada’s implementation of the EIFEL rules, is principally intended to target multinational enterprises and cross-border investments.

These new rules apply for taxation years of corporations and trusts starting on or after Oct. 1, 2023. Generally, for taxation years starting on or after Jan. 1, 2024, net interest expense is denied for a particular taxpayer to the extent it exceeds 30 per cent of tax EBITDA. Additionally, the rules offer specific considerations for certain industries as well, including the real estate industry.

Unfortunately, the implementation of these rules has raised many interpretational uncertainties as well as possibly inadvertent tax implications. For example, the Joint Committee on Taxation of The Canadian Bar Association and Chartered Professional Accountants of Canada has recently published two submissions, one addressing EIFEL administration and the other addressing EIFEL technical issues, sent to the Canada Revenue Agency and Department of Finance, respectively. These submissions cover even more topics within the EIFEL regime that are littered with administrative and technical concerns.

While the EIFEL rules offer some exceptions to certain corporations and trusts from its application, the rules can be complex. This results in many taxpayers needing to consider EIFEL despite not falling within the intended scope of these rules, resulting in unexpected possible tax implications and compliance burdens.

Wide scope of included entities

Generally speaking, a group of entities for EIFEL purposes includes “related” or “affiliated” trusts and corporations, as defined in the Income Tax Act. These definitions can be broad and have technical nuance depending on particular situations. However, this can result in some unintuitive groupings of corporations or trusts for EIFEL purposes that may not have mattered too much for tax purposes historically.

For example, take two spouses who both operate independent businesses of one another. Spouse 1 owns a large group of corporations that are subject to EIFEL. Spouse 2 conducts a small business out of a single corporation that, on its own, would fall within an exception from being subject to EIFEL. Despite the small business of Spouse 2 of being otherwise distinct from the business of Spouse 1, the small business can be considered related to the group of corporations owned by Spouse 2. This would mean that the small business of Spouse 2 would have to consider whether they fall within the relevant EIFEL exceptions considering the corporations owned by Spouse 1, as well as possibly prepare related filings to submit to the CRA.

There are more complicated examples as well where relationships for EIFEL purposes pop up in even more unexpected places. This can include situations involving donations by estates, investments in registered plans, and income-splitting tax structures.

Iterative loss utilization

The EIFEL rules, as mentioned previously, utilize a tax calculation of EBITDA to determine how much interest expense can be deducted. This EBITDA calculation for EIFEL purposes is quite technical, but it includes an adjustment in taxation years when loss carryforwards are utilized. In essence, the EBITDA calculation will have an addition to the extent a loss carryforward was utilized and was generated by net interest expense. Additionally, an election is available to deem losses incurred for taxation years that end before Feb. 4, 2022 to be 25 per cent related to net interest expense.

The issue lies with how the legislation is drafted, since it results in an iterative calculation for a taxpayer that is intending to utilize losses to make their taxable income nil. For example, if a taxpayer determines that EIFEL applies and calculates a certain amount of denied interest, and then applies non-capital losses to make taxable income nil, this results in more EBITDA and therefore less denied interest, resulting in the need to claim less non-capital losses. While there is a way to mathematically optimize this calculation, this can result in unaware taxpayers claiming too much (or too little) non-capital losses due to the application of EIFEL.

EIFEL and leases

EIFEL is intended to deny interest expenses as well as amounts that can economically be considered interest. This includes leases, as oftentimes long-term lease contracts are structured in a way to allow for an interest component. Many GAAP-compliant financial statements are drafted to calculate this inherent interest expense or revenue, while other simple financial statements may not. Further, the calculation of interest relevant for EIFEL purposes will oftentimes not correspond with the accounting calculation of interest, as the calculation assumes the usage of certain prescribed interest rates that change quarterly. This can result in the need to maintain a separate lease interest amortization table for tax purposes that differs from accounting, which increases compliance burden.

Further, there are numerous exclusions that can allow a taxpayer to ignore certain lease financing amounts in EIFEL. These exclusions can provide relief from considering the inherent interest in many leases, such as leases of real property. However, the current exclusions have interpretational uncertainty. In particular, it is currently unclear how to navigate land portions of real property leases. The exclusion appears to apply to the building portion of a real estate lease only. As a result, taxpayers would need to consider their lease contracts and determine how much of the inherent lease interest expense needs to be included for EIFEL purposes.

EIFEL is not as easy to avoid as you think!

Middle-market taxpayers should be concerned about EIFEL and how it impacts their business. It is not always intuitive whether a group of companies can fall within an exclusion, or what the group of companies even is for EIFEL purposes. Lingering uncertainties can make compliance with these new rules burdensome and confusing.