Excessive Interest and Financing Expense Limitation (EIFEL) Analysis: A Comprehensive Overview
The Excessive Interest and Financing Expenses Limitation (EIFEL) is part of the OECD’s Base Erosion and Profit Shifting (BEPS) Action 4 and was introduced to address concerns over multinational companies shifting profits through excessive interest deductions. The rules aim to curb tax avoidance strategies that involve inflating interest expenses to reduce taxable income.
Key Areas of EIFEL
- Background and Purpose
The EIFEL rules were introduced to limit base erosion resulting from multinational groups using excessive interest expense deductions to reduce taxable income, particularly by shifting debt across jurisdictions in ways that exploit tax arbitrage opportunities. - Main BEPS Scenarios Targeted
- Shifting debt to high-tax jurisdictions: Multinational groups placing debt in high-tax jurisdictions to maximize interest deductions.
- Generating excessive interest deductions through intragroup loans: Leveraging loans within a group to generate interest deductions that exceed third-party interest expenses.
- Generating tax-exempt income: Using financing to create income that is exempt from tax.
- Scope and Exclusions
- Excluded Entities: EIFEL does not apply to certain entities, such as:
- Canadian-controlled private corporations (CCPCs) with taxable capital less than $50 million.
- Groups with net interest and financing expenses less than $1 million among Canadian entities.
- Entities conducting business entirely in Canada, meeting specific conditions.
- Excluded Entities: EIFEL does not apply to certain entities, such as:
Deduction Limit on Interest Expenses
The key provision in the EIFEL rules is found in Section 18.2(2), which limits the deduction of interest and financing expenses to 30% of adjusted taxable income (EBITDA), with temporary adjustments for certain tax years (up to 40% for years between 2023 and 2024).
Interest and Financing Expenses:
These include not only traditional interest payments but also capitalized interest, finance lease interest, and any amounts economically equivalent to interest.
Adjusted Taxable Income:
This is a complex tax calculation that begins with taxable income, adjusts for non-capital losses, certain foreign losses, and adds back interest expenses, capital cost allowances, and financing revenues.
The deduction for interest and financing expenses is limited based on the following formula:
- (A – (B + C + D + E)) ÷ F
- A: Total interest and financing expenses for the year.
- B: Maximum permissible deduction based on the taxpayer’s EBITDA (30% or 40% depending on the period).
- C: Interest and financing revenues for the year.
- D & E: Additional factors related to excess capacity and carryforward deductions.
- F: Total otherwise deductible interest and financing expenses.
Excluded Interest
Certain interest amounts, known as Excluded Interest, are not subject to the EIFEL limitations. This typically applies to intragroup loans between Canadian corporations in a group, provided the entities involved elect in writing for such interest to be excluded.
Conditions for Excluded Interest include:
- Interest must be paid between two Canadian corporate members of the same group.
- Both corporations must elect jointly to treat the interest as excluded.
- The election must be filed annually and specify the amount of interest to be excluded.
Group Ratio Rules (AGRA)
Multinational groups can apply for a higher interest deduction if they can demonstrate that their group net interest expense to EBITDA ratio exceeds the 30% (or 40% for specific years) limit. This option is available through the Allocated Group Ratio Amount (AGRA) rules, which allow for a higher deduction based on the group’s actual third-party interest expense.
The key concepts for the AGRA include:
- Consolidated Group: Entities must be part of a consolidated group that prepares consolidated financial statements and can demonstrate a qualifying group interest-to-EBITDA ratio.
- Group Net Interest Expense: Total interest and financing costs across the group, adjusted for certain exclusions.
- Group Adjusted Net Book Income: Adjusted earnings from the consolidated financial statements that reflect EBITDA.
The Group Ratio is calculated as:
- Group Net Interest Expense ÷ Group Adjusted Net Book Income
Compliance and Reporting
Taxpayers must file a prescribed form to report interest expense deductions in compliance with the EIFEL rules. Failure to file or inaccuracies in the prescribed form may lead to reassessment by the CRA outside of the normal reassessment period.
Compliance Tip: Ensure that all necessary elections, such as for Excluded Interest, are filed correctly and on time to avoid penalties or lost deductions.
Summary of Key EIFEL Elements:
- Deduction Limit: Interest and financing expenses are capped at 30% (or 40% in some years) of adjusted taxable income.
- Excluded Entities: Certain entities and groups are excluded from the rules.
- Excluded Interest: Intracorporate interest can be excluded through a joint election.
- AGRA: The group ratio method allows a group to exceed the interest deduction limits under certain conditions.
- Compliance: Strict filing requirements ensure proper application of these rules.
Next Steps for Taxpayers
To fully comply with EIFEL:
- Understand your group’s interest and financing expenses.
- Determine if your group qualifies for the AGRA.
- Elect for Excluded Interest if applicable.
- File the necessary forms and documentation with the CRA.
By following these steps, taxpayers can ensure that they are within the bounds of the EIFEL rules, minimizing their risk of non-compliance and potential penalties.
This article is posted at wolterskluwer.com
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