The EIFEL Rules and Section 216 Filers

In its May 5, 2022 submission regarding the proposed excessive interest and financing expenses limitation (EIFEL) rules, the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada (“the joint committee”) had suggested that accommodations be introduced to address the impact of these rules on section 216 filers. Section 216 allows a non-resident taxpayer in receipt of rent on real or immovable property in Canada or a timber royalty that would otherwise be subject to part XIII tax on a “gross” basis to elect to pay tax instead on the net income from related properties for the year under part I as if the taxpayer were a person resident in Canada.

Unfortunately, neither the revised draft legislative proposals regarding the EIFEL rules nor the related explanatory notes (both released on November 3, 2022) make any specific reference to the intended treatment of non-resident taxpayers that are filing pursuant to section 216.

Under the proposals, the fundamental uncertainty for section 216 filers is whether a non-resident taxpayer should be considered to be a person resident in Canada for the purposes of applying the EIFEL rules. If so (on the basis of the deeming rule in paragraph 216(1)(a)), it appears that the taxpayer would be treated as a resident for the purposes of certain provisions that were likely intended to apply only to “actual” Canadian residents. For example, the taxpayer could qualify as an “excluded entity” under paragraph (b) of the definition of that term (the $1 million “de minimis” net interest test). Less clear is whether the taxpayer might be considered to be an eligible group entity in respect of other related Canadian-resident entities, such that if the taxpayer is a “fixed interest commercial trust” (as a result of being considered “resident in Canada”), it could potentially transfer and receive excess capacity from other eligible group entities. Being an eligible group entity in respect of other taxpayers could result in other Canadian eligible group entities failing to qualify as excluded entities under the de minimis net interest exception. Status as an eligible group entity could also be relevant for the purposes of the group ratio rules in proposed section 18.21. Although the taxpayer might be treated, for the purposes of its section 216 filing, as resident in Canada, such that it could have eligible group entities for the purposes of applying the EIFEL regime to its own return, it is arguable that this deemed residence status would likely not apply to the taxpayer in determining its status as an eligible group entity in respect of its other Canadian affiliates and related parties for the purposes of applying the EIFEL regime to their returns. The rules clearly do not contemplate such a “dual status” application.

If, on the other hand, the taxpayer is treated as a non-resident (despite paragraph 216(1)(a)), the definition of “adjusted taxable income” (ATI) would not work properly because the taxpayer would have no “taxable income earned in Canada” for the year, as required under paragraph D(a): that term applies only to taxpayers filing under section 115.

To deal with a similar potential uncertainty, Parliament, when amending the thin capitalization rules in 2013 so as to address non-residents and trusts, included a specific reference to the treatment of a section 216 filer in the definition of “equity amount” in subsection 18(5). Similar clarification should be added to the EIFEL rules.

The definitions of “excess capacity” and “cumulative unused excess capacity” appear to apply to a section 216 filer (although it ought to be clarified whether the references to prior-taxation-year amounts in the latter definition should take into account only amounts reported in prior-year section 216 returns, not other returns that may have been filed by the taxpayer pursuant to section 115, such as a return reporting a gain or loss on the sale of a taxable Canadian property). As a result, the taxpayer should be able to deduct interest expense that is in excess of the current-year 30 percent limit as “absorbed capacity” to the extent that the taxpayer has its own excess capacity from the preceding three taxation years. However, because a section 216 filer cannot claim any deductions in computing taxable income (under paragraph 216(1)(c)), restricted interest and financing expenses (RIFE) for a year cannot be claimed as a deduction in a subsequent year when the taxpayer has excess capacity.

The joint committee had recommended that RIFE for a year that did not create or increase a loss for the year should be able to be deducted by a section 216 filer in a subsequent year to the extent that the taxpayer had excess capacity for that year. The more symmetrical treatment of excess capacity that results would arguably not conflict with the non-availability of loss carryovers for section 216 filers (apparently intended to limit the “net income” nature of the section 216 election to current-year results, given that part XIII is otherwise a “point-in-time” withholding regime), because the proposed “limited RIFE” for a year (that did not create or increase a loss) was otherwise deductible for the year. Moreover, the ability of a section 216 filer to deduct CCA on a discretionary basis (with the resulting potential for future recapture in a subsequent disposition year) already deviates from a “current year only” position.

If the proposed rules are modified to give a section 216 filer access to RIFE deductions as suggested, a related uncertainty could arise as a result of the August 9, 2022 proposed technical amendments to subsection 212(13.2). The amended provision will require a section 216 filer to withhold part XIII tax on the portion of certain payments of interest that are “deductible” in computing the amount on which the taxpayer is liable to pay tax under part I because of section 216. It is not clear whether interest that is initially non-deductible under proposed section 18.2 might be considered “deductible” to the extent that it is included in an “allowable” RIFE balance (such that it could potentially become deductible in a future year) and whether, if so, its status as deductible would arise at the time of payment or only in a later year, when actually deducted. Although a similar uncertainty can arise in connection with interest that is rendered non-deductible under the thin capitalization rules (where the denied amount may not be known until the end of the year), that uncertainty is at least resolved for the year. The potential uncertainty regarding the deductibility of RIFE balances could remain for much longer, and it would create obvious compliance challenges. However, this issue would not be unique to a section 216 filer; the same uncertainty regarding interest denied under the EIFEL rules will exist for non-resident taxpayers carrying on business in Canada through a branch.

It is hoped that the next version of the EIFEL draft legislation will be modified to address the uncertainties facing taxpayers filing under section 216.

Ken Griffin
PricewaterhouseCoopers LLP, Toronto