The EIFEL Proposals and Controlled Foreign Affiliates, Updated

On February 4, 2022, Finance released the first draft of the excessive interest and financing expenses limitation (EIFEL) rules. In that first draft, Finance did not address how the new rules would interact with the foreign affiliate (FA) regime. On November 3, 2022, Finance released a revised draft of the rules that addressed their application to controlled foreign affiliates (CFAs). (For an overview, see “The EIFEL Proposals and Controlled Foreign Affiliates,” in the February 2023 issue of this newsletter.)

On August 4, 2023, Finance issued a newly revised set of EIFEL proposals. This release addresses certain concerns that interested parties have raised about the EIFEL rules and their application to CFAs.

Finance has made two notable changes to the way in which the EIFEL rules apply to CFAs. It has introduced (1) a definition, in proposed subsection 18.2(19), similar to that of “excluded interest” in the CFA context; and (2) an election, pursuant to proposed clause 95(2)(f.11)(ii)(E), that would allow a taxpayer to forgo the foreign accrual property losses (FAPL) that would have been included in its FA’s “relevant affiliate interest and financing expenses” (RAIFE). The result of the proposed clause 95(2)(f.11)(ii)(E) election would be the non-inclusion of FAPL in the CFA’s RAIFE.

Proposed Subsection 18.2(19)

The August release modified the proposed definitions of RAIFE and “relevant affiliate interest and financing revenues” (RAIFR) by adding new exclusions pursuant to proposed subsection 18.2(19).

In addition, a new proposed definition, “relevant inter-affiliate interest” (RIAI), was introduced to proposed subsection 18.2(1). RIAI generally includes interest paid or payable between two CFAs of the taxpayer or of an eligible group entity in respect of the taxpayer, in a situation where the interest would be included in the payer CFA’s RAIFE and the recipient CFA’s RAIFR. The proposed RIAI definition was added for the purposes of proposed subsection 18.2(19).

Proposed subsection 18.2(19) effectively excludes certain RIAI from a CFA’s RAIFE and/or RAIFR. It is similar to the “excluded interest” definition in proposed subsection 18.2(1), but no election needs to be made: if the conditions in proposed subsection 18.2(19) are met, the exclusion of the RIAI is automatic.

Proposed subsection 18.2(19) essentially sets up a formula to determine a CFA’s RAIFE and RAIFR for a taxation year, a formula that can result in a partial exclusion (versus a full exclusion) and asymmetrical results.

Let’s consider a simple example.

Canco, a corporation resident in Canada, has two CFAs (CFA1 and CFA2) for its relevant taxation year.

Canco has a specified participating percentage of 65 percent in CFA1 and 75 percent in CFA2 for the purposes of proposed subsection 18.2(19).

CFA1’s only income is $40 million of interest earned from CFA2, and the interest payments would be deductible in computing CFA2’s FAPI. CFA2 has no other income or expenses.

Pursuant to proposed paragraph 18.2(19)(a), the amount included in respect of CFA2’s RAIFE is the lesser of (1) the RIAI and (2) the result of the formula A × B.

A is the result of the formula (C − D) × E ÷ C, where

• C is the taxpayer’s specified participating percentage in CFA2 (the payer affiliate) if the RIAI were not paid or payable (75 percent, in this case);
• D is the taxpayer’s specified participating percentage (65 percent, in this case) in CFA1 (the recipient affiliate); and
• E is the RIAI, which is $40 million.

On the basis of the foregoing, A should be $5.3 million.

B is the result of the formula (F − G) × E ÷ H, where

• F is CFA2’s RAIFR for the year, which in this case is $0;
• G is CFA2’s RAIFE for the year if it had no RIAI for the taxation year ($0, in this case); and
• H is CFA2’s RAIFE for the year, determined without regard to proposed subsection 18.2(9) ($40 million, in this case).

According to this formula, B should be $0.

As a result of the computation, only $5.3 million of interest would be included in CFA2’s RAIFE.

CFA1’s RAIFR is then determined under proposed paragraph 18.2(19)(b). It is determined by the following formula: B × C ÷ D. In this case, the amount is $0.

In summary, it is generally the case that, subject to certain nuances (as seen above), interest paid or received between CFAs should not affect the interest deduction allowed to a Canadian taxpayer.

Election Pursuant to Proposed Clause 95(2)(f.11)(ii)(E)

Proposed clause 95(2)(f.11)(ii)(E) allows a taxpayer to elect to forgo an FA’s FAPL in certain cases. The amount to be elected must be an amount that would have been included in the FA’s RAIFE and would have been deductible in computing the FA’s income or loss from a property, from a business other than an active business, or from a non-qualifying business. In addition, the taxpayer can elect only the lesser of the FA’s FAPL and its RAIFE.

The addition of this election was Finance’s response to taxpayers’ concerns about their allowed interest deduction being reduced by FAPL when they had no expectation of using the FAPL. Some taxpayers hoped that this response would simplify the EIFEL computation, but the election does not seem to do so. To file the election, the taxpayer is required to provide detailed information that includes

• the elected amounts,
• the FA’s RAIFE (determined without regard to clause 95(2)(f.11)(ii)(E)) for the taxation year,
• the FA’s RAIFR for the taxation year,
• the FA’s FAPL (determined without regard to clause 95(2)(f.11)(ii)(E)) for the taxation year, and
• the FA’s FAPL or FAPI, as the case may be, for the taxation year.

The election must also be made for each elected amount and each foreign affiliate—a requirement that, although it can create complexity, also seems to provide flexibility.

This article has offered a broad summary of Finance’s updates, in the most recently proposed EIFEL rules, to the application of these rules to CFAs. It should be noted, of course, that we have not addressed all of the complexities and nuances that taxpayers will need to consider in applying the new proposed legislation.

Samantha D’Andrea
EY Law LLP, Montreal