Excessive Interest and Financing Expense Limitations (EIFEL)

The Excessive Interest and Financing Expense Limitation (EIFEL) rules, which were enacted in June 2024 and are effective for tax years beginning on or after October 1, 2023, introduce important new constraints on the deductibility of interest and financing expenses under the Income Tax Act (Canada). These rules, found under Section 18.2 of the Income Tax Act, aim to prevent the erosion of Canada’s tax base by limiting the ability of businesses to deduct excessive interest and financing expenses in relation to their income. The implementation of EIFEL aligns Canada’s tax laws with the OECD’s Base Erosion and Profit Shifting (BEPS) recommendations, targeting aggressive tax planning strategies that artificially inflate interest deductions.

For family-owned enterprises, which often rely on debt as a strategic tool for growth and operations, the EIFEL rules pose significant considerations. Interest deductions have long been a tax-efficient way to manage financing costs, but the introduction of a fixed-ratio limitation changes the game. This limitation restricts the amount of interest expense that can be deducted to a percentage of a taxpayer’s adjusted taxable income. The ratio is 40% during the transitional period (tax years beginning between October 1, 2023, and January 1, 2024), and will reduce to 30% thereafter. This is outlined in subsection 18.2(3) of the Act.

Key Sections of the Income Tax Act Relevant to EIFEL:

• Section 18.2(1): Defines the scope of the EIFEL rules, setting out which taxpayers are subject to the limitations and providing key definitions, such as “interest and financing expenses” (IFE) and “adjusted taxable income.”
• Subsection 18.2(3): Provides the core limitation, specifying that the amount of net IFE a taxpayer can deduct is limited to a fixed percentage of adjusted taxable income.
• Subsection 18.2(4): Introduces the group ratio election, which allows certain groups of Canadian corporations to elect for a higher interest deduction limit if they can demonstrate that their group’s overall debt-to-income ratio exceeds the fixed ratio. This is particularly relevant for family-owned groups of companies, as it allows greater flexibility in interest deduction planning across multiple entities.

For family-owned businesses, particularly those with intergenerational ownership structures, this change necessitates a thorough review of existing financing arrangements. Many family businesses have relied on debt financing not only for operations but also for succession planning, expansions, and other long-term investments. Under Section 18.2, these businesses must now ensure that their interest expenses align with the new rules, or risk being denied significant deductions.

Moreover, the EIFEL rules introduce additional complexity when there are cross-border elements involved. For instance, if a family-owned business has foreign affiliates or non-resident shareholders, it must be mindful of how paragraph 18.2(2)(c) applies to transactions involving non-arm’s length parties or tax-indifferent entities (entities that are either exempt from Canadian tax or subject to low foreign tax rates). The rules specifically target financing arrangements designed to shift taxable income away from Canada or dilute taxable income through excessive interest deductions.

Why EIFEL Matters to Family-Owned Enterprises

Given that many family-owned enterprises operate with tighter margins than larger corporations, the restriction on interest deductions can have a direct impact on their bottom line. For example, under Section 18.2(2), if a family business incurs interest expenses exceeding the fixed ratio limitation, the excess portion will be non-deductible and could create restricted interest that may be carried forward indefinitely. This results in higher taxable income in the current year, thus increasing the immediate tax liability and affecting cash flow—an issue that could be critical for businesses with significant debt.

Furthermore, many family-owned enterprises are structured as Canadian-controlled private corporations (CCPCs), and while some smaller CCPCs are excluded from EIFEL if their taxable capital employed in Canada is less than $50 million, larger family businesses will still need to comply. It’s also important to note that family-owned enterprises with complex ownership structures involving partnerships or trusts could face indirect exposure to EIFEL through subparagraph 18.2(2)(e), which attributes excessive partnership-level interest expenses to corporate or trust members.

In summary, understanding and adhering to the EIFEL rules is not just about tax compliance—it’s about strategic tax planning and ensuring the long-term financial health of your family business. Financing decisions must now be carefully structured to avoid adverse tax consequences. For family-owned enterprises, especially those planning expansions, acquisitions, or intergenerational transfers, it is essential to work with tax professionals to navigate the new rules, optimize interest deductibility, and safeguard the business’s cash flow and profitability.

This blog post aims to provide families with a clear understanding of how Section 18.2 of the Income Tax Act will affect their financing structures, ensuring that they can make informed decisions about debt management and tax planning. Families with family-owned enterprises in Canada should review their current and planned financing structures to ensure they comply with these new limitations and explore strategic options for minimizing the impact of EIFEL on their business.

 

Who Is Affected by EIFEL?

The Excessive Interest and Financing Expense Limitation (EIFEL) rules apply broadly to a range of corporate and trust taxpayers in Canada. However, not all entities are subject to these rules, and understanding which businesses fall under the EIFEL umbrella is crucial for effective tax planning, especially for family-owned enterprises.

Affected Entities: Corporations and Trusts

Under the Income Tax Act (Canada), Section 18.2, the EIFEL rules primarily target corporations and trusts. The rules are intended to curb the use of excessive interest deductions by limiting the amount of Interest and Financing Expenses (IFE) that can be deducted for tax purposes. Any corporation or trust that falls under these provisions must carefully assess its financing structures to ensure compliance.

The types of entities subject to EIFEL include:

• Canadian corporations (excluding certain small Canadian-controlled private corporations, as detailed below).
• Trusts that incur interest expenses in connection with income-producing activities.

These entities must calculate their allowable interest deduction based on a fixed ratio of their adjusted taxable income (ATI), as outlined in subsection 18.2(3). For taxation years beginning on or after October 1, 2023, and before January 1, 2024, the fixed ratio is 40%, dropping to 30% for later taxation years.

Excluded Entities: CCPCs and Small Businesses

There are important exclusions to the EIFEL rules, particularly for smaller businesses. Canadian-controlled private corporations (CCPCs), which along with any associated corporations have taxable capital employed in Canada of less than $50 million, are excluded from the EIFEL provisions. This exclusion, detailed in subsection 18.2(1), aims to reduce the compliance burden on smaller CCPCs that are unlikely to engage in the kinds of aggressive tax planning the EIFEL rules are designed to target.

Additionally, certain Canadian resident corporations and trusts may also be excluded if they meet specific criteria. For instance, groups of Canadian resident corporations and trusts whose aggregate net interest and financing expenses among their Canadian members is less than $1,000,000 annually may be exempt from EIFEL under paragraph 18.2(1)(c). This provision provides relief for smaller groups of businesses that do not generate significant interest and financing expenses, allowing them to continue their operations without the administrative burden of the EIFEL calculations.

Another important exclusion applies to corporations and trusts whose activities are carried out almost exclusively in Canada. If all or substantially all of the business, undertakings, and activities are conducted within Canada, and certain ownership and financing conditions are met (such as the absence of non-resident shareholders or specified beneficiaries), these entities may be exempt under paragraph 18.2(1)(d). This exclusion is particularly relevant for family-owned businesses that operate solely in Canada and have no significant foreign affiliate holdings or financing arrangements involving tax-indifferent entities.

Associated Corporations in Family-Owned Businesses

Family-owned businesses often have multiple entities that are associated corporations, which can complicate the application of the EIFEL rules. The Income Tax Act defines associated corporations based on ownership and control, meaning that multiple corporations under common control (such as different entities owned by family members) may be considered associated for tax purposes.

When applying the EIFEL rules, associated corporations must aggregate their interest and financing expenses to determine if the group falls below the $50 million taxable capital threshold for exclusion. If the associated group exceeds this threshold, the EIFEL rules apply to each corporation within the group, and careful attention must be paid to the allocation of interest deductions across the entities.

For family businesses with multiple corporations, subsection 18.2(4) offers some flexibility through the group ratio election. This election allows Canadian group members to allocate interest deduction capacity based on the group’s consolidated financial results, rather than applying the fixed ratio to each entity individually. This can be particularly beneficial for family-owned business groups with uneven income distributions among their entities, as it enables the group to shift deduction capacity to entities with higher interest expenses, optimizing the overall tax outcome.

Implications for Partnerships

Family-owned enterprises structured as partnerships may also be indirectly affected by EIFEL. The rules apply to corporations and trusts that are members of a partnership, even though the partnership itself is not directly subject to the EIFEL rules. Under subparagraph 18.2(2)(d), if a corporation or trust member of a partnership incurs interest and financing expenses, their proportionate share of the partnership’s IFE is included in their own EIFEL calculation.

This means that excessive interest incurred by the partnership may be deemed as income for the corporation or trust partner, rather than being denied at the partnership level. The partnership itself is not subject to the EIFEL limitations, but the partners are, and they must account for their share of the partnership’s financing expenses in their EIFEL calculations. For family businesses structured as partnerships, this indirect application of EIFEL could result in reduced deductions at the partner level, potentially increasing taxable income for the corporation or trust member.

Summary

The EIFEL rules apply broadly to corporations and trusts, but there are several important exclusions that may provide relief for smaller family-owned businesses. Canadian-controlled private corporations with less than $50 million in taxable capital, certain resident corporations, and trusts with limited interest expenses or foreign involvement are all excluded from the rules.

However, for larger family-owned enterprises, particularly those with multiple associated corporations or partnership structures, the EIFEL rules require careful planning and consideration. The group ratio election provides some flexibility in optimizing interest deductions within a corporate group, but the overall limitation on interest deductibility means that family-owned businesses must review their financing structures to minimize the impact of EIFEL on their tax liabilities.

By understanding which entities are affected and how the rules apply to associated corporations and partnerships, family-owned enterprises can better navigate the complexities of EIFEL and ensure compliance while optimizing their tax planning strategies.

 

Key Elements of EIFEL Calculation

The Excessive Interest and Financing Expense Limitation (EIFEL) rules introduce a mechanical, multi-step formula to calculate the maximum deductible Interest and Financing Expenses (IFE) for impacted entities. At its core, the EIFEL calculation centers on a fixed-ratio limitation, though there are provisions for using an alternative group ratio election that can be beneficial for family-owned businesses with multiple entities.

The Fixed Ratio Limitation

The fixed ratio limitation is the cornerstone of the EIFEL rules, restricting the amount of IFE a taxpayer can deduct based on a percentage of their Adjusted Taxable Income (ATI). This ratio is designed to prevent the deduction of excessive interest expenses that could erode the Canadian tax base.

Under subsection 18.2(3) of the Income Tax Act, the fixed ratio is set at 40% during the transitional period, which applies to tax years beginning on or after October 1, 2023, and before January 1, 2024. For tax years beginning after January 1, 2024, the fixed ratio drops to 30%. This means that after the transitional period, a taxpayer’s IFE deductions are limited to 30% of their adjusted taxable income, subject to certain exceptions and elections.

Adjusted Taxable Income (ATI), which is discussed in greater detail below, serves as the base on which this ratio is applied. For family-owned businesses, this means that careful planning around their debt structures and income levels is essential to optimize the use of interest deductions.

How Adjusted Taxable Income Is Calculated

The calculation of Adjusted Taxable Income (ATI), as outlined in paragraph 18.2(2)(b), involves a series of adjustments to the taxpayer’s net income. Essentially, ATI is similar to a tax version of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), with certain tax-specific modifications. The formula adds back certain deductions to taxable income to establish the base amount on which the fixed ratio is applied. These adjustments include:

1. Taxable income for the taxation year, before considering any EIFEL restrictions.
2. Add back interest and financing expenses (IFE) deducted under the rules.
3. Add back capital cost allowance (CCA) and other depreciation-type deductions.
4. Add back resource pool deductions or other tax-specific depreciation items.
5. Add back any partnership amounts that flow through to the taxpayer.

The resulting figure is the taxpayer’s Adjusted Taxable Income (ATI). This adjusted figure is then multiplied by the fixed ratio (either 40% or 30%, depending on the tax year) to determine the maximum deductible IFE for the taxpayer.

For example, if a family-owned enterprise has an adjusted taxable income of $1 million, under the transitional period (40%), the taxpayer would be able to deduct up to $400,000 in interest expenses. For later years, with the fixed ratio dropping to 30%, the same taxpayer would be limited to $300,000 in interest deductions, potentially increasing their taxable income and resulting in a higher tax liability.

Impact of Net Income and Interest Expenses

It is important to note that Adjusted Taxable Income (ATI) is distinct from a business’s net income, as the calculation adjusts for certain non-cash expenses such as depreciation. Family-owned businesses often have multiple streams of income and various financing arrangements, so the calculation of ATI can have a direct impact on the amount of interest that is deductible. If a business has low ATI due to losses, it may find that a large portion of its interest expenses becomes non-deductible under EIFEL, which could significantly increase its tax burden.

If the taxpayer’s IFE exceeds the allowable deduction under the EIFEL rules, the excess portion becomes restricted interest under subsection 18.2(2)(f). Restricted interest is not lost but can be carried forward indefinitely and applied in future years when there is available capacity under the EIFEL limits.

The Group Ratio Election

For family-owned businesses with multiple entities, the group ratio election offers an alternative to the fixed ratio limitation. This election, found under subsection 18.2(4), allows corporate groups to use their consolidated financial results to calculate an allowable interest deduction based on the group’s overall leverage, rather than relying solely on the fixed ratio.

The group ratio is calculated as follows:

The numerator, Group Net Interest Expense, includes the total interest expense of the group, while the denominator, Group Adjusted Net Book Income, represents the group’s consolidated earnings before interest, taxes, depreciation, and amortization, adjusted for tax purposes. The 1.1 factor provides a buffer for accounting and tax differences, allowing a modest amount of additional deductibility compared to the fixed ratio approach.

The group ratio can be beneficial for family-owned businesses where one entity within the group incurs significant interest expenses, but other entities have minimal or no interest expenses. By electing to apply the group ratio, the group can allocate interest deduction capacity to the entities that need it most, optimizing the overall tax position of the group. This flexibility can be particularly valuable for family enterprises involved in diverse business activities, where financing needs may differ across entities.

However, the election must be made on an annual basis, and businesses must evaluate whether the group ratio approach will consistently provide a better result than the fixed ratio. Careful modeling of the group’s financial results is necessary to determine which option yields the most favorable tax outcome.

Strategic Use of the Group Ratio Election

Family-owned businesses can strategically use the group ratio election to maximize interest deductibility, especially when different entities within the group have varying financing structures or income levels. For example, if one entity within the family group has high interest expenses but low taxable income, while another entity has high taxable income but little or no debt, the group ratio election allows the deduction capacity to be shifted between entities. This can result in significant tax savings by maximizing the use of interest deductions across the group.

Additionally, the group ratio election may be particularly useful for family-owned enterprises engaged in intergenerational planning, where different entities are involved in succession, estate planning, or expansion efforts. By pooling the financial results of the entire group, the family can ensure that interest expenses are fully utilized, minimizing the tax impact of financing decisions across generations.

Conclusion

The fixed ratio limitation and the group ratio election are critical components of the EIFEL rules, and their application can significantly impact the tax position of family-owned businesses. By understanding how Adjusted Taxable Income (ATI) is calculated and how the fixed ratio or group ratio limits interest deductions, family enterprises can develop strategies to optimize their tax planning and minimize the impact of EIFEL on their financing structures. Whether applying the fixed ratio or electing the group ratio, family-owned businesses must carefully model their interest expenses and income levels to ensure they are maximizing the potential tax benefits available under the new rules.

 

Exemptions and Special Cases

The Excessive Interest and Financing Expense Limitation (EIFEL) rules include several important exemptions and exclusions that can significantly benefit certain businesses, including family-owned enterprises. Understanding these exemptions is essential for effective tax planning, as they provide opportunities to avoid the strict limitations on interest deductibility imposed by EIFEL. These exemptions are particularly relevant for businesses involved in specific industries, such as public-private infrastructure projects, rental housing, and the energy sector.

What Qualifies as “Excluded Interest” and “Exempt IFE”

Under subsection 18.2(2) of the Income Tax Act (Canada), certain types of interest and financing expenses (IFE) are excluded from the EIFEL rules. These categories of “excluded interest” and “exempt IFE” can be leveraged by family-owned businesses engaged in specific projects or industries. The main types of exempt IFE are:

1. Public-Private Partnership (P3) Infrastructure Projects
   Interest and financing expenses related to public-private partnership (P3) infrastructure projects are generally exempt from EIFEL. These projects typically involve long-term contracts between public authorities and private businesses for the provision of public services or infrastructure. Family-owned enterprises participating in such projects—whether through construction, maintenance, or operation—can benefit from the EIFEL exemptions, allowing them to deduct all associated interest expenses without being subject to the fixed-ratio limitation.
2. Rental Housing Construction
   In the 2024 Federal Budget, the government proposed an expansion of the EIFEL exemptions to include interest and financing expenses related to the construction or acquisition of rental housing. This exemption applies to “eligible purpose-built rental housing” projects and is available for interest incurred before January 1, 2036. Family-owned enterprises involved in real estate development, particularly those focused on rental housing, can leverage this exemption to fully deduct interest expenses tied to such projects. This provision aims to incentivize the construction of rental housing in Canada to address housing shortages.
3. Energy Utility Businesses
   Another exemption proposed in the 2024 Federal Budget relates to regulated energy utility businesses. Family-owned enterprises involved in the development, management, or operation of energy utilities—such as electricity, gas, or water services—may benefit from an elective exemption for arm’s-length interest and financing expenses. This exemption recognizes the public service nature of utility businesses and allows for the full deduction of financing costs tied to these projects.
4. Certain Leasing Arrangements Within Canadian Corporate Groups
   Excluded interest also includes certain lease financing payments made between related entities within a Canadian corporate group, as per subsection 18.2(2). For instance, if one family-owned entity leases equipment or property to another entity within the same corporate group, the interest expenses related to these lease payments may be excluded from the EIFEL calculation. This exclusion is designed to prevent EIFEL from adversely affecting internal transactions that are common in Canadian business groups, allowing family-owned enterprises to optimize their tax positions when engaging in intercompany leasing.

Leveraging Exemptions in Specific Industries

For family-owned enterprises operating in the real estate, infrastructure, and energy sectors, these exemptions provide critical opportunities to avoid the restrictive impact of the EIFEL rules. By understanding how to qualify for and apply these exemptions, family businesses can maintain full deductibility of interest expenses, minimizing their taxable income and ensuring that their financing arrangements remain tax-efficient.

For example, family-owned businesses involved in real estate development can benefit from the rental housing exemption if they focus on purpose-built rental properties. This not only allows them to fully deduct the associated financing costs but also enables them to engage in longer-term, debt-financed projects without worrying about the 30% limitation imposed by EIFEL.

Similarly, if a family-owned enterprise is involved in infrastructure development through public-private partnerships, such as building or maintaining roads, hospitals, or schools, the exempt IFE provisions ensure that the financing costs associated with these projects are fully deductible. By taking advantage of these exemptions, businesses can optimize their debt structures, secure larger financing, and invest in capital-intensive projects without incurring a tax penalty due to interest limitation rules.

For energy utilities, the elective exemption for regulated businesses allows family-owned enterprises to maintain their interest deductions, particularly for projects that require significant capital investment. By electing into the exemption, family businesses in the energy sector can avoid the limitations that might otherwise hinder their ability to grow or maintain critical infrastructure.

Elective Exemptions and Strategic Planning

The EIFEL rules also provide for elective exemptions in certain cases, allowing businesses to strategically manage their interest deductions based on the nature of their financing and the types of projects they are involved in. Elective exemptions are particularly useful for businesses in the energy and housing sectors, where financing arrangements may be complex and involve multiple entities or cross-border elements.

One notable elective exemption applies to certain Canadian corporate groups with lease financing payments between group members. This election, found in subsection 18.2(3), allows family-owned enterprises to exclude specific lease payments from the EIFEL calculation. This ensures that family businesses with complex internal leasing arrangements—common in industries like real estate and energy—are not penalized for engaging in legitimate intercompany transactions designed to optimize asset use and capital allocation.

Furthermore, under the proposed budget amendments, the elective exemption for rental housing construction provides flexibility for family-owned enterprises that are actively involved in developing or acquiring rental properties. By electing to apply this exemption, these businesses can structure their financing in a way that maximizes interest deductions, ensuring that their projects remain financially viable in a competitive real estate market.

Conclusion

The EIFEL rules are complex, but the “excluded interest” and “exempt IFE” provisions offer significant relief for family-owned enterprises involved in industries like public-private infrastructure projects, rental housing construction, and energy utilities. By understanding how to qualify for these exemptions and applying the elective provisions where necessary, family businesses can minimize the impact of EIFEL on their financing structures.

For family-owned businesses with diversified investments or intercompany transactions, leveraging these exemptions is crucial to maintaining financial efficiency and optimizing tax planning. By strategically applying for exempt IFE or electing out of certain interest limitations, family-owned enterprises can ensure that they continue to benefit from the full deductibility of their interest and financing expenses, safeguarding their bottom line while complying with the new rules under Section 18.2 of the Income Tax Act.

Family businesses should work closely with tax professionals to identify which exemptions apply to their projects and how best to structure their financing arrangements to maximize tax efficiency under EIFEL. With careful planning, these exemptions can be powerful tools for navigating the new tax landscape while ensuring continued growth and profitability.

 

Step-by-Step Guide to the EIFEL Calculation

The Excessive Interest and Financing Expense Limitation (EIFEL) calculation follows a precise mechanical formula set out in subsection 18.2(2) of the Income Tax Act (Canada). This formula determines the non-deductible portion of Interest and Financing Expenses (IFE) for the tax year, with the goal of preventing excessive deductions that could erode Canada’s tax base. For family-owned enterprises, especially those with complex financing structures, understanding how to apply this formula is essential for ensuring compliance and optimizing interest deductibility.

Here, we will break down the formula step by step, provide a practical example, and explain the concepts of “absorbed capacity” and “received capacity” in relatable terms.

The EIFEL Calculation Formula

The formula to determine non-deductible IFE is as follows:

Where:

• A = The taxpayer’s total IFE for the year.
• B = The taxpayer’s Adjusted Taxable Income (ATI) multiplied by the fixed or group ratio.
• C = The taxpayer’s interest and financing revenues for the year.
• D = The taxpayer’s received capacity (amount transferred from another group member, if applicable).
• E = The taxpayer’s absorbed capacity (amount carried forward from prior years, if applicable).
• F = The total IFE (adjusted for specific circumstances) incurred by the taxpayer for the year.

Each of these elements plays a crucial role in determining how much of a taxpayer’s IFE is non-deductible. Let’s break down each element in detail with a practical example.

Example: CanCorp, A Family-Owned Business

Consider CanCorp, a family-owned corporation with a December 31 year-end, involved in both real estate and manufacturing. CanCorp is not an excluded entity and must calculate the non-deductible portion of its interest and financing expenses under EIFEL for the 2025 tax year.

CanCorp’s 2025 Financials:

• IFE (A) = $4 million
• Taxable income before EIFEL = $3.5 million
• Capital cost allowance (CCA) = $1 million
• Interest and financing revenues (C) = $500,000
• CanCorp has no received capacity (D) or absorbed capacity (E) from prior years.

Step-by-Step Breakdown of the Formula

1. Element A: IFE
   CanCorp’s total IFE for 2025 is $4 million. This includes all interest and financing expenses incurred by CanCorp in relation to its business activities. In calculating the total IFE, CanCorp must consider not only direct interest payments but also other financing-related expenses, such as embedded interest within lease payments and any interest expenses that flow through from partnerships.
2. Element B: Adjusted Taxable Income (ATI)
   To calculate the amount of interest CanCorp can deduct, we first need to determine its Adjusted Taxable Income (ATI). ATI is essentially CanCorp’s taxable income before the application of EIFEL, adjusted by adding back IFE and certain non-cash deductions such as capital cost allowance (CCA).

ATI is calculated as follows:

CanCorp’s ATI is $8 million.

1. Applying the Fixed Ratio to ATI
   Since CanCorp’s 2025 tax year is after the transitional period, the applicable fixed ratio is 30%, as per subsection 18.2(3).

B=ATI×30%=8 million×0.30=2.4 million\text{B} = \text{ATI} \times 30\% = 8 \text{ million} \times 0.30 = 2.4 \text{ million}B=ATI×30%=8 million×0.30=2.4 million

This means CanCorp is allowed to deduct up to $2.4 million of interest based on its ATI and the fixed ratio.

1. Element C: Interest and Financing Revenues
   CanCorp also has interest and financing revenues for the year, which must be subtracted from its deductible interest. These revenues represent any income CanCorp earns from interest on loans it has made, lease financing income, or other financing-related income streams. For CanCorp, this amount is $500,000.
2. Element D: Received Capacity
   Received capacity represents any unused deduction capacity that CanCorp may have received from other entities within its corporate group. In this case, CanCorp is not part of a corporate group that transfers received capacity, so D = 0.
3. Element E: Absorbed Capacity
   Absorbed capacity refers to any unused deduction capacity from prior years that CanCorp may carry forward to reduce its current non-deductible interest. Again, in CanCorp’s case, there is no prior-year capacity to absorb, so E = 0.
4. Element F: IFE
   F equals the total IFE incurred by CanCorp for the year, which is $4 million. This figure is used to determine what portion of the interest is non-deductible.

Final EIFEL Calculation for CanCorp

Now that we have all the necessary elements, we can calculate CanCorp’s non-deductible IFE using the formula:

Thus, 27.5% of CanCorp’s IFE is non-deductible. This means that of the $4 million in total interest expenses, $1.1 million will be non-deductible and added back to taxable income for 2025.

Understanding Absorbed Capacity and Received Capacity

Two important concepts in the EIFEL calculation are absorbed capacity and received capacity. These elements can reduce the amount of non-deductible IFE, providing flexibility for businesses with fluctuating interest expenses or group structures.

• Absorbed Capacity (E): If a business’s allowable deduction capacity (i.e., the amount of interest that can be deducted) exceeds its actual interest expenses in a given year, the unused capacity becomes absorbed capacity. This capacity can be carried forward for up to three years, allowing the business to apply it in future years to reduce non-deductible IFE. For example, if CanCorp had been under its limit in previous years, it could use that absorbed capacity in the current year to offset non-deductible interest.
• Received Capacity (D): In a corporate group, members can transfer unused capacity to other entities within the group. For example, if a sister company of CanCorp had excess capacity (i.e., it incurred less interest than its limit allowed), it could elect to transfer that capacity to CanCorp. This transferred capacity would then reduce CanCorp’s non-deductible IFE for the year.

Conclusion

The EIFEL rules impose significant limitations on the deductibility of interest expenses, but the precise mechanical calculation offers clarity. By understanding how to break down the formula and apply it, family-owned businesses can ensure they remain compliant while optimizing their interest deductions. In cases where non-deductible IFE arises, concepts like absorbed and received capacity provide valuable tools to mitigate the impact, particularly for family businesses operating within corporate groups. Proper planning, especially in complex family business structures, can help ensure that interest expenses are fully utilized to reduce taxable income and improve financial outcomes.

 

Strategies to Minimize the Impact of EIFEL

The Excessive Interest and Financing Expense Limitation (EIFEL) rules can significantly affect the tax position of family-owned businesses, particularly those with complex financing structures. However, with careful planning and strategic adjustments, businesses can minimize the negative impact of these rules. Below are several practical strategies that family-owned businesses can implement to reduce their exposure to EIFEL and preserve tax-efficient financing.

1. Restructuring Debt for Optimal Interest Deductions

One of the most effective ways to minimize the impact of EIFEL is by restructuring debt to ensure that interest expenses remain within the allowable deduction limits. This can involve:

• Refinancing high-interest loans: Family businesses with high-interest debt may consider refinancing to lower interest rates, which reduces the overall amount of interest subject to EIFEL. By lowering the total Interest and Financing Expenses (IFE), the business is more likely to stay within the limits of the fixed or group ratio.
• Consolidating loans: Combining multiple loans into a single financing arrangement can streamline interest payments and help businesses more easily manage their overall interest expenses. Consolidation can also allow the business to secure better terms and potentially reduce the IFE subject to EIFEL.
• Switching from debt to equity financing: For some businesses, reducing reliance on debt and increasing equity financing can be a viable option. Although equity financing does not provide the same tax advantages as deductible interest, it avoids the limitation imposed by EIFEL and reduces the risk of non-deductible interest expenses.

2. Adjusting Financing Arrangements to Maximize Deductions

Family-owned businesses can also optimize their financing arrangements to reduce the impact of EIFEL. Several approaches can be considered:

• Reviewing and reallocating debt among entities: In family businesses with multiple entities, it may be beneficial to reallocate debt among the different entities to ensure that the interest deduction capacity is maximized across the corporate group. For instance, interest deductions can be shifted to entities with higher Adjusted Taxable Income (ATI) to make full use of the available deduction limits. This requires a comprehensive review of how debt is structured and allocated within the group.
• Maximizing use of the group ratio election: Businesses with multiple entities can take advantage of the group ratio election under subsection 18.2(4). This election allows businesses to apply a ratio based on the group’s overall debt and earnings, rather than the fixed 30% ratio. If the group has a high overall debt-to-income ratio, using the group ratio election may result in a higher allowable deduction of interest expenses. Family-owned businesses should model both the fixed and group ratio approaches annually to determine which option is more beneficial.
• Timing of debt incurrence: Another strategy is to carefully time when new debt is incurred to match periods of higher taxable income or available deduction capacity. By aligning financing arrangements with profitable years, businesses can ensure that they are making full use of their interest deduction limits without exceeding the fixed ratio or creating non-deductible IFE.

3. Strategic Use of Elective Exemptions

For family-owned businesses involved in public-private partnership (P3) infrastructure projects, rental housing construction, or regulated energy utilities, the elective exemptions offered under EIFEL can provide significant relief. These businesses should:

• Elect for exempt interest treatment: By electing for certain interest and financing expenses to be classified as “exempt IFE”, businesses involved in these industries can bypass the EIFEL limitations entirely for specific projects. For example, family-owned enterprises constructing purpose-built rental housing may qualify for the elective exemption, ensuring full deductibility of interest expenses for these projects.
• Evaluate project-specific financing: For businesses with multiple ventures, segregating financing by project and electing for EIFEL exemptions on qualifying projects can help preserve deductibility for other business activities. Family-owned businesses should work closely with tax advisors to identify which projects qualify for exemptions and how best to structure the related financing.

4. Reviewing and Restructuring Intercompany Transactions

Family-owned enterprises that include multiple corporate entities often engage in intercompany transactions to optimize capital and asset use. Under EIFEL, these businesses must carefully structure such transactions to avoid triggering non-deductible interest. Key strategies include:

• Intercompany leasing and financing: When one family entity leases property or equipment to another, ensuring that the lease or financing arrangements are structured as excluded interest under the EIFEL rules can prevent the limitation from applying. By making the appropriate elections for intercompany lease payments, businesses can maintain full deductibility of these expenses.
• Transfer of unused capacity: Entities within the same family-owned group can elect to transfer unused deduction capacity to other group members under subsection 18.2(4). This strategy ensures that any unused interest deduction capacity in one entity is fully utilized by another, preventing non-deductible IFE. This is especially useful for groups with uneven income or financing needs across their entities.

5. Conducting a Comprehensive Review of Current Financing Structures

A critical step for any family-owned business is to review their current financing structures and determine whether they need to adjust to minimize the impact of EIFEL. This review should focus on:

• Assessing debt levels: Businesses should calculate their current Adjusted Taxable Income (ATI) and IFE to see if they are approaching or exceeding the allowable deduction limits. If they are close to or above the limits, immediate steps should be taken to restructure debt, refinance, or shift interest expenses to other entities.
• Reviewing historical deduction capacity: By analyzing prior years’ interest deduction capacity, businesses can identify whether there is any absorbed capacity to carry forward and apply against current-year non-deductible IFE. This provides a buffer for years when interest expenses are high relative to taxable income.
• Modeling future interest expenses: It is important to forecast future financing needs and interest expenses to ensure that planned financing aligns with the available deduction capacity. If future interest expenses are expected to exceed the allowable limit, businesses should consider alternative financing options or seek opportunities for exemption.

6. Adjusting Tax Planning to Mitigate Cash Flow Reductions

Lastly, EIFEL introduces the possibility of cash flow reductions due to higher taxable income resulting from non-deductible interest expenses. To mitigate these potential impacts, family-owned businesses should adjust their overall tax planning strategies:

• Deferring capital expenditures: In years where the business is nearing its EIFEL limit, deferring capital expenditures that would incur additional financing costs may help to reduce interest expenses and preserve cash flow.
• Using capital cost allowance (CCA) strategically: While CCA is added back to taxable income for the purposes of calculating ATI, businesses may choose to accelerate or defer CCA claims depending on their interest deduction needs. This ensures that taxable income is optimized to allow for the maximum deduction of interest expenses.
• Revisiting dividend and profit distribution plans: Family businesses may also adjust their dividend distribution policies to retain more earnings within the business, increasing taxable income and thereby creating more room for interest deductions. This can help to smooth out the impact of EIFEL over multiple tax years.

Conclusion

The EIFEL rules pose a complex challenge for family-owned businesses, but with the right strategies in place, their impact can be minimized. By restructuring debt, adjusting financing arrangements, strategically using exemptions, and reviewing intercompany transactions, family enterprises can optimize their interest deductions and ensure that EIFEL does not adversely affect their cash flow or profitability.

Conducting a thorough review of financing structures and tax planning is essential for mitigating the risk of non-deductible interest expenses. Family-owned businesses should work closely with tax advisors to develop strategies that align with the EIFEL rules while protecting their long-term financial health and ensuring compliance with Canada’s evolving tax landscape.

 

Other Considerations for Family-Owned Businesses

The Excessive Interest and Financing Expense Limitation (EIFEL) rules not only impose immediate limitations on the deductibility of interest and financing expenses (IFE), but they also introduce longer-term considerations for family-owned businesses. Proper planning, documentation, and awareness of other intersecting tax rules are essential to ensuring compliance and maximizing tax benefits. Below are key considerations that family-owned enterprises should keep in mind when navigating the EIFEL landscape.

1. Carryforward Options for Denied IFE

One of the most important features of the EIFEL rules is the ability to carry forward denied IFE to future tax years. Under subsection 18.2(5), any non-deductible IFE from a given year can be carried forward indefinitely and applied in future years when there is sufficient capacity to deduct the expense. This provision can be extremely useful for family-owned businesses that experience fluctuations in income or financing needs over time.

How the Carryforward Works:

• If a family-owned business incurs IFE that exceeds the deductible limit in a particular year, the excess amount is treated as “restricted IFE” and is added to a pool of non-deductible expenses.
• This restricted IFE can be applied against future excess capacity, which occurs when the business’s Adjusted Taxable Income (ATI) in a subsequent year provides room to deduct more interest.
• Excess capacity is created when the business’s ATI and allowable deductions exceed the actual interest and financing expenses incurred in that year.

For example, consider a family-owned business that incurs $1 million in non-deductible IFE in 2025 due to low income and high interest expenses. In 2026, the business generates higher income and incurs fewer interest expenses, resulting in $500,000 of unused deduction capacity. The business can apply $500,000 of its 2025 restricted IFE against the available capacity in 2026, thus reducing taxable income and recovering some of the tax benefits from the prior year.

This carryforward mechanism provides flexibility and ensures that businesses with cyclical income or variable financing needs are not permanently penalized for exceeding the deduction limits in any one year. For family-owned enterprises, particularly those in industries with fluctuating cash flows (e.g., real estate development or agriculture), this option can be a critical component of their long-term tax planning.

2. Importance of Proper Documentation and Timely Filing

Compliance with EIFEL requires meticulous documentation and timely filing to avoid extended reassessment periods and potential penalties. Family-owned businesses must ensure that all interest and financing transactions are thoroughly documented, as the Canada Revenue Agency (CRA) may scrutinize financing arrangements to ensure they align with the EIFEL rules.

Key Documentation Requirements:

• Interest payments and agreements: Businesses must retain detailed records of all interest payments, loan agreements, and financing arrangements to substantiate their claims for interest deductions. This includes any agreements related to intercompany financing, external loans, and lease arrangements.
• Elections and filings: If the business is making use of any elections, such as the group ratio election under subsection 18.2(4) or exemptions for public-private partnerships or rental housing, it must ensure that these elections are filed accurately and on time. Late filings or errors in reporting could lead to the denial of deductions or trigger extended reassessment periods.
• Tracking absorbed and received capacity: Businesses that use the carryforward mechanism for denied IFE must maintain clear records of how much restricted IFE is carried forward and applied in future years. Similarly, for businesses transferring received capacity within a corporate group, accurate tracking and reporting of these amounts is crucial.

Timely Filing and Reassessment Periods:

• The normal reassessment period for a tax return does not begin for EIFEL-related items until the business has filed the required forms detailing the IFE deductions and any elections made. As such, failing to submit these forms could result in extended reassessment periods, increasing the risk of audits or penalties.
• To avoid any issues, family-owned businesses should work closely with their tax advisors to ensure that all filings are made on time and all documentation is up to date. This will not only ensure compliance but also protect the business from any potential challenges by the CRA regarding interest deductibility.

3. Interaction with Other Tax Rules: Thin Capitalization and Transfer Pricing

The EIFEL rules interact with other provisions in the Income Tax Act, particularly those related to thin capitalization and transfer pricing. Family-owned businesses with international operations or intercompany financing structures must consider how these rules interplay with EIFEL to avoid double limitations on interest deductibility.

Thin Capitalization Rules:

The thin capitalization rules, found in Section 18(4) of the Income Tax Act, limit the amount of interest a Canadian business can deduct on loans from non-resident shareholders or related parties if the debt-to-equity ratio exceeds a certain threshold (currently 1.5:1). These rules are intended to prevent excessive debt financing from foreign-related parties, which could shift taxable income out of Canada.

Under EIFEL, the thin capitalization rules apply before the EIFEL limitation is calculated. This means:

• If interest is denied under the thin capitalization rules, it is excluded from the EIFEL calculation altogether.
• For businesses subject to both rules, it is essential to ensure that they are not penalized twice for the same interest expense.

For family-owned enterprises with foreign shareholders or financing from non-resident entities, managing the interaction between thin capitalization and EIFEL is critical. Businesses should structure their debt carefully to avoid triggering the thin capitalization limits and ensure that any interest deductions that survive these rules can be maximized under EIFEL.

Transfer Pricing Rules:

Transfer pricing rules apply when a Canadian business engages in transactions with related foreign entities, requiring that these transactions be conducted at arm’s length prices. These rules are designed to prevent profit shifting through inflated or deflated pricing between related parties, including the interest charged on intercompany loans.

Under EIFEL, the interest charged on intercompany loans must comply with transfer pricing rules. If the CRA determines that the interest rate on a loan between related entities is not at arm’s length, it could adjust the interest amount, affecting both the thin capitalization and EIFEL calculations.

Family-owned businesses with international subsidiaries or financing arrangements involving non-resident entities should ensure that their transfer pricing policies comply with the CRA’s guidelines. This will prevent any adjustments that could reduce the amount of deductible interest, both under EIFEL and thin capitalization.

Conclusion

While the EIFEL rules impose new limitations on the deductibility of interest expenses, family-owned businesses can mitigate these effects through careful planning and strategic use of the available carryforward options. Maintaining thorough documentation, filing the required forms on time, and ensuring compliance with other relevant tax rules—such as thin capitalization and transfer pricing—are all critical steps for minimizing the risks and maximizing the available deductions.

By integrating EIFEL considerations into their broader tax strategy, family-owned enterprises can protect their cash flow, optimize their interest deductions, and ensure compliance with Canada’s evolving tax landscape. Careful coordination with tax advisors is essential to navigate these complex rules and to develop strategies that align with both EIFEL and other key provisions of the Income Tax Act.

 

Conclusion: Navigating EIFEL with Expert Guidance

The Excessive Interest and Financing Expense Limitation (EIFEL) rules introduce a new level of complexity for family-owned enterprises. While these rules are designed to prevent excessive interest deductions and protect the Canadian tax base, they can pose significant challenges for businesses that rely on debt to finance growth, operations, or intergenerational transitions. For family-owned businesses, navigating the EIFEL rules is essential to protect their financial health, preserve cash flow, and maintain tax efficiency.

The complexity of EIFEL lies not only in understanding how the limitations are calculated but also in the broader implications for long-term tax planning and compliance. From managing carryforward options for denied interest expenses to ensuring proper documentation and aligning with other tax rules like thin capitalization and transfer pricing, there are many moving parts that require careful attention. For businesses with multiple entities, cross-border operations, or significant debt financing, the stakes are even higher.

This is where expert guidance becomes crucial. At Shajani CPA, we specialize in helping family-owned businesses like yours navigate these complex rules with confidence. Our team of tax professionals can:

• Review and optimize your financing structures to ensure compliance with EIFEL while maximizing your available interest deductions.
• Develop tax-efficient strategies to minimize the impact of non-deductible interest and leverage the available carryforward options.
• Evaluate your eligibility for exemptions and help you strategically apply elections, such as the group ratio election, to improve your overall tax position.
• Assist with proper documentation and filings to avoid extended reassessment periods and ensure smooth compliance with CRA requirements.

The EIFEL rules are complex, but with the right strategies in place, family-owned businesses can navigate them successfully while protecting their bottom line. Whether you’re restructuring debt, adjusting financing arrangements, or planning for future growth, having an experienced team on your side is key to making informed decisions that align with your business goals.

Call-to-Action: How Shajani CPA Can Help

At Shajani CPA, we understand that every family-owned business is unique. We offer personalized tax planning and consulting services tailored to your specific needs, ensuring that you not only comply with the EIFEL rules but also take full advantage of the opportunities they provide.

Contact us today to schedule a consultation and see how the EIFEL rules affect your business. We’ll work with you to develop a plan that optimizes your financing, safeguards your tax position, and helps you achieve your financial ambitions. Whether you’re expanding, transitioning ownership, or simply looking to protect your cash flow, our team is here to guide you every step of the way.

Let us help you navigate the complexities of EIFEL so you can focus on growing your family business with confidence.

 

FAQs on EIFEL for Family Businesses

This FAQ section addresses common questions that family-owned enterprises may have regarding the Excessive Interest and Financing Expense Limitation (EIFEL) rules. By answering these questions upfront, family businesses can gain a clearer understanding of how EIFEL might affect their tax planning and financing decisions.

1. What are the EIFEL rules, and why were they introduced?

The EIFEL rules, introduced in June 2024 and effective for tax years beginning on or after October 1, 2023, limit the amount of Interest and Financing Expenses (IFE) that businesses can deduct for tax purposes. The goal is to prevent excessive interest deductions that erode the Canadian tax base, particularly in cases where businesses are over-leveraged or engage in tax planning strategies that artificially inflate interest expenses.

2. Does EIFEL apply to all family-owned businesses?

No, not all family-owned businesses are subject to EIFEL. Canadian-controlled private corporations (CCPCs) with less than $50 million in taxable capital employed in Canada, along with certain other excluded entities, are exempt from these rules. However, larger family-owned businesses or those with complex financing structures should carefully assess whether EIFEL applies to them.

3. How does EIFEL impact interest deductions?

EIFEL imposes a fixed-ratio limitation that restricts the amount of IFE a business can deduct. For tax years beginning on or after October 1, 2023, and before January 1, 2024, the deduction is limited to 40% of the business’s Adjusted Taxable Income (ATI). For subsequent tax years, this ratio decreases to 30%. Any interest expenses exceeding this limit are considered non-deductible but can be carried forward to future years as restricted IFE.

4. What is Adjusted Taxable Income (ATI) under EIFEL?

Adjusted Taxable Income (ATI) is a measure similar to EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) but for tax purposes. It is calculated by taking the business’s taxable income and adding back interest expenses, capital cost allowance, and certain other deductions. The fixed-ratio limit is then applied to the ATI to determine the maximum deductible interest for the year.

5. Can denied interest expenses be used in future years?

Yes, any interest that is non-deductible under EIFEL can be carried forward indefinitely and applied in future years when there is excess capacity to deduct interest. This provides flexibility for businesses with fluctuating income and interest expenses over time.

6. What are the exemptions from EIFEL?

Certain industries and projects are exempt from EIFEL, including public-private partnership (P3) infrastructure projects, purpose-built rental housing (for interest incurred before 2036), and regulated energy utility businesses. Family-owned enterprises involved in these types of projects may be able to exclude the related interest expenses from EIFEL limitations.

7. How can family businesses with multiple entities benefit from the group ratio election?

Family businesses with multiple entities can elect to apply the group ratio under subsection 18.2(4). This allows the group to calculate interest deductions based on the group’s overall debt and earnings, rather than using the fixed 30% ratio. This can benefit groups with uneven income or debt across entities by allowing the business with the highest interest expenses to maximize its deductions.

8. How does EIFEL interact with other tax rules like thin capitalization?

The EIFEL rules work in conjunction with existing tax provisions, including the thin capitalization rules under Section 18(4) of the Income Tax Act. Thin capitalization limits the amount of interest that can be deducted on loans from non-resident shareholders if the debt-to-equity ratio exceeds a certain threshold. Thin capitalization rules apply before EIFEL, meaning that interest denied under thin capitalization is excluded from the EIFEL calculation.

9. What should family-owned businesses do to ensure compliance with EIFEL?

Family-owned businesses should:

• Review their financing structures to assess whether they are affected by EIFEL.
• Ensure proper documentation of interest payments, loan agreements, and elections.
• Consider restructuring debt to optimize interest deductions.
• Consult with a tax professional to navigate the complexities of EIFEL and ensure compliance.

10. Who can help us understand and implement EIFEL strategies?

At Shajani CPA, we specialize in helping family-owned businesses navigate complex tax rules like EIFEL. We can assist with reviewing your financing structures, ensuring compliance, and developing tax-efficient strategies to optimize your interest deductions. Contact us today to learn more about how EIFEL affects your business and how we can help.

 

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. ©2024 Shajani CPA.

Shajani CPA is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning service.

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