The s. 18.2 rules include anomalies

Observations on the interest-limitation rules in ss. 18.2 and 18.21 include:

• The effect of the apparent exclusion of interest received from any non-arm’s length nonresident from interest and financing revenues (IFR) is that they are instead included in adjusted taxable income (ATI) so as to result in a 30% rather than 100% capacity per dollar of income.
  • This is especially anomalous where the IFR is for example interest paid by a Canadian branch business of the non-resident such that the deductibility of that interest to the non-resident in computing its income earned in Canada was restricted under s. 18.2.
  • This rule could also apply to a Canadian parent, acting as the market-facing entity for a group of companies, that borrows in the market (thus incurring interest expense) and then on-lends to its foreign affiliates.
• Variable C of the adjusted taxable income definition effectively reverses inclusions in taxable income of various items including foreign income covered by tax credits claimed under ss. 126(1) and (2). “[T]here appears to be a circularity problem with respect to foreign income, in that the amount of tax credits to which the taxpayer may be entitled under subsections 126(1) or (2) could be affected by its deductible IFE, which cannot be determined without first taking into account the tax credits.”
• Unlike under s. 18.2, there is no requirement under the s. 18.21 rules to determine the “excess capacity” for any particular group member and then separately transfer excess capacity of one particular group member to another. Rather, the total amount of IFE that may be deducted for the group is determined and as part of the joint election is merely allocated out to each member in that election itself. No group member should have restricted IFE to the extent that the allocated group ratio amount allocated to that member is less than that member’s net IFE.
• Unlike the s. 18.2 rules, under which there is no ability for trusts within a group to transfer or receive excess capacity, the mechanics of the s. 18.21 rules effectively permit the transfer of excess capacity to or from trusts within the Canadian group (although the s. 18.21 rules are unavailable where a group member is a mutual fund trust).

Neal Armstrong. Summaries of EY, “Proposed EIFEL rules,” Tax Alert 2022 No. 13, 9 March 2022 under s. 18.2(12), s. 18.1(1) – excluded interest, adjusted taxable income – B(a), adjusted taxable income – C(b), s. 111(1)(a.1), s. 18.21(3) and s. 18.21(2).