Low de minimis threshold
- The “excluded entity” definition in draft s. 18.2(1), which includes groups of corporations and trusts whose aggregate net interest expense among their Canadian members is $250,000 or less, thus provides a lower “de minimis” threshold than, for example, the U.K. (£2m) and Germany (€3m).
Unclear whether s. 18.2 applies to computing FAPI
- It is unclear whether the rules apply to computing the income of a foreign affiliate, which is generally deemed by s. 95(2)(f) to be a Canadian resident for FAPI-computation purposes “except to the extent that the context otherwise requires.” If the rules did so apply, this could cause significant practical difficulties, such as conflicts with the interest limitation rules of foreign jurisdictions.
Double-deductions of non-capital losses
- Item A in the ATI formula is reduced by the non-capital loss and net capital loss generated for the current year – yet if these losses are applied in a future year, there is no consequential ATI adjustment for that subsequent year (except for the partial addback of the portion of a non-capital loss that reasonably relates to the taxpayer’s net interest and financing expense). “This results in these losses reducing ATI twice (once in the year incurred, and once in the year applied).”
Potential inclusion of amounts under derivatives
- The definitions of interest and financing expenses and revenues, as supplemented by the Explanatory Notes, may be broad enough to include amounts arising under derivatives.
Effect of increasing future recapture
- Draft s. 18.2(3) deems amounts of previously capitalized interest that are otherwise deductible as CCA or resource pool deductions, but are denied as a deduction under s. 18.2(2), to have been allowed as deemed UCC or resource pool deductions - so as to prevent the taxpayer from receiving the “double benefit” of having a higher UCC or resource pool (potentially deductible in a future year) while at the same time having a restricted interest expense carryforward for future deduction.
- However, this deemed deduction also has the effect of increasing recapture to the taxpayer on a future disposition of such assets.
General scope of excluded interest rules
- The “excluded interest” rules depart from the 2021 federal budget proposals (which stated that interest income and expense between Canadian members of a corporate group would be generally excluded) by requiring an election between two eligible group corporations.
- These rules (unlike the unused capacity rules) do not exclude financial institutions, but they are unavailable to trusts and partnerships.
Non-recognition of local European GAAP
- The group ratio rule in draft s. 18.21, which may enable taxpayers to access a higher fixed percentage than 30% where the group as a whole is bearing higher interest and financing expenses as a result of its external debt and as measured by the group GAAP financial statements, does not recognize any local European GAAP – so that the group ratio calculations could be unavailable for European-headed groups that do not consolidate using IFRS.
Potential difficulties in annually assessing whether the election should be made or is practicable
- Application of the group ratio regime requires an annual election and, therefore, annual consideration as to whether it would be beneficial. This regime “requires information that may not easily be available to the Canadian group members, particularly in large conglomerate or private equity structures.”
Difficulties for consolidated operation of financial services groups
- S. 18.2(4)(c), which effectively prevents a “relevant financial institution” from transferring any portion of its “cumulative unused excess capacity” for a year (as, for example, would typically be the case for a profitable bank with an excess of interest income over interest expense) to another member of its group having excessive interest and financing expenses, could cause significant difficulties for Canadian financial services groups, for example, where regulatory restrictions limit a regulated financial institution’s incurring of third party debt, leading other group members to incur such debt.
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