Canada’s EIFEL rules in practice
October 2026 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
October 2026 Issue
Under Canada’s Income Tax Act (ITA), interest is generally deductible provided that a taxpayer has a legal obligation to pay interest, and the interest is paid or payable on borrowed money used for the purpose of gaining or producing income from a business or property.
Interest expense deductions are limited to the lesser of the amount of interest that is paid or payable in the year and a ‘reasonable amount’. The ITA also contains specific rules that limit the deduction of interest expense, including longstanding ‘thin capitalisation’ rules and, more recently, the excessive interest and financing expense limitation (EIFEL) rules which are generally applicable to taxation years beginning on or after 1 October 2023.
The EIFEL rules are Canada’s response to the recommendations of the Organisation for Economic Co-operation and Development’s Action 4 report under the Base Erosion and Profit Shifting (BEPS) Action Plan. The rules limit deductions for ‘interest and financing expenses’ to a fixed percentage of ‘adjusted taxable income’ (ATI) which is, generally speaking, a proxy for earnings before interest, taxes, depreciation and amortisation (EBITDA), computed in accordance with tax principles. As discussed below, the fixed percentage may be substituted for a ‘group ratio’ percentage of a consolidated group on an elective basis.
According to the Department of Finance, the EIFEL rules are intended to curtail perceived base erosion concerns by addressing “BEPS issues arising from taxpayers deducting for income tax purposes excessive interest and other financing costs, principally in the context of multinational enterprises and cross-border investments”.
However, there is no avoidance or purpose test governing the application of the EIFEL rules. The rules apply to all entities meeting the statutory definitions in a mechanical and automatic manner.
The EIFEL rules in brief
Under the EIFEL rules, deductions by corporations or trusts for interest and financing expenses (net of interest and financing revenues) are capped at either a fixed ratio equal to 30 percent of ATI or the group ratio percentage of ATI.
Mechanically, the EIFEL rules apply by calculating a proportion of otherwise deductible interest and financing expenses and denying a deduction in respect of that proportion. The restriction is computed using a complex formula that can generally be summarised as the amount by which the taxpayer’s interest and financing expenses exceed the sum of its interest and financing revenues and 30 percent of ATI, all divided by the taxpayer’s interest and financing expenses for the year.
The EIFEL rules also include an elective group ratio rule that can be utilised by a ‘consolidated group’, which is defined to mean two or more entities – other than an equity-accounted entity but including an ultimate parent entity – that are required to prepare consolidated financial statements for financial reporting purposes or would be required to do so if they were subject to International Financial Reporting Standards.
If a single entity is not otherwise part of a consolidated group, it is deemed to be a consolidated group of one and a so-called ‘single member’ group election may be made in certain circumstances. Because the group ratio election applies on an annual basis, it can be utilised in one year and the fixed ratio of 30 percent could be utilised in another year if it would be beneficial to do so.
Under the group ratio rule, the maximum amount of net interest and financing expenses that a group member can deduct for the year is not limited by the 30 percent fixed ratio, but rather by the ratio of the ‘group net interest expense’ to the ‘group adjusted net book income’, multiplied by a factor of 1.1. In simplified terms, group net interest expense represents the group’s net third-party interest expense and group adjusted net book income represents the book EBITDA of the group for the year.
The maximum amount of interest and financing expenses that the members of a group can collectively deduct under the group ratio rule is generally determined by multiplying the total of each member’s ATI by the group ratio, with the resulting amount then being allocated among the group members in the group ratio election.
Where the fixed ratio is used, denied interest expenses become ‘restricted interest and financing expenses’, which can generally be carried forward indefinitely (subject to the ITA’s loss-trading restrictions on an acquisition of control) and deducted in future taxation years to the extent the taxpayer has excess interest deduction capacity. A taxpayer utilising the group ratio for a taxation year cannot generate any restricted interest and financing expense carryforwards for such year.
Exceptions to the EIFEL rules
In certain circumstances, an election can be made to exclude payments of ‘excluded interest’ in computing the payer’s interest and financing expenses and the payee’s interest and financing revenues. The effect of the election is generally to cause payments of excluded interest to not be subject to the EIFEL rules.
The stated purpose of this exception is to ensure that the EIFEL rules do not negatively impact so-called ‘loss consolidation’ transactions whereby the losses of one member of a Canadian corporate group are used to offset the income of another member of the group.
The excluded interest election is only available to eligible group entities that are taxable Canadian corporations or partnerships all of the members of which are taxable Canadian corporations. Thus, if either the payer or the payee is an individual, a trust or a partnership whose members include an individual or a trust, the election is not available.
A specific exception is also provided in respect of certain Canadian public-private partnership infrastructure projects, and legislative amendments propose to provide similar exceptions (available on an elective basis) for purpose-built residential rental projects and regulated energy utility businesses.
Unlike the comparable US rules in section 163(j) of the Internal Revenue Code limiting deductions for business interest expense, the Canadian EIFEL rules do not contain a general exception for real estate businesses.
Certain entities, referred to as ‘excluded entities’, are excepted from the EIFEL rules altogether. The excluded entity exception is intended to provide relief to small and medium-sized Canadian businesses and Canadian groups having limited foreign ownership and activities.
Practical considerations under the EIFEL rules
Prior to the enactment of the EIFEL rules, multinational groups often financed Canadian subsidiaries with a combination of equity and intercompany debt not exceeding the maximum 1.5 to 1 allowable debt to equity ratio under the thin capitalisation rules.
However, such financing structures can result in denied interest deductions under EIFEL where the net interest and financing expenses of the Canadian subsidiary (including both third-party interest and intercompany interest) exceed 30 percent of the subsidiary’s ATI.
The group ratio may not provide adequate relief with respect to intercompany debt as the interest income of the foreign parent and the interest expense of the Canadian subsidiary will generally net to zero for purposes of calculating the ‘group net interest expense’ of the consolidated group.
Similarly, it was common practice in the M&A context to align interest expense with operational cash flows by replacing acquisition debt with debt of the Canadian target company. Following the enactment of the EIFEL rules, further analysis is required to confirm whether the Canadian target company has sufficient ATI to support a ‘push down’ of the acquisition debt to the operational level.
The group ratio may assist in providing additional interest deduction capacity, but generally only to the extent that leverage at the Canadian target company level is commensurate with the overall leverage of the consolidated group.
Group ratio complexities can also arise for foreign investment funds that account for their Canadian investments using the equity method of accounting. Equity-accounted entities cannot form part of a ‘consolidated group’ for the purposes of the group ratio election, and it is often necessary for investment funds to rely on the ‘single member’ group election to access interest deductibility capacity in excess of 30 percent of ATI.
Among other things, the single member group election requires standalone financial statements to be prepared for the Canadian subsidiary and for those financial statements to be audited. Where an investment fund uses fair value accounting, consideration may be given to whether it would be beneficial to make an election to exclude ‘fair value amounts’ from the calculation of the group ratio.
However, this election must be made in the first taxation year in which a consolidated group elects to apply the group ratio and the election applies to all subsequent taxation years of each Canadian group entity.
Conclusion
The EIFEL rules represent a significant change to the interest deductibility landscape in Canada. Traditional cross-border financing structures may no longer be viable under EIFEL and it may be necessary to alter the capital structure of Canadian subsidiaries or make various tax elections to increase interest deduction capacity.
Multinationals and investment funds considering Canadian investments would be well-advised to consider the EIFEL rules at the early stages of a transaction and to monitor the impact of the rules on an ongoing basis to ensure that interest deductibility is preserved.
Elie S. Roth and Ryan Wolfe are partners at Davies Ward Phillips & Vineberg LLP. Mr Roth can be contacted on +1 (416) 863 5587 or by email: eroth@dwpv.com. Mr Wolfe can be contacted on +1 (416) 367 7479 or by email: rwolfe@dwpv.com.
© Financier Worldwide
BY
Elie S. Roth and Ryan Wolfe
Davies Ward Phillips & Vineberg LLP