Part II of this four-part series delves into the issues occurring in modelling EIFEL with respect to non-capital and capital losses.
Navigating the evolution of EIFEL rules: Part IV
In the final part of our series, we explore the recent updates with EIFEL rules.
Read morePart II – Non-capital and capital losses
a) Tracking losses
When modelling restricted interest and financing expenses (RIFE) for a taxpayer, one of the initial steps is computing adjusted taxable income (ATI). ATI is computed as taxable income subject to specific adjustments including, but not limited to capital cost allowance, interest and financing expenses and revenues, and the portion of net interest and financing expenses (IFE) deducted in the non-capital loss (NCL) utilized for the taxation period.
The adjustment for IFE deducted in the NCL pool is determined via a prescribed formula in the Act. It is important to note, this adjustment requires the taxpayer to determine the IFE arising in the taxation period that gave rise to the NCL being utilized and incorporates adjustments with respect to attributes of controlled foreign affiliates. This adds additional complexity in computing ATI, and further emphasizes the necessity of determining and tracking IFE arising in each taxation period in which a non-capital loss is generated.
As an alternative to the detailed calculation, the legislation offers an election to treat non-capital losses arising pre-Feb. 4, 2022, as a specific pre-regime loss, deeming 25% of the NCL balance utilized to have arisen from IFE related amounts. While this provides administrative relief, it may not be beneficial for taxpayers with insignificant IFE related deductions in prior periods.
IFE for a taxpayer contains amounts included within a capital loss deducted in computing taxable income for the year, which relate to amounts arising on debt; an example would include foreign exchange. This is commonly observed in private equity structures whereby acquisitions or ongoing operations may be funded using foreign denominated debt. As repayments of principal arise, a foreign exchange loss may be realized, giving rise to a capital loss.
Unfortunately, no grandfathering date is provided for capital losses. Instead, tracking is required from when the capital loss first arose to determine the proportion related to IFE amounts. For example, realized foreign exchange loss on capital loans. This can present difficulties for many taxpayers—adding to the administrative and compliance cost burden.
b) Utilization of non-capital losses
Non-capital losses expire after 20 taxation periods and can be utilized against taxable income at the taxpayer's discretion. RIFE, however, can be carried forward, indefinitely but can only be utilized in a taxation period that gives rise to excess capacity. Like NCL's, RIFE are also subject to loss-restriction rules.
The utilization of NCL's in computing ATI effectively reduces a taxpayer's capacity for deducting net IFE, which in turn increases the amount of RIFE. It is vital for the taxpayer to understand the impact utilizing NCL's will have on their cash taxes payable, especially where there are insufficient NCL's available to shelter additional taxable income arising from EIFEL restrictions. Where there are NCL's and RIFE, we are essentially trading NCL's, which have a wider application against income sources for RIFE. It is likely due to RIFE having a narrower application that it has an unlimited carry-forward period.
As discussed above, a portion of net IFE deducted in the NCL utilized is added back in computing ATI. Given the circular impact of NCL's offsetting additional taxable income arising from EIFEL restrictions, taxpayers must adjust the EIFEL calculation based on the final amount of NCL's utilized in the EIFEL year. This iterative process entails complex calculations to determine the optimal NCL required to offset the additional taxable income resulting from EIFEL restrictions. Further, the taxpayer's decision on utilizing NCL's is also expected to impact the recognition of deferred tax assets on NCL's and RIFE.
Utilization of NCL's is at a taxpayer's discretion. Historically, NCL's have not previously retained their character based on the source of expense on which they arose. Consequently, a first-in, first-out approach was commonly adopted when utilizing NCL's. However, the EIFEL legislation alters this dynamic by designating a portion of NCL's as arising due to IFE. This raises the question, if certain taxation periods generate NCL's unrelated to IFE, can taxpayers prioritize the utilization of those NCL's over others? Clarification from the Canada Revenue Agency on this is eagerly awaited.
Key takeaways and next steps
The tracking of IFE amounts within NCL and capital loss pools adds complexity to taxpayers' compliance burden. While the specified pre-regime loss election provides relief, it may not always be advantageous. Taxpayers impacted by these rules should consider the following next steps:
- Taxpayer's which bring NCL's into taxation periods to which EIFEL applies should carry out a review of their historical operations to determine IFE arising in each NCL generating taxation period.
- Following the above analysis, the taxpayer should determine whether the specified pre-regime loss election provides additional relief or whether adjusting for IFE arising in the NCL year is beneficial.
- Prepare conservative forecast models for an EIFEL modelling exercise to determine the optimal utilization of NCL's and RIFE. This calculation should assist the taxpayer in supporting their position on the recognition of deferred tax assets arising on NCL and RIFE attributes.
Contact your BDO advisor to learn more about how we can help you manage the impact of these proposals on your business.
Harry Chana,
International and Cross-Border Tax Services Leader
Jaskirit Randhawa,
Senior Manager, International Tax
The information in this publication is current as of April 16, 2025.
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