What are the EIFEL rules?

Near the end of 2022, the CRA introduced new rules that limit the proportion of interest & financing expense that may be deducted for tax purposes. These new rules may impact family office financing and income splitting arrangements. To provide clarity about how your family office financing arrangements might be influenced, this post will briefly outline what the new rules are, and how your arrangements might adapt.

Many multi-family offices typically finance their operations in certain tax efficient ways that resemble “family banks”.

Family banks are private financing arrangements that share resources, risks, costs & benefits among family members spanning generations.

For example, a corporation holding assets belonging to the entire family may be owned by multiple generations of the same family by way of different equity classes and debts. Such arrangements might include a class of “frozen shares” and/or promissory notes with voting rights owned by grandparents, voting shares owned by parents, and non-voting growth shares owned by grandchildren (inside trusts or held directly).

The interest rates paid on promissory notes (advances from shareholders and loans to shareholders) may carry low or high interest rates that balance the tax and economic benefits between various generations. Such arrangements may result in some entities having low or negative taxable income when they are young & growing while others having high taxable income being offset by charitable donations, etc when they are closer to the end of life.

These high-level estate & succession financing arrangements also consider where shared services costs will fall. This includes the management & administrative (family office) services provided by a small group of employees serving the family (including private holdings & charitable foundations).

One simple example of this would be a corporation owned by grandparents that provides low interest (prescribed rate) loans to corporations owned by children & grandchildren so that growth is in the hands of younger generations (to delay the realization of capital gains).

The result of such arrangements might result in a break-even level of tax income showing on the books of the corporation owned by the children & grandchildren because interest expense makes up almost all the corporation’s expenses.

Such family office financing arrangements may be impacted by the new Excessive Interest and Financing Expenses Limitation (“EIFEL”) rules.

New EIFEL rules limit interest deductions by capping interest and financing expenses net of interest and financing revenues to 30 per cent of adjusted taxable income for taxation years starting on or after Jan. 1, 2024.

Notable “excluded entities” will not be subject to this requirement include:

• Canadian-controlled private corporations and any associated corporations with taxable capital employed in Canada of less than $50 million.
• Corporations or trusts that are part of a group where the Canadian members have total interest & financing expense (net of interest & financing revenues) for the year of $1 million.

This means that if your family’s group of corporations & trusts that may be subject to the EIFEL rules has capital under $50 million or interest & financing revenues under $1 million, your family will not be subject to these new rules.

The new EIFEL rules are designed to catch large multinational corporations who are attempting to avoid taxation in Canada, but the result may be that some wealthy Canadian investors might be caught in the same net.

The new EIFEL rules will make it so that entities (corporations & trusts) used for the purposes of shared financing arrangements will not be able to claim deductions for financing expenses past a threshold of 30% of adjusted taxable income.

Some family holding structures may need to be re-organized as result of these tax rule changes. If your family’s financing revenue or expenses has crossed $1 million or you are employing more than $50 million in capital, meeting with your accountant to consider alternative arrangements is prudent this year.

If it turns out that your financing arrangements will need to be changed due to the new EIFEL rules, it might be as simple as re-papering promissory notes to reflect new rates of interest or updating share ownership between generations.

Our family office has experience supporting the financing arrangements of wealthy families who are trying to transition wealth to multiple generations including support for philanthropy. Please contact our office to learn more about the management & administrative services we provide.