OTTAWA — Business groups representing Canada’s venture capital and private equity firms and the chief executives of some of the country’s largest firms are urging the federal government to revise and delay debt-related changes to tax rules set to take effect next year as part of a global crackdown on corporate tax avoidance.
Canada is among 141 countries and jurisdictions participating in an OECD- and G20-led effort to update international tax rules so multinational companies can’t shift money around the world to minimize what they owe. In October 2021, the group agreed to rules including a deal on a new global minimum tax rate.
Talking Point
Business groups want Ottawa to delay and amend forthcoming restrictions on the amount companies can use interest expenses on debt to reduce their corporate taxes. Finance Canada’s consultations on the new excessive interest and financing expenses limitation closed last week, and the measures are scheduled to take effect next year.
The Business Council of Canada, the Canadian Chamber of Commerce and the Canadian Venture Capital & Private Equity Association (CVCA) are raising concerns about some new rules Ottawa is pursuing as another part of that international effort.
Under proposed changes to the Income Tax Act that would take effect in January, businesses operating in Canada would face tighter limits on how much they can reduce their tax bill by deducting from their incomes the interest they pay on loans and other forms of debt.
Some firms would be exempt, including Canadian-controlled private corporations—a popular business structure for tech startups—with less than $15 million in taxable capital, and companies that really only operate domestically.
However, the business groups are concerned that the new restrictions would cover existing loans, which have rates and terms that price in the current tax deduction. The government is “basically asking people to go back and renegotiate” their existing debt, said Kim Furlong, CEO of the CVCA.
“If you’re in private equity or a space where high amounts of leverage are just normal, you have existing [debt] that depends on the interest deductibility,” said Timothy Hughes, who leads the capital-markets tax practice at Osler, Hoskin & Harcourt. Without the tax break, those financing structures “just don’t work anymore.”
During the government’s consultations on the proposals, which closed in early May, the business groups asked Ottawa to apply the new rules only to loans issued after they come into effect.
Canada and its international partners are cracking down on a practice known as base erosion and profit shifting. Some multinational companies use the differences between the laws of the countries in which they operate to minimize what they pay in taxes. Under Canada’s system, which lets businesses deduct interest expenses from their taxable income, a company could have its subsidiary in one country borrow from another of its subsidiaries in a lower-tax country and pay it interest; the first entity would save on its taxes by deducting its interest payments, while the second would pay less tax on those payments.
Canada already has rules to address these kinds of arrangements, said Jeffrey Shafer, a partner at Blake, Cassels & Graydon. But with the proposed changes, businesses would only be able to use the interest deduction on 30 per cent of their earnings before interest, taxes, depreciation and amortization, a basic measure of profit. That would bring Canada into line with the U.S., U.K., and Germany, which have the same 30 per cent cap.
“The potential impact is quite sweeping in terms of its impact on Canadian [corporate] taxpayers,” Shafer said. In the 2021 budget, Finance Canada estimated the new restrictions would bring in almost $5.32 billion in new tax revenue over five fiscal years.
The finance department did not directly answer The Logic’s questions about whether it will accept the recommendations. “The government is committed to moving forward with an earnings-stripping rule that ensures large companies pay their fair share, aligns with our peers, and aligns with the [international] recommendations,” said spokesperson Anna Arneson, noting all other G7 countries have already limited “excessive interest deductions.”
The business groups also want Ottawa to delay the rollout of the changes by at least a year, to the start of 2024. “Our members see the writing on the wall, [and] that other countries are moving in this direction,” said Patrick Gill, the Canadian Chamber of Commerce’s senior director of tax and financial policy. “Their concern is that it’s happening very quickly.”
While the changes were first signalled in the April 2021 federal budget, Finance Canada only launched its consultations in February. Under the current timeline, businesses would have only a few months to adapt once the department publishes its final rules. Gill and Shafer also both noted that the department has several other proposals underway for substantial changes to the federal tax code, increasing firms’ compliance burden. “Our companies, entrepreneurs and investors are dealing with a number of challenges, be it supply-chain, inflation, wage-pressure [or] geopolitical issues,” said Furlong.
Business groups and lawyers warn of other unintended consequences from the changes. The Business Council and Chamber are calling for Finance Canada to carve out large infrastructure builds, citing a similar exemption in the U.S. “Any type of project that’s not going to generate profits for a long, long time and needs funding to get going [will] have a lot of interest expense at the front end,” said Hughes, citing large green-energy or carbon-capture projects.
Hughes also noted that the new rules could cause Canadian multinationals to seek financing outside the country, getting subsidiaries based in jurisdictions with more generous interest-deduction rules to do the borrowing. “That’s not very good for the Canadian capital markets.”