Thin capitalization rules

A foreign buyer who funds a Canadian company with shareholder loans may meet these rules. Subsection 18(4) applies despite other provisions of the Act, apart from subsection 18(8), when a corporation or trust works out income from a business (other than the Canadian banking business of an authorized foreign bank) or property. Whether a lender counts depends on the definitions in subsection 18(5). Whether the rules reach a given structure is a question for the buyer’s tax advisers on a holdco purchase.

How it works

The denied proportion is worked out from debts to specified non-residents, set against an equity amount that, for a corporation resident in Canada, the section builds from retained earnings, contributed surplus and paid-up capital, each as the definition limits them. The debt figure is an average of each month’s greatest total. The CRA’s T2 guide says interest disallowed under these rules is deemed to be a dividend paid to the non-resident. Finance Canada’s notes say the newer limit on interest and financing expenses applies after the thin capitalization rules; see EIFEL.

What to ask

• Whether any lender falls within the definition of outstanding debts to specified non-residents in subsection 18(5)
• How the section measures the debt and the equity for each month
• Whether disallowed interest creates a deemed dividend to the lender