Canadian "Thin Capitalization" Rules: Further Broadening

Canada, like many developed countries, restricts the amount of interest a corporation resident in Canada (CRIC) may deduct on loans made by non-residents who are the CRIC's significant shareholders or their affiliates. The aim of these rules is to protect the Canadian tax base from erosion by limiting the extent to which foreign investors may take profits out of their Canadian subsidiaries in the form of tax-deductible interest, rather than after-tax dividends. These rules are commonly referred to as "thin capitalization" rules.

The thin capitalization rules generally deny the deduction by a CRIC of interest payable to specified non-residents (a non-resident owning shares representing more than 25% of the votes or value of the CRIC and any other non-resident who does not deal at arm's length with such shareholder) to the extent that a debt-to-equity ratio is exceeded. Historically, the rules in the Income Tax Act (Canada) (ITA) did not take into account debt owed