The New Thin-Cap: Lenders Take Heed!

Canada's thin-capitalization rule has changed. Intra-group loans into Canada must be reviewed if adverse tax consequences are to be avoided. Most importantly, those lenders who accepted the non-deductibility of interest by the borrower must now look to their own tax liability under a rule which is already in effect.

Thin-Cap As It Was

The policy behind the thin-cap rule is to prevent the erosion of Canada's tax base given that interest payments are deductible whereas dividends are not. This rule applies to debt owed by Canadian-resident corporate taxpayers to non-residents that own 25% or more of the corporation's votes or value—such a lender is referred to as a "specified non-resident". The effect of this rule is to deny an interest deduction to the extent that a 2:1 debt to equity ratio is exceeded.