The interest deductibility limitation proposal – a new, critical tax issue

Besides the promise to review the capital gains inclusion rate, the Liberals made another tax promise in the October campaign that could have serious unintended consequences, detrimental to rental housing providers and renters. It now appears that a decision on any change to capital gains taxes is not imminent. However, unless the federal government reverses course, it is our understanding that a change to the interest deductibility rules will be announced in Budget 2020, which is likely to be tabled in March or early April.

Explanation of the issue

The federal government proposes to set a limit on the amount of interest that any business can claim as an expense against gross income for tax purposes. The proposed limit is 30% of the corporation’s “earnings before the deduction of interest, taxes, depreciation and amortization” (EBITDA). EBITDA is similar to net operating income less applicable administrative expenses.

The proposal seems like a gross interference with a person’s right to run their business as they choose. However, the measure has been recommended for all countries by the Organization for Economic Cooperation and Development (the OECD), as a step to avoid income shifting, whereby multinational corporations shift expenses, and thus income, between countries to avoid taxes.

Such a limitation would have a serious impact, raising taxes on rental housing providers, because rental housing is capital intensive, and most rental providers pay more than 30% of EBITDA on interest. See the table below for two examples.

The table shows two typical situations for a building which has been held for five or ten years: first, a typical income, expense and tax situation for a principal business corporation (a PBC), and second, the situation for a real estate investment company, with five or fewer full-time employees. All the figures are based on one unit in a multi-unit building.

SectionBuilding item (per rental unit)Principal Business Corp (PBC)Real Estate Investment Corp
Basic building facts
Property value$180,000$180,000
Gross rental income$12,000$12,000
NOI (approx = EBITDA)$7,200 $7,200
Interest payments per year (at 4% and a $90,000 loan amount)$3,600$3,600
Capital cost allowance claimed$2,000$2,000
Current tax situation
Net income before tax$1,600$1,600
Total corporate tax (fed & prov – approx)$585$803
Net income after tax$1,015$797
Apparent proposal
Interest payment allowed (30% of EBITDA)$2,160$2,160
Notional net income for tax calculation$3,040$3,040
Total corporate taxes (fed & prov – approx)$1,110$1,526
Actual net income (from above)$1,600$1,600
Actual net income after tax$490$74
Increase in tax (in dollars)$525$723
Increase in tax (as percentage)90%90%

To see what you can do to help prevent this tax change, click here.

John Dickie, CFAA President