New interest deductibility regime will change foreign investment landscape: Stikeman tax partner

A revamping of Canada’s interest deductibility regime for tax purposes means foreign investors who borrow to finance Canadian acquisitions could face complex limitations on deducting interest on these loans, says John Lennard, a new tax partner at Stikeman Elliott LLP.

“Canada announced a couple of months ago a wholesale change to the way we view interest deductibility,” says Lennard, noting that it will impact foreign investors who borrow through a Canadian entity to pay for their purchase of a Canadian firm. “That’s something that I think is particularly going to be of interest to investors from other jurisdictions who are coming into Canada.”

Lennard adds that an affected taxpayer’s interest and financing deductions will be limited to a fixed percentage (eventually 30 percent) of the taxpayer’s EBITDA. However, higher ratios may be available for taxpayers in multinational groups with audited consolidated financial statements.

Capital-intensive industries, such as real estate and infrastructure, will be particularly affected, Lennard says. And relative to other counties with similar rules, Canada’s laws are arguably more onerous in that they, as currently drafted, kick in at lower thresholds and do not provide as many exceptions.

Until the changes came, Lennard says, Canada had a system of rules for debt financing by foreign investors who borrow through their Canadian corporate entity. “There were certain deductibility limits that were well known, easy to understand.” Now, with these new interest deductibility rules as a function of EBITDA, “it is going to be incredibly complex” and have an impact on how investors kind of approach things.

Lennard points out that Canada, along with other OECD countries, has been in extensive negotiations on changing international tax rules to ensure multinational enterprises [MNEs] are paying their “fair share” in tax, no matter where they operate.

The OECD recently announced a “two pillar” approach. Pillar one involves a complex set of rules allocating taxing rights to various countries where a large MNE operates. Pillar two involves a similarly complex set of rules that essentially establish a 15 per cent minimum tax for large MNEs.

While these rules try to create a fairer international tax system, Lennard says it isn’t clear yet the extent to which Canada will benefit.

“Our current international tax regime generally encourages the growth of Canadian MNEs by allowing foreign business profits to be brought back to Canada tax-free, even when earned in low-tax jurisdictions. By setting a 15 percent minimum tax, the concern is that Canada will effectively be allowing low-tax jurisdictions to collect tax on profits of Canadian MNEs that could otherwise be brought back and used to invest in Canada.”

With many economists are predicting an economic slowdown, Lennard says a recession tends to raise tax issues for businesses as it relates to debt. As creditors become more inclined to forgive or settle the debt without full or even partial repayment, more corporations may find that they are settling the debt for less than the principal amount.

While this may initially seem like a favourable result for debtor corporations, tax implications must be considered. “Specifically, debtor corporations need to consider the impact of the debt forgiveness rules so they can plan accordingly,” he says.

“This will be on the tax landscape in the next year or two, as companies go through a transition period of dealing with a recession coming out of a pandemic.”

Lennard joined Stikeman’s tax group practice in June, having spent the prior ten years at Davies Ward Beck and Vineberg. He works closely with leading private and public companies, pension funds, sovereign wealth funds, private equity firms and Crown corporations. He is involved in corporate reorganizations, mergers and acquisitions, investment fund formation, and corporate finance matters.

Lennard is also frequently called upon to consult on cross-border transactions, structuring non-resident investment into Canada and outbound investment by Canadian multinationals.

In addition, Lennard advises high-net-worth individuals on a wide variety of taxation matters. John’s clients turn to him for his practical and business-oriented advice on all aspects of domestic and international tax planning. He also represents taxpayers in tax audit matters and disputes with the Canada Revenue Agency and provincial taxation authorities and acts as counsel in tax litigation matters before the courts.

John Lorito, head of the Toronto tax group at Stikeman, says that Lennard “stands out as an up-and-coming practitioner with deep knowledge of tax laws in Canada. He adds that his addition to the Stikeman tax team strengthens the firm’s ability to provide clients with counsel on complex tax matters “at a time when the rules are changing at a rapid pace.”

Lennard adds that with Stikeman being a significant player in M&A in Canada, it is at the forefront of development in related tax law, especially in an era of increased cross-border transactions.

Lennard is also a long-time advocate for diversity, equity and inclusion in the legal profession. He is a member of the Canadian Association of Black Lawyers, the Canadian Bar Association’s Québec Steering Committee for the Sexual Orientation and Gender Identity Committee, and L’Association des juristes d’expression française de l’Ontario.

“This is my 11th year as a lawyer, and when I started, there were fewer people of colour in the legal space and even fewer partners,” he says. By being part of these organizations and helping mentor young black students wanting to become lawyers, Lennard hopes he can be someone “that they look up to and can see as an example of what is possible.”