This article is for informational purposes only and does not constitute tax or financial advice. Consult a qualified accounting professional before making any tax or financial decisions.
Quick Answer
- Interest on a Canadian business loan is generally deductible, but only the interest portion, not the principal, and only when the borrowed money is used to earn income from a business or property under Section 20(1)(c) of the Income Tax Act.
- Three federal rules can reduce or disallow the deduction even when a loan is clearly for business use: the CRA purpose test, the Excessive Interest and Financing Expenses Limitation (EIFEL), and the thin capitalization rules for debt owed to non-residents.
- Most small Canadian corporations qualify as excluded entities under EIFEL and are not capped, but owners whose corporate group has combined net interest above the $1 million de minimis threshold or non-resident shareholders can lose part of the deduction.
- Business owners should keep traceable records showing how each borrowed dollar was used, because CRA may disallow interest on loans that cannot be clearly tied to an income-earning purpose.
The Chamber of Commerce Just Told Ottawa a Rule You Have Never Heard Of Is Hurting You
This week, as the federal budget lands, the Canadian Chamber of Commerce is publicly asking Finance Canada to change a tax rule most small-business owners cannot name: the limit on how much business loan interest a Canadian company can deduct. The lobbying push has made headlines because mid-sized and larger corporations are already losing part of their interest deduction under the new Excessive Interest and Financing Expenses Limitation, known as EIFEL.
If you own or run a Canadian corporation and you have ever signed a loan agreement, this matters to you, even if the headlines sound like big-company news. The default assumption, that every dollar of interest a business pays is automatically written off against taxable income, has quietly stopped being true for a growing number of Ontario owner-managers.
Quick Start: Pick Your Path Through This Article
Sole proprietor or a single-shareholder corporation with no related companies and under $1 million of total interest expense. Start with the Section 20(1)(c) purpose test and the loan-type reference table.
Several related corporations, group net interest above $1 million, or any non-resident shareholder or lender. Read the EIFEL and thin capitalization sections carefully before signing new facilities.
If you are still weighing whether to operate as a sole proprietor or a corporation, start with our guide to self-employed or incorporated before layering on interest rules.
What CRA Actually Lets You Deduct Under Section 20(1)(c)
The good news first: if your loan was drawn down to buy inventory, finance receivables, acquire equipment, or fund day-to-day operations, the interest typically qualifies. The federal tax system treats interest as a cost of doing business. You can see how this interacts with your overall corporate tax bill in our explainer on Canada's corporate tax rates.
Where owners run into trouble is co-mingling. If you deposit a $100,000 business loan into an account that already held personal money, then pay yourself a dividend from the same account, CRA can argue that part of the borrowing financed the dividend rather than the business. The direct-use test looks at what the money actually did, not what the loan paperwork said it was for.
The second trap is capital versus income account. Interest to buy a piece of land you plan to develop may be capitalized to the land's cost rather than deducted now. The rule is nuanced and depends on how the property is used in your business.
The EIFEL Rule: Why Small Does Not Always Mean Safe
Here is the reassuring part: if you run a single Ontario CCPC with reasonable debt levels and no foreign parent, EIFEL probably does not apply to you. Finance Canada built an excluded-entity exception precisely so that ordinary owner-managed businesses would not be dragged into a rule designed for multinationals.
The less reassuring part is the aggregation rule. EIFEL looks at your corporate group, not just one company. If you own three related corporations, each paying $400,000 of net interest, you are at $1.2 million as a group, which is over the de minimis threshold. That is the trap owners miss.
EIFEL compliance is filed as Schedule 130 with your corporate T2 return. If your accountant has not mentioned it, and your corporate group has crossed the threshold or added a non-resident shareholder recently, that is a conversation worth having before your next filing deadline. You can see how taxable capital and related tests interact with other SME rules in our piece on the small business deduction and taxable capital.
| Scenario | Net interest | Related group? | Non-resident? | EIFEL applies? |
|---|---|---|---|---|
| Single Ontario CCPC | $200K | No | No | No |
| Two related CCPCs | $400K combined | Yes | No | No (under $1M) |
| Related private group | $1.2M combined | Yes | No | Yes |
| CCPC with non-resident parent | Any | N/A | Yes | Yes (even below threshold) |
| Public corporation | Any | Yes | Often | Yes |
Thin Capitalization: The Rule That Catches Cross-Border Owners
If your corporation has a shareholder, parent company or related party who is not a resident of Canada, a separate rule may apply on top of EIFEL. The thin capitalization rules generally limit interest deductibility when debt owed to specified non-residents exceeds 1.5 times the corporation's equity attributable to those non-residents.
This often catches Canadian subsidiaries of foreign parents, owners who have emigrated but kept a Canadian company, and family groups where capital was loaned in by a relative living abroad. The disallowed interest is permanently lost. It does not carry forward. If this situation sounds familiar, the planning window is before you take on the next loan, not after.
Loan Type Matters: Not All Business Borrowing Is Treated the Same
The structure of your financing decides when, and sometimes whether, the interest becomes deductible. A term loan used to buy inventory produces an immediate deduction. A loan used to buy a capital asset may force the interest to be added to the asset's cost base. And interest you pay on a line of credit you also use for personal purchases is a split calculation CRA expects you to document.
The common risk across every loan type is traceability. Owners who use one business account for everything often cannot prove, two years later during an audit, which dollars funded which expense. If you want to know which financing structures Canadian SMEs are using today, our overview of alternative business financing in Canada walks through the options.
| Loan type | Interest treatment | Common trap | Documentation |
|---|---|---|---|
| Term business loan | Generally deductible as paid | Fund diversion to non-business use | Drawdown memo, invoices |
| Operating line of credit | Deductible on business-use share | Co-mingled personal spending | Monthly use allocation |
| Equipment financing | Interest deductible; asset capitalized | Mixed personal use | Usage log |
| Shareholder loan to corp | Deductible to corp if reasonable rate | No written agreement | Loan agreement, rate basis |
| Commercial mortgage | Generally deductible if property earns income | Partial personal use of building | Square-footage split |
| Vehicle financing | Deductible on business-use percentage | No mileage log | Mileage log, trip detail |
| Business credit card | Deductible on documented business charges | Mixed card used for both | Charge-by-charge tagging |
A Six-Step Roadmap to Protect Your Interest Deduction
- 1Separate borrowing by purpose.Keep operating loans, capital-asset loans and shareholder loans in distinct accounts so direct use is traceable without reconstruction.
- 2Document direct use at drawdown.A short memo saved to your accounting file, naming the invoices or assets the funds will pay, is often enough. Do this when the loan funds, not during the audit.
- 3Track every refinancing with a paper trail.Replacing one loan with another does not automatically carry forward the original purpose. CRA can ask you to re-prove direct use.
- 4Run the EIFEL de minimis test annually.Add up net interest and financing expenses across every related corporation. If the group is near $1 million, flag it for your accountant.
- 5Review intercompany and shareholder loans before year-end.Interest rates on shareholder loans should align with the CRA prescribed rate or be supported by documentation.
- 6Book a planning review before signing any new facility.Our guide to smart tax strategies for Canadian small businesses covers how financing choices interact with other SME tax rules.
Common Mistakes That Cost Owners the Deduction
Across CRA audits of Ontario SMEs, a handful of errors show up repeatedly. Each one is easy to avoid with better habits, and most can be corrected if caught before the return is filed. Our broader CRA audit business checklist covers the full review process.
- →Co-mingling a business line of credit with personal spending, then claiming the full interest without a split calculation.
- →Deducting interest on a loan that CRA later classifies as capital in nature, usually because the funds bought land or a long-term asset.
- →Treating interest on a shareholder loan the company used for personal expenses as a corporate deduction, when only the business-use portion qualifies.
- →Missing EIFEL filing obligations after a corporate group crosses the $1 million de minimis threshold, often triggered by growth or an acquisition.
- →Setting intercompany or shareholder loans without a written loan agreement, interest rate or repayment terms, which weakens the deduction on audit.
- →Assuming all mortgage interest on a business property is deductible when part of the property is used personally or rented at below-market rates.
- →Paying off a deductible business loan with cash that could have paid down non-deductible personal debt instead, which permanently loses a deduction.
Frequently Asked Questions
Can I deduct the whole loan payment, or only the interest?
Is interest on my business line of credit tax deductible in Canada?
What happens if I used a business loan partly for personal expenses?
Does the EIFEL rule apply to a small Ontario corporation?
If I refinance a business loan, do I lose the interest deduction?
Is interest on money I lent my own corporation deductible by the company?
Can I write off interest on a mortgage for my business's building?
What records does CRA expect me to keep to prove my interest is deductible?
Talk to ClearWealth Before Your Next Loan
Interest deductibility is one of the few tax areas where the decisions you make at loan signing determine the outcome. Owners who document direct use, separate borrowing by purpose, and run an annual EIFEL check rarely lose deductions they should have kept. If you are signing a new facility, restructuring a group, or unsure whether EIFEL or thin capitalization applies, a short planning conversation before year-end is almost always cheaper than fixing a disallowed deduction later. You can also review our services to see how we work with Ontario owner-managers.
Book a ConsultationThis article is for informational purposes only and does not constitute tax or financial advice. Tax rules may change, and the application depends on individual facts and circumstances. Consult a qualified accounting professional before making any tax or financial decisions.
Sources & References
- →Government of Canada, Income Tax Act, Section 20(1)(c): laws-lois.justice.gc.ca/eng/acts/i-3.3/
- →Department of Finance Canada, Excessive Interest and Financing Expenses Limitation legislative proposals: canada.ca/en/department-finance
- →Canada Revenue Agency, Interpretation Bulletin IT-533 (archived), Interest Deductibility and Related Issues: canada.ca — IT-533
- →Canada Revenue Agency, Prescribed Interest Rates: canada.ca — prescribed rates
- →Canada Revenue Agency, business income and expenses guidance: canada.ca — business expenses
- →Canadian Chamber of Commerce, pre-budget submissions: chamber.ca
- →CPA Canada, Tax Blog on EIFEL implementation: cpacanada.ca
