CRA finds that interest paid by a US Opco FA to a Finco FA would qualify under s. 95(2)(a)(ii)(B)(I) even if the IRC denied the deduction or required its capitalization to depreciable property

16 September 2026 - 11:39pm
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Canco wholly-owns (through a US holding company) a US Opco, and also wholly owns Luxco, which is a financing subsidiary. Opco uses a loan from Luxco in its US business. The deduction by USco of the interest on that loan is denied under the US hybrid mismatch rules.

Regarding the application of s. 95(2)(a)(ii)(B)(I) (“Cap B”), CRA indicated:

  1. If the interest paid or payable by USco was permanently denied under the US hybrid mismatch rules, then Reg. 5907(2)(j) would apply to provide for the deduction of the interest from USco’s “earnings” under para. (a) of the definition thereof in Reg. 5907(1) – so that such interest would accordingly be recharacterized under Cap B as income from an active business of Luxco.
  2. Having regard to the expanded post-2017 US rules for denying interest deductions, where the deduction of the interest was deferred by those rules, the interest would be considered deductible in computing the amount prescribed to be USco’s “earnings” for purposes of Cap B, given that: “It is sufficient that the amounts be deductible for ‘a’ taxation year of USco.”
  3. However, if USco ceased to be a foreign affiliate of Canco before such deduction became available, this might alter the initial determination in 2 above as to deductibility – however, if so, Reg. 5907(2)(j)(i) likely would be satisfied, so that 1 above would apply.
  4. If the interest instead was capitalized to depreciable property or inventory, it would thereby be expected that the interest expense would be deductible by USco in computing its earnings or loss for a taxation year from an active business as depreciation or the cost of inventory sold – so that, as in, 2, Cap B would deem the interest payable to be income from an active business of Luxco (and similarly re 3 above).

Neal Armstrong. Summary of 5 February 2026 Internal T.I. 2025-1054461I7 under s. 95(2)(a)(ii)(B)(I).