Income Characterization for Canadian Corporations Doing Business Outside Canada – Foreign Accrual Property Income (FAPI)

Income Characterization for Canadian Corporations Doing Business Outside Canada - Foreign Accrual Property Income (FAPI)




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Canadian tax liability generally turns on whether a person is a resident or a non-resident of Canada. A person who is resident in Canada during a tax year is subject to Canadian income tax on his or her worldwide income from all sources, which includes income from an office, employment, property, or business. Accordingly, an individual who is a resident of Canada is subject to Canadian tax on any income earned directly from a source outside Canada. This includes dividends received on shares of non-resident corporations, which would generally be characterized as income from property and included in a taxpayer's income for the year in which the dividends are received (or in which the taxpayer becomes entitled to receive the amount).

Subsection 91(1) is an exception to the general rule that income is recognized in the year in which it is received or receivable by a taxpayer. Canadian taxpayers are subject to current taxation on FAPI earned by closely held corporations (CFAs) regardless of whether the FAPI is repatriated to Canada in the year income or profits are realized by the CFA. Specifically, in computing taxable income for a taxation year, taxpayers are required to include their "participating percentage" of the FAPI earned by each of their CFAs pursuant to subsection 91(1). The amount corresponding to the taxpayer's FAPI inclusion for the year is added to the adjusted cost base (ACB) of its shares in the CFA.

Subsection 91(1) characterizes the inclusion of FAPI as "income from a share," meaning that FAPI is considered to be income from property under the Act. As a result, FAPI included in the income of a CCPC is Aggregate Investment Income (AII). AII earned by a CCPC is subject to a refundable tax on investment income, which results in AII being taxed at an initial rate of 48.7 percent to 54.7 percent. The additional investment tax is refunded to a corporation when it pays out sufficient dividends. When combined with the general corporate income tax rate, the refundable tax on AII results in an initial corporate rate of tax roughly equivalent to the top marginal rate for individuals, thereby denying individual taxpayers any deferral advantage from earning investment income through a corporation[1].

ITA provides specific definitions of types of income Passive income for the purpose of FAPI. Nonresident corporations are generally referred to as foreign affiliates, and there are rules when a corporation is a foreign affiliate or a controlled foreign affiliate of a Canadian resident taxpayer.

[1] Corporate Integration: Outbound Structuring in the United States After Tax Reform, Kevin Duxbury and Tim Barrett.

Quick Facts About FAPI


The actual purpose of FAPI is to avoid a tax deferral by Canadian tax residents, potentially indefinite on most foreign passive investments. Before we go to the overview of different income types included in FAPI, let’s have some quick facts:

  • FAPI is included in the income of the Canadian shareholder when earned by its Controlled Foreign Affiliate (CFA) not when distributed. It’s on a current and accrual basis and included based on a term specifically defined as a participating percentage. 
  • Foreign taxes do not provide a direct foreign tax deduction or credit, instead, an income deduction is available for a term defined as Foreign Accrual Taxtimes relevant factor. See further below.
  • Active business income may be recharacterized as FAPI in certain cases and vice versa.
  • It is calculated on an affiliate-by-affiliate basis in a way that it cannot be a negative number.
  • Net losses from CFA  cannot be used to offset income from other sources of a Canadian corporation or the FAPI from another CFA. However, FAPI can offset a corporation’s non-capital losses from other sources.
  • If the income inclusion under FAPI is less than $5,000, it does not need to be included in the income of its shareholder.
  • FAPI is calculated using the Canadian income tax rules in Canadian dollars.
  • FAPI affects the ACB of shareholders in the shares of CFA and negative ACB can trigger capital gains in Canada.
  • Repatriation of the income already taxed as FAPI is not taxed again in Canada.


6-Step Approach To FAPI Determination


Adopting the below systematic approach may help in determining the FAPI and its tax effects on the Canadian taxpayer:

  1. Identify foreign affiliates and determine if there are any Controlled Foreign Affiliates.
  2. Calculate the FAPI as per subsection 95(1) of ITA.
  3. Determine the participating percentage of the Canadian shareholder as per subsection 95(1), and include in the income of Canadian shareholder’s income as per subsection 91(1).
  4. Determine the Foreign taxes already paid by the CFA and calculate the deduction allowed as per subsection 91(4).
  5. Calculate Canadian income tax on FAPI
  6. Calculate the Adjusted cost basis for the shares of the CFA. If any negative ACB, determine if it triggers capital gains.

Controlled Foreign Affiliate

A Canadian shareholder of a foreign affiliate (FA) includes FAPI in its income only if it is a Controlled Foreign Affiliate (CFA). A CFA is always a FA, however, FA does not have to be a CFA. Therefore, the first step is to determine whether the foreign affiliate is a CFA or not.

Generally, a foreign affiliate is a CFA if the Canadian shareholder owns more than 50% of the shares. De Jure Control is an ability to elect members of the board of directors and can exist even if the equity percentage is less than 50%. Subdivision i of ITA provides the definition of FA and CFA. The definition seems to be straightforward but it may not be the case always. Subsection 95(1) also provides that if the Canadian shareholder and a specified number of other Canadian shareholders in aggregate control the foreign affiliate, it is a Controlled Foreign Affiliate of the taxpayer!


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Income from property 

Generally, income from the property is passive income such as rent, royalties, dividends, and royalties.

  • ITA 95(1) specifically includes “Income from an investment business”. It also provides the definition of investment business and related exceptions. Again, in general, income is from rents, royalties, interest and dividends.

Income from Non-Qualifying Business


Canada has tax treaties with the majority of countries across the world. Canada discourages business with countries that do not have a tax treaty with it or have not signed a tax information exchange agreement (TIEA). Active income from business in such a Non-Designated Treaty Country (Non-DTC) is FAPI.

Income from an Active Business 


Income from an active business from a Designated Treaty Country (DTC) in most cases is not FAPI. There are situations where this active income might be recharacterized as FAPI or situations where foreign-affiliated dumping rules apply. Similarly, there are certain situations where income from the property might be recharacterized as active business income.

Excluded Property 

As mentioned in the definition of FAPI, taxable capital gains from the disposition of property add to FAPI unless they are from Excluded Property. 

If the property used in the active business of a foreign affiliate is very closely related to running an active business, the gains from the disposition of such properties do not give rise to FAPI inclusion.

Investment Property

An investment property is not an excluded property. Gains on the disposition of an investment property are included in FAPI. Investment property includes shares, partnership interests, trust interests, annuities, indebtedness real property or immovable property, resource properties, interests in funds and entities, and interests or options in any of the above.

Participating Percentage 

FAPI is calculated on a share-by-share basis and the participating percentage is the share of this income established for Canadian shareholders of CFA. Subsection 95(4) defines and modifies the definition of participating percentage so that only the lowest tier Canadian shareholder includes FAPI in its income. This is important in situations with multi-tier corporate structures.

Depending on equity share in different classes of shares, if the FAPI of the controlled foreign affiliate is $5,000 or less, the participation percentage is zero. Note that this ($5,000 threshold) is the FAPI of the CFA, not the FAPI of its shareholders.

The product of the participating percentage and per share FAPI of the CFA is added to the income of the Canadian shareholder.


FAPI is calculated on the last date of the fiscal year end of a CFA and added to the shareholder’s income on that date. There are provisions for short year ends and other reorganizational changes during the year.  FAPI is normally calculated in Canadian dollars.

 Income Deduction based on Foreign Accrual Taxes (FAT)

The foreign taxes paid or accrued by a CFA do not give rise to an equivalent deduction from the income or income tax in Canada as one may think. The deduction is instead allowed from the income included as FAPI under subsection 91(4) equivalent to the product of Foreign Accrual Tax (FTA) and a Relevant Tax Factor (RTF).

The purpose of FAPI inclusion is to deter Canadian shareholders of foreign corporations (base companies) to get tax deferral advantage while earning FAPI-styled passive income. In the absence of these base companies, Canadian taxpayers must include such an income on an accrual and current basis. The underlying concept is to allow a deduction equivalent to what would have been Canadian income if the same amount of taxes were paid in Canada.

Foreign Accrual Tax includes income tax paid by CFA on the income included in FAPI, FAPI of another fiscally transparent FA, or withholding taxes paid on receiving dividends from other FAs if they are part of the FAPI inclusion.

The amount of deduction from FAPI included in shareholder income is equal to FAT x relevant tax factor (RTF). The deduction is not available to finance the higher taxes in foreign jurisdictions, therefore, there is a limit imposed on this deduction that it cannot be more than the FAPI inclusion. The taxes must be paid in order to claim this deduction.

Adjusted Cost Base of Shares 

The final step is to calculate the Adjusted Cost Base (ACB) of the shares of the CFA.

The income included under 91(1) is added to ACB and the amount deducted under 91(4) is subtracted from the ACB of the share of the CFA that the Canadian taxpayer holds. The FAPI calculation is never a negative number. In case of negative ACB of the shares, a Capital gain is triggered. Subsections 93(1) and 92(1) further provide mechanisms to avoid double taxes on capital gains.



Two Canadian resident individuals own a Canadian corporation (CanCo) that owns U.S. treasury bills in a fully owned U.S. Corporation (USCO) – 100 shares.

Step 1: Since the ownership of USCO is with CanCo and not the individuals, FAPI analysis and income inclusion need to be done for CanCo. USCO is a CFA of CanCo.

Step 2: Assume this corporation earned interest on T-bills worth $10,000 during its fiscal year.

Step 3: Participating percentage per share is 100%.  Therefore per share, the FAPI of CFA is $100

Step 4: Calculating income inclusion and deduction. Assume $2,000 taxes already paid in the U.S. by CFA.

[Participating percentage x FAPI per share is $100] x 100 shares = $10,000 income as per 91(1)

[1/(38%-13%) x taxes paid of $2,000] = [4 x 2,000] = $8,000 deduction as per (91(4)

Step 5: The net amount added to the Canadian tax base is $2,000. After applying a tax rate of 25%, CanCo pays $500 tax in Canada. The total tax paid now is 2,000 in U.S. and 500 in Canada with a total of $2,500.

Step 6: Add $10,000 to the ACB of shares and deduct $8,000 from the ACB. [2]

[2] “Foreign Accrual Property Income”, Maroof Hussain Sabri

Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at or on Facebook at Kilpatrick for more information on our firm.  




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