What is FAPI?
Foreign Accrual Property Income, or FAPI, are a set of rules in the Income Tax Act (the “ITA”) that treats property income the same as if accrued domestically or abroad. Where a Canadian resident has a substantial interest or level of control in a foreign corporation, the corporation will be treated as an extension of the Canadian shareholder. The FAPI regime is intended to prevent Canadian residents from avoiding Canadian income tax on passive investment income earned through a controlled foreign affiliate located in a low tax country or tax haven. In this way, income in a controlled foreign affiliate will be taxed in the hands of the Canadian shareholder, even if the shareholder has not yet received funds. The income is taxed in Canada as if it was earned directly. This eliminates any tax deferral advantage in investing offshore.
The FAPI rules only apply to passive income held in a corporation (which is a controlled foreign affiliate) off-shore. They do not apply to active business income earned by a corporation off-shore or to a corporation that is not a controlled foreign affiliate. Passive income includes income from rents, royalties, or taxable capital gains. Active business income includes most types of businesses, such as manufacturing, or other services which require active management.
Canadian resident shareholders to which FAPI can be imputed include individuals, corporations, partnerships, and trusts.
Controlled Foreign Affiliate and FAPI
The level of control that a shareholder exercises over an off-shore corporation is determinative of whether the FAPI rules will apply. If the shareholder owns more than 50% of the shares of the offshore corporation, then the corporation will be considered a controlled foreign affiliate. However, the definition of control is broad and the rules are designed to capture instances where the shareholder continues to control the foreign corporation indirectly.
Where the corporation is a controlled foreign affiliate, the ITA taxes the Canadian shareholders directly when the controlled foreign affiliate earns passive income, eliminating any tax deferral. Where passive income is earned by the controlled foreign affiliate, it is irrelevant whether the foreign country has a tax treaty with Canada.
FAPI is not applicable where the level of control exercised by the shareholder over the off-shore corporation is under 50%, or where the off-shore corporation is otherwise not considered a controlled foreign affiliate. However, there are other tax consequences applicable once a shareholder owns 10% or more of an off-shore corporation. These tax consequences fall under a different regime.
The control rules in the ITA are complex and situation based, and it is recommended a tax lawyer is consulted.
FAPI and Equality / Neutrality
The tax system is designed to be neutral with respect to an investor’s global tax; the Canadian investor’s worldwide tax payable to Canada will be the same whether they invest at home or abroad. The principal of capital export neutrality prevents a Canadian investor from avoiding taxes by moving investments to a tax haven. Income earned abroad is taxable in the country of residence. However, to alleviate double taxation, tax relief is provided to account for foreign taxes paid abroad.
Foreign Tax Credits and FAPI
Canada provides a foreign tax credit under section 126 of the ITA to alleviate any double taxation that may arise when taxes were paid in the foreign jurisdiction on the same income taxed by Canada. For shareholders whose controlled foreign affiliate received FAPI, foreign tax credits are generally applicable where foreign taxes were also paid.
Foreign tax credits are computed by country and must be applied to foreign tax paid on non-business income before being applied to foreign tax paid on business income.
You should know it is possible that your offshore corporation pays tax, and you do not receive tax credits for the taxes paid. A lawyer should be consulted so you are not double taxed.
The CRA also requires a corporation with off-shore affiliates to comply with certain foreign reporting requirements. The FAPI rules are complex and their application will differ on a case-by-case basis. You should speak with a qualified tax lawyer to discuss how FAPI may arise in estate planning or offshore investment planning. Contact us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.