Understanding Foreign Accrual Property Income in Canada.

Are you a Canadian Taxpayer looking to invest in another country? Have you heard of the ‘Foreign Accrual Property Income (FAPI)? If you have not, do not invest before you read this article!  

Imagine, if you will, a scenario. There is a wealthy Canadian taxpayer in the highest personal tax bracket. He has contributed the maximum amount to his RRSP and TFSA, and is looking to invest his excess cash. Regardless of whether he invests his money in a Canadian corporation or other company, the CRA will tax him at a rate of 46-47%. Are you receiving a foreign inheritance? Visit our resource: taxes on foreign inheritance.

Let us say our wealthy taxpayer hears of a lucrative opportunity. In a small Caribbean country, the corporate tax rate is a very low 1%. He plans to set up a corporation there, named CariCo. The government of the small country will tax Investments through the corporation taxed at 1%. Compare this to 46-47% in Canada. Paying less tax, our taxpayer has more money to invest and can grow his investments more than he could in Canada.

So why isn’t everyone investing like our wealthy taxpayer? The Canada Revenue Agency (“CRA”) recognized this opportunity for arbitrage years ago. They closed the loophole through the “Foreign Accrual Property Income” or FAPI. For more information on how’s the CRA Assessing Position can reduce your FAPI, please visit McCarthy Tétrault: How the CRA’s New Assessing Position Can Reduce Your FAPI.

What is the Foreign Accrual Property Income (FAPI) in Canada?

FAPI credits any investment income earned by a controlled foreign affiliate (“CFA”) to the Canadian resident. The CRA bases this on the resident’s ownership percentage in the CFA. Do you have foreign employment income? Want to reduce your taxes? See our resource: can I reduce my Canadian taxes for foreign taxes?

Going back to our example, let us assume our investor sets up a corporation he owns by himself. This corporation earns interest income by investing in international bonds. The CRA will credit all interest income to the Canadian resident and tax the income as if the Canadian resident earned it directly.

The CRA does this to negate any unfair advantage gained by setting a dummy corporation in a lower tax jurisdiction. Note that they only apply FAPI on passive income. If the Canadian resident earns active business income through CariCo (such as growing bananas, or providing tours), the CRA will not apply FAPI.

When is FAPI applicable?

FAPI is applicable if the Canadian resident holds an interest in a CFA. The rules surrounding this are somewhat complex, but direct holding 51% or more interest in a foreign corporation will normally qualify you. Income Tax Act S.95 (1) has the detailed definition of CFA.

What is the filing requirement?

If a taxpayer holds interest in a CFA or a Foreign Affiliate (“FA”), he or she is required to file form T1134. It is due 15 months after the taxpayer’s year-end. As the form can be quite confusing, I recommend contacting me if you hold interest in a CFA or FA. For more information, please visit Osler at Canada’s Foreign Affiliate Rules: A Decade of Proposals Nearing Completion or the Canadian Tax Forum’s Back to Basics “FAPI-tizers” – Canadian Tax Foundation.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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