Understanding Foreign Accrual Property Income (FAPI) Rules for Canadian Corporations

Foreign Accrual Property Income, commonly known as FAPI, is a term found in subsection 95(1) of the Income Tax Act (ITA). In simpler terms, FAPI refers to the passive income earned by foreign corporations, which is then included in the income of a Canadian resident taxpayer on an accrual basis. The ITA provides specific definitions for types of passive income related to FAPI. Generally, non-resident corporations are termed as foreign affiliates. There are specific criteria to determine when a corporation qualifies as a foreign affiliate or a controlled foreign affiliate of a Canadian resident taxpayer. 

Key Points about FAPI: 

• FAPI aims to prevent Canadian tax residents from indefinitely deferring taxes on most foreign passive investments. 
• FAPI is included in the Canadian shareholder’s income when earned by its Controlled Foreign Affiliate (CFA), not when it’s distributed. 
• Foreign taxes don’t directly offer a tax deduction or credit. Instead, an income deduction is available based on specific terms. 
• Active business income can sometimes be recharacterized as FAPI and vice versa. 
• FAPI is calculated for each affiliate separately, ensuring it’s never a negative value. 
• Net losses from a CFA can’t offset other income sources of a Canadian corporation or FAPI from another CFA. However, FAPI can offset a corporation’s non-capital losses from other sources. 
• If FAPI income inclusion is less than $5,000, it doesn’t need to be included in the shareholder’s income. 
• FAPI is calculated using Canadian income tax rules and in Canadian dollars. 
• Once income is taxed as FAPI, it isn’t taxed again when repatriated to Canada. 

6-Step Approach to Determine FAPI: 

• Identify Foreign Affiliates: Determine if there are any Controlled Foreign Affiliates. 
• Calculate FAPI: Use the guidelines in subsection 95(1) of ITA. 
• Determine Participating Percentage: Include this in the Canadian shareholder’s income. 
• Account for Foreign Taxes: Calculate the allowed deduction based on taxes paid by the CFA. 
• Calculate Canadian Income Tax on FAPI: Apply Canadian tax rates. 
• Determine Adjusted Cost Base: Calculate the Adjusted Cost Base (ACB) for the shares of the CFA. If there’s a negative ACB, it might trigger capital gains. 

T1134 – Information Return: Canadian corporations with FAPI income must also file T1134, an information return related to foreign affiliates. Ensure timely filing of these returns and supplements. 

Conclusion: FAPI rules can be intricate. If you’re working on a corporate income tax return involving FAPI income, consider seeking expert assistance to navigate the complexities. Additionally, be aware of the proposed changes in Budget 2022, which aim to adjust the relevant tax factor for CCPCs.