Introduction
Recently proposed amendments to the Income Tax Act (Act) provide Canadian-Controlled Private Corporations (CCPCs) and Substantive CCPCs (SCCPCs) with an elective regime that allows them a greater deduction against Foreign Accrual Property Income1 (FAPI) earned, and repatriated, from a foreign real estate investment business. This new elective regime is a specific benefit to Canadian based real estate investors that employ minimal or no personnel who are physically located in the foreign jurisdiction. These amendments offer flexibility, allowing investors to hold foreign properties within structures involving partnerships while still accessing tax-efficient income repatriation and deductions against FAPI.
Background on FABI and FABI Surplus
Proposals to amend the Act introduced in August 2024 include new Foreign Accrual Business Income (FABI) and FABI Surplus concepts, offering favorable tax treatment for CCPCs and SCCPCs that have foreign subsidiaries. This preferential treatment, allowing for a greater deduction against FAPI and surplus repatriated to Canada, applies to income earned from certain foreign sources, including a real estate investment business income.
For CCPCs and SCCPCs, the greater deduction is caused by an increase to the Relevant Tax Factor (RTF) in respect to specific foreign income, according to an election. This RTF is essentially a gross up factor to determine the following:
- Deductions from Foreign Accrual Property Income (FAPI) – Allowing Canadian parent companies to offset Canadian tax on income from a Controlled Foreign Affiliate (CFA), based on foreign corporate tax paid.
- Deductions on Dividends from Foreign Affiliates – Reducing Canadian tax on dividends paid from a foreign affiliate (FA) to its Canadian parent company based on foreign corporate and withholding tax paid.
The election to apply this enhanced RTF is time-sensitive: Filings for this election must be made by the tax filing deadline of the first tax year starting after 2024.
Read more general insights about the FABI regime here.
Real estate insight on FABI and FABI Surplus
Generally, a real estate investment business is already excluded from FAPI if there are more than five full-time employees (FTEs) working for the business outside of Canada, that are either employed by the CFA itself or a related corporation that receives adequate compensation for having the FTEs engaged in the active business conduct of the CFA. In that case, the corresponding income should arise from an active business and should not be taxed in the Canadian parent on a current basis as FAPI.
Where FABI elections become a valuable tool in the real estate sector is if the relevant FTEs are in Canada. A relevant scenario may be where a CCPC or SCCPC intends to establish a real property portfolio to earn rental income outside of Canada and intends to maintain more than five FTEs in Canada (or between Canada and the US in aggregate) engaged in the active conduct of the business. In this scenario, even though the rental income would typically be considered Foreign Accrual Property Income (FAPI), the CCPC or SCCPC could elect to apply the higher RTF. This election would allow for a greater deduction in determining the FAPI amount included in Canadian income.
By electing to apply a higher RTF, CCPCs and SCCPCs may be able to mitigate or even neutralize Canadian tax on certain foreign income when sufficient tax is paid in the foreign jurisdiction. This allows for greater tax efficiency on international income, especially for real estate investment income that would otherwise be included in FAPI and included in Canadian income on a current basis.
Of importance, the proposed rules provide a look-through where the CCPC or SCCPC parent is a member of a partnership with one or more CFAs. In certain real estate holding structures, a partnership may be used to pool resources and for flexibility of bringing in new partners, but the investment properties could be contained in foreign corporate entities to minimize liabilities or for creditor proofing. As such, the ability to make a FABI election where a CFA is held by an intermediary partnership is a boon to real estate investors.
The deemed election system
The new FABI rules are applicable for tax years that begin on or after Jan. 1, 2025, but taxpayers are entitled to elect to deem that the rules are applicable for pre-2025 years.
The deemed election provisions may be particularly useful where in a prior year:
- a real estate investment business of a CFA generated FAPI and had more than five FTEs in the active conduct of its business who were in Canada, or
- where a foreign affiliate paid a dividend out of what would have been related to FABI for a tax year beginning on or after April 7, 2022.
Similar to ordinary FABI and FABI Surplus elections, the deadline to make these deemed elections for a CCPC or SCCPC is the filing due date for their first tax year that begins after 2024.
