CRA provides a formula for prorating foreign tax between a FAPI and non-FAPI business for FAT purposes

If a foreign affiliate (FA) carries on a business in a foreign county and pays tax to that country on income which the ITA segregates into income from a business other than an active business and active business income, how will the determination of what portion of the foreign tax paid “may reasonably be regarded as applicable to” foreign accrual property income (FAPI) of FA in accordance with the foreign accrual tax (FAT) definition be made?

CRA indicated that it would consider it reasonable to compute FAT by multiplying the total amount of foreign tax paid to the foreign jurisdiction by the foreign affiliate for its taxation year by a fraction:

• the numerator of which is the net income of the foreign affiliate for the taxation year computed under the foreign tax laws from the activities that generate FAPI for Canadian income tax purposes (the “FAPI business”); and
• the denominator of which is the total net income of the foreign affiliate computed under the foreign tax law.

Thus, for the purposes of computing the numerator it is necessary to first identify the activities that would form part of FAPI business, and then the gross income under the foreign tax rules from that FAPI business is to be computed, with that amount then being reduced by the total amount of deductions that are allowed under the foreign tax law and claimed by the foreign affiliate in the taxation year that may reasonably be regarded as directly applicable only to the FAPI business; this amount should also be reduced by the prorated amount of deductions (again allowed under the foreign tax law and claimed by the foreign affiliate) that would not reasonably be regarded as applicable to either the FAPI business or any other income-generating activities, such as overhead or head office expenses.

If there were any tax credits that reduced the foreign tax liability of FA, the above formula might have to be modified or a case-by-case approach might be required.

Neal Armstrong. Summary of 28 May 2025 IFA Roundtable, Q.5 under s. 95(1) – FAT.