28 May 2025 IFA Roundtable Q. 5, 2025-1063771C6 - Computation of FAT

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Allocation of deductions allowed under foreign law between the active business and the FAPI-generating business of a foreign affiliate for the purpose of determining the amount of foreign tax that is FAT applicable to the FAPI of the foreign affiliate.

Position: Foreign deductions should first be allocated to income from an activity to which they may reasonably be regarded as applicable.

Reasons: The language in the FAT definition in subsection 95(1) requires an allocation of foreign tax to FAPI on reasonable basis.

IFA 2025 Annual Conference – CRA Roundtable

Question #5 – Computation of FAT

Subsection 95(1) defines foreign accrual tax (FAT), in part, as the portion of any income or profits tax “that may reasonably be regarded as applicable” to any amount of foreign accrual property income (FAPI) included under subsection 91(1) in computing a taxpayer’s (Canco) income for a taxation year in respect of a particular foreign affiliate (FA).

FA carries on a business in a foreign jurisdiction and pays income or profits tax to that country on income which the Income Tax Act (the “Act”) segregates into income from a business other than an active business and active business income.

The definition of FAT requires a determination of what portion of the foreign tax paid “may reasonably be regarded as applicable to” FAPI of FA. If a proration of the foreign tax between the two streams of income of FA is required in order to determine FAT, how should deductions available under the foreign tax law (which effectively reduce the amount of the foreign tax of FA) be allocated to make that proration?

Would foreign deductible amounts be allocated to the two streams of income on the same basis regardless of whether they arose in the taxation years before FA became a foreign affiliate of Canco (the “pre-acquisition amounts”) or after?

CRA Response

The phrase “may reasonably be regarded as applicable” in the definition of FAT contemplates the reconciliation of a wide range of temporary and permanent differences that can result from FAPI being computed pursuant to the provisions of the Act and the amount of the foreign taxable income being determined in accordance with foreign tax law.

In the generic scenario described in this question, the Canada Revenue Agency (CRA) generally considers it reasonable to determine FAT applicable to the amount of FAPI of FA for a taxation year of FA by multiplying the total foreign tax paid by FA to the foreign country for a taxation year of FA by the fraction that the amount of the net income from the activities generating FAPI for Canadian tax purposes (the “FAPI Business”) represents of the total net income of FA for the taxation year of FA, both as computed under foreign tax law. A formulaic approach appears adequate.

To compute the net income of FA from the FAPI Business for purposes of establishing the numerator of that fraction, FA’s activities that generate FAPI first need to be reasonably identified.

Once those activities are identified, the second logical step requires the determination of the following amounts:

A - the amount of gross income from the FAPI Business for the taxation year computed under foreign tax law.

B - the total amount of deductions allowed under foreign tax law and claimed by FA in the taxation year that may reasonably be regarded as directly applicable only to the FAPI Business.

C - the amount of gross income from all sources for the taxation year computed under foreign tax law that is subject to foreign tax.

D - the total amount of deductions allowed under foreign tax law and claimed by FA in the taxation year which are not directly allocable to either the FAPI Business or to other income-generating activities, multiplied by the ratio of A over C (or allocated between the two streams of income on other reasonable grounds).

Once those values are determined, the formula to compute the net income of FA from the FAPI Business becomes: A – B – D. The resulting amount divided by the total net income of FA for the taxation year determines the fraction which, applied to the amount of total foreign tax paid by FA, determines the amount of foreign tax “that may reasonably be regarded as applicable” to FAPI in that taxation year (i.e. the FAT). The amount determined pursuant to this formula is converted to Canadian currency pursuant to section 261.

The approach described above is consistent with prior CRA statements in Technical Interpretations 9719055 and 2002-0134201I7, as well as our prior position on the allocation of foreign tax credits in Technical Interpretation 5021-4. Should a taxpayer be in a situation where a different approach is viewed by the taxpayer as reasonable, a request can be made to the Income Tax Rulings Directorate of the CRA for a determination as to whether or not that approach would be viewed as reasonable by the CRA in those circumstances.

The approach above applies regardless of whether the amounts deducted by FA in the taxation year arose in a taxation year before it became a foreign affiliate of Canco or after. Pre-acquisition amounts, including loss carryovers, are allocated consistently with the post-acquisition amounts when determining amounts B and D above.

This response does not address an allocation of tax credits that may be available to FA in the foreign jurisdiction since the hypothetical scenario does not contemplate FA using tax credits to reduce its foreign tax liability. The allocation of tax credits may require modifications to the above formula or a case-by-case determination.

Ina Eroff
2025-106377
May 28, 2025