CRA rules on applying its formula for prorating foreign tax between a FAPI and non-FAPI business for FAT purposes

A CFA of the Canadian taxpayer (“FA Opco” or “FA”) carried on a business giving rise to FAPI (the “FAPI Business”), as well as an active business. FA Opco had incurred non-capital losses in carrying on its active business for purposes of the Foreign Country tax laws and also had unused discretionary deductions in respect of that active business.

It was projected that in respect of a particular taxation year, FA Opco would generate net income from both the FAPI business and the active business and partially eliminate corporate income tax imposed by the Foreign Country through the use of its loss carryforwards and the discretionary deductions.

CRA ruled as to methodology for determining the amount of foreign accrual tax (“FAT”) applicable to the FAPI from the FAPI Business. This methodology was summarized as follows in 28 May 2025 IFA Roundtable Q. 5, 2025-1063771C6:

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] FAPI Business … represents of the total net income of FA for the taxation year of FA, both as computed under foreign tax law. …

[Once] FA’s activities that generate FAPI [are] reasonably 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).

Neal Armstrong. Summary of 2025 Ruling 2024-1039511R3 under s. 95(1) – FAT.