What is FAPI?

Canadian residents are taxed on their worldwide income, but corporations are separate entities so normally one taxpayer will not be taxed in Canada for income earned from a company in another jurisdiction . . . unless that income is FAPI.

FAPI, which stands for Foreign Accrual Property Income is when you own a foreign corporation that is earning passive income.  The section of the Income Tax Act that applies to FAPI is very complicated but in general can be thought of this way:

If you want to create a company someplace nice and warm and open up a bar selling those drinks with umbrellas, Canada has no problem with that - the income earned in that company belongs in the place with the beaches.

On the other hand, if you are opening up that company only to earn income from interest and dividends at a lower tax rate than you would have paid in Canada in a place where Canada does not have a tax treaty - you are going to end up being taxed on that income in Canada.

FAPI brings into income the foreign passive income earned in a foreign corporation.  There are mechanisms to reduce that income to allow for taxes you have paid in that other country - so if you're paying taxes at the same rate as Canada, you won't pay tax on FAPI income in Canada. 

Sometimes it is a timing issue because if you are receiving dividends from that foreign corporation, you will pay taxes when you receive the dividends.  So, if and when you do earn dividends, there is a adjustment to reduce the dividends you report to account for the FAPI income previously reported.

FAPI is only reported on income earned by "controlled foreign affiliates" but the definition of control is different for FAPI purposes than it is for regular income tax purposes.  More on that next week.