At a glance
- What is the FABI election, and when can it apply?
- When FAPI may qualify for business income treatment.
- Eligibility criteria, including employee and activity tests.
- Examples of qualifying structures, including real estate and leasing.
- Key filing deadlines and considerations for CCPCs.
This article is Part 2 of a two-part series. Part 1 can be accessed here. Readers are encouraged to review Part 1 for background on the concepts referenced below.
In Part 1, we discussed the example of a Canadian couple, Jackson and Amelia, and their corporations to illustrate the impact of the changes in the taxation of passive income earned in a controlled foreign affiliate (CFA) of a Canadian-controlled private corporation (CCPC). That article focused on a change in the inclusion rate of passive income earned in a CFA, which reduced the deferral of Canadian tax on such income.
This article will discuss the impact of a second change that could affect the taxation of passive income earned in a CFA of a CCPC.
Foreign accrual business income
Included with the introduction of these changes for investment income is the ability, in certain circumstances, to make an election such that foreign accrual property income (FAPI) can be treated as business income for Canadian tax purposes, and not investment income. This can happen to a subset of FAPI that qualifies as foreign accrual business income (FABI).
The benefits of a FABI election include:
- A relevant tax factor of 4 is restored, resulting in a greater deferral of Canadian tax on the income accrued from the CFA.
- Any residual accrued income, after taking the deduction for foreign tax multiplied by the relevant tax factor, is taxed as business income, or at a rate of approximately 26.5%, using 2026 Ontario tax rates.
What types of income qualify as FABI?
Income that qualifies as FABI can be broadly described as income that is FAPI, but if it were taxed in Canada as income earned directly by a CCPC, it would not be aggregate investment income (AII), a defined term generally including interest, rent, royalties, taxable capital gains, and other income from property. There are also some additional complex tests to determine the source of the FAPI and who paid the amount. If the tests are not met, then FABI treatment is not available. A proactive election is required by the CCPC to get FABI treatment.
Unfortunately, while this election is likely to be relieving, it has introduced more complexity to an area of income tax that is already very complex. For example, it will be necessary to have a detailed knowledge of the taxation of Canadian source investment income of CCPCs, as well as rules that exclude such passive income where they are part of a business that employs more than five full-time employees.
However, we have identified three examples where FABI may apply:
- Where the CFA leases tangible equipment to unrelated third parties. This is because leasing property is generally a passive activity (and therefore would be FAPI), but it is specifically excluded from the definition of AII in CCPCs.
- Where the CFA carries out commercial real estate rentals, with five or fewer full-time foreign employees, but the CCPC also carries on commercial real estate rentals. The CCPC charges the CFA for services related to its rental business. When taken together, the CCPC and the CFA have more than five full-time employees carrying on commercial rental activities of the CFA.
- Where one or more CFA carries out real estate development in a corporation with five or fewer full-time foreign employees, but the CCPC and/or other CFAs of the CCPC also carry on real estate development. The CCPC charges the CFA for services related to its real estate development business. When taken together, the CCPC and the CFA have more than five full-time employees carrying on real estate development of the CFA.
The rules and examples have been simplified for illustration purposes. There are similar rules for certain partnerships.
Recall Jackson and Amelia from Part 1. The illustration in the appendix below shows the impact of a FABI election on their situation numerically. As you can see, the deferral in year one is restored when a FABI election is made. They should be able to make the FABI election because CanRealCo and USInvestco both carry on real estate development. We assume CanRealCo charges USInvestco for services related to its real estate development business. Taken together, there are more than five full-time employees working on the business of USInvestCo.
An election is required to designate FABI
One of the drawbacks of the FABI rules is that it is necessary for the CCPC to make an election on a timely basis in respect of this income to have the more favourable rules apply.
Because of a three-year delay in implementing these rules, where it is desirable to make elections that pertain to earlier years, FABI elections must be made by the filing due date for the first fiscal period that starts after 2025. For a corporation with a December year-end, this would be June 30, 2027, the due date for a corporate tax return for a corporation with a December 31, 2026, year-end. The due date for taxation years starting after 2026 is the normal corporate tax return due date of six months after the corporation’s year-end.
How BDO can help
This legislation is unusual in that it was proposed in 2022, primarily for taxation years starting on or after April 7, 2022, and that it is just now becoming law. It can also be extremely complex. A BDO international tax advisor can assist you in carrying out the following steps to determine if any adjustments should be made for tax returns filed for the 2023 to 2025 taxation years, and if a FABI election would be advisable.
The following steps are recommended:
While the deadline for FAPI elections is about a year out, now is the best time to do these calculations. This will assist in determining if any adjustments are needed to the FAPI reported for taxation years starting on or after April 7, 2022. If any additional taxes are owing, they should be paid now.
If returns were filed and did not correctly reflect FAPI inclusions and deductions, an analysis of a possible FABI election can be done to see if that will mitigate the additional tax costs that may arise. The previous year returns that did not reflect the FAPI changes should be amended.
The complexity of these calculations warrants the time invested now to assist in minimizing taxes resulting from these changes to FAPI taxation. A BDO tax advisor is ready to help you navigate these complexities.
Appendix
| Income earned in foreign affiliate (year 1) | Previous law ($) | New law - FAPI ($) | FABI election ($) |
|---|---|---|---|
| Net FAPI earned in foreign affiliate | 1,000 | 1,000 | 1,000 |
| Foreign income taxes (FAT) [1] | (210) | (210) | (210) |
| Net income after tax in foreign affiliate | 790 | 790 | 790 |
| FAPI in the Canadian parent company | 1,000 | 1,000 | 1,000 |
| Relevant tax factor (RTF) | 4 | 1.9 | 4 |
| FAT x RTF | (840) | (399) | (840) |
| Canadian FAPI earned in the year | 160 | 601 | 160 |
| Canadian tax on FAPI | 80 | 302 | 42 |
| Effective total tax rate before distribution [4] | 29% | 51% | 25% |
| Distribution of funds to the Canadian parent company (year 2) | Previous law ($) | New law - FAPI ($) | FABI election ($) |
|---|---|---|---|
| Income available for distribution | 790 | 790 | 790 |
| Dividend withholding tax [2] | (40) | (40) | (40) |
| Recovery of Part I tax on distribution [3] | -79 | -38 | -42 |
| Distribution of funds to individual shareholder | Previous law ($) | New law - FAPI ($) | FABI election ($) |
|---|---|---|---|
| Tax-free capital dividend | 225 | ||
| Taxable dividend to individual shareholder | 751 | 423 | 750 |
| Total dividend | 751 | 648 | 750 |
| Tax on dividends at the top Ontario tax rate | 295 | 202 | 295 |
| Net funds to individual | 455 | 446 | 455 |
| Effective total tax rate | 55% | 55% | 55% |
[1] Assumed a foreign tax rate of 21%
[2] Assumed a 5% rate of withholding tax
[3] Assumed the non-capital loss arising on dividend repatriation to the Canadian taxpayer, after statutory deductions, will be carried back to year 1, resulting in Part I tax recovery
[4] The difference in the effective tax rates between the previous law and the FABI election is that the residual income under the FABI election is taxed at active business income rates.
The information in this publication is current as of April 29, 2026.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.