CRA confirms that the gain on the shares of CFA2 (sub of CFA1) on the continuance of CFA1 (a sub of Canco) to Canada could be taxed again when CFA1 actually disposes of the CFA2 shares

CFA1 (a Country A resident) wholly owned CFA2 (a Country B resident) and was wholly owned by Canco.

Pursuant to s. 128.1(1)(b), at the time immediately before the deemed taxation year of CFA1 arising on the continuance (the “immigration”) of CFA1 to Canada (the “Last FA Year”), CFA1 was deemed to dispose of the shares of CFA2 for proceeds equal to their FMV at that time of $100. The resulting $90 capital gain on the shares of CFA2, which were not excluded property, gave rise during the Last FA Year to FAPI of CFA1 that was included in Canco’s income.

If there subsequently was an actual disposition of the shares of CFA2 by CFA1, CFA1 would be liable to tax of 30% in Country B on the capital gain computed based on the (low) pre-immigration costs of the shares to it of CFA2, thereby likely resulting in the same gain being taxed a second time. In particular, as the ACB of the CFA2 shares of CFA1 would have been stepped-up under s. 128.1(1)(c), on such sale CFA1 would not be subject to tax in Canada on the capital gain accrued prior to the immigration, and would not generate a foreign tax credit under s. 126 for the Country B tax paid on that accrued gain unless it had qualifying income from Country B sources. Further, since CFA1 ceased to be a foreign affiliate of Canco upon the immigration, the Country B tax paid on the actual disposition of the CFA2 shares would not be FAT in respect of Canco.

In addition to the FAPI inclusion under s. 128.1(1)(b) to Canco, s. 128.1(1)(d)(ii) required the inclusion, in computing the FAPI of CFA1 for the Last FA Year, of the amount prescribed under Reg. 5907(13), which would include any undistributed taxable surplus of CFA1, as reduced by its net earnings in respect of the FAPI for the Last FA Year from the deemed disposition under s. 128.1(1)(b). In these circumstances, where the only relevant FAPI was from the gain to CFA1 on the CFA2 shares on the continuance, there would be no net amount to add under Reg. 5907(13).

Neal Armstrong. Summaries of 22 August 2025 External T.I. 2019-0826681E5 under Reg. 5907(13), ITA s. 91(4) and s. 128.1(1)(b).