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: Whether, as a result of paragraph 128.1(1)(b) of the Act, there would be an income inclusion in computing income of Canco on the immigration of CFA1 that could potentially result in taxation of the same amount of the capital gain accrued on the shares of CFA2 in the hands of Canco and CFA1, if the shares of CFA2 are not considered excluded property. If so, whether any relief is available.
Position: The taxable capital gain realized by CFA1 pursuant to paragraph 128.1(1)(b) will be included in its FAPI and will be included in computing income of Canco pursuant to subsection 91(1) without any deduction on account of FAT.
Reasons: A deduction for notional foreign taxes in subsection 5907(13) of the Regulations is only available when computing the prescribed amount included in FAPI of a foreign affiliate pursuant to subparagraph 128.1(1)(d)(ii), and not when computing FAPI inclusion as a result of paragraph 128.1(1)(b).
XXXXXXXXXX 2019-082668
M. Chan
August 22, 2025
Dear XXXXXXXXXX,
RE: Immigration of a Controlled Foreign Affiliate
We are writing in reply to your letter in which you inquired into the application of subsection 128.1(1) of the Income Tax Act (Canada), R.S.C. 1985, c. 1 (5th Supp.), as amended (the “Act”) and subsection 5907(13) of the Income Tax Regulations, C.R.C., c.945, as amended (the “Regulations”) in relation to the immigration of a controlled foreign affiliate.
More specifically, you asked us to confirm whether the application of paragraph 128.1(1)(b) to the hypothetical scenario described below would result in an income inclusion for Canco on the immigration of CFA1. If that is the case, you are concerned that the same amount of capital gain accrued on the shares of CFA2 prior to the immigration of CFA1 could be taxed in Canada in the hands of Canco on the immigration of CFA1 and in Country B in the hands of CFA1 on the actual disposition of the shares of CFA2. As such, you would like to know whether any remedy would be available.
Unless otherwise noted, all references herein to sections or components thereof are references to the Act. All terms used herein that are defined in the Act or in the Regulations have the meaning given in such definition.
Facts:
The facts described in the request are:
1. Canco is a “taxable Canadian corporation”, as defined in subsection 89(1).
2. CFA1, incorporated in a foreign jurisdiction (“Country A”), is a wholly owned subsidiary of Canco, and is resident in Country A for income tax purposes.
3. CFA2, wholly owned by CFA1, is a corporation incorporated in another foreign jurisdiction (“Country B”) and resident in Country B for income tax purposes.
4. CFA1 and CFA2 are “foreign affiliates” and “controlled foreign affiliates” of Canco as defined in subsection 95(1).
5. There are no “exempt surplus”, “hybrid surplus”, or “taxable surplus”, as defined in Regulation 5907(1), available in respect of CFA1 or CFA2.
6. No foreign accrual property income (“FAPI”), as defined in subsection 95(1), arose in respect of CFA1 or CFA2 in previous years.
7. The fair market value (“FMV”) and the adjusted cost base (“ACB”) of the shares of CFA2 owned by CFA1 are $100 and $10, respectively.
8. Under the legislation of Country B, a direct foreign parent of a Country B corporation (CFA1) is subject to tax in Country B equal to 30% of the capital gain realized on a disposition of the shares of the Country B corporation (CFA2). We are asked to assume that no treaty relief is available in respect of this tax.
9. CFA1 will be legally continued from Country A to Canada. The current directors of CFA1 will resign and new directors will be appointed.
10. From Country A's legal and tax perspective:
- the legal continuance of CFA1 from Country A to Canada will not result in any tax payable in Country A;
- no new corporation will be created;
- CFA1's assets and liabilities will remain unchanged.
11. From the legal and tax perspective of Country B, the legal continuance of CFA1 from Country A to Canada, will not result in a disposition and reacquisition by CFA1 of the shares of CFA2, and will not result in taxes payable in Country B.
12. The shares of CFA2 are not “excluded property” of CFA1 under the definition in subsection 95(1).
Our Comments:
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of a request for an advance income tax ruling submitted in the manner set out in Information Circular 70-6R12. Nonetheless, we have provided general comments below, which we hope will be of assistance to you.
Pursuant to paragraph 128.1(1)(b), at the time that is immediately before the deemed taxation year-end of CFA1 occurring immediately before its immigration (the “Last FA Year”), CFA1 is deemed to dispose of the shares of CFA2 for proceeds equal to their FMV at that time. This deemed disposition results in a realization of the capital gain accrued at that moment on the shares of CFA2. Since the shares of CFA2 are not excluded property as defined in subsection 95(1), the taxable capital gain is included in computing FAPI of CFA1 for the Last FA Year and in computing income of Canco pursuant to subsection 91(1).
Had there been an actual disposition of the shares of CFA2 before the immigration of CFA1, Canco would have incurred a foreign accrual tax (“FAT”), as defined in subsection 95(1), and would have been entitled to a deduction under subsection 91(4). Since under the tax laws of either Country A or Country B there is no actual or deemed disposition of the shares of CFA2 on the immigration of CFA1, no taxes will be paid in that respect in those jurisdictions, no FAT will be applicable to the FAPI included in computing Canco’s income under subsection 91(1), and no deduction under subsection 91(4) will be available.
In addition to the FAPI inclusion resulting from the application of paragraph 128.1(1)(b), subparagraph 128.1(1)(d)(ii) requires to include in computing the FAPI of CFA1 for the Last FA Year an amount prescribed by subsection 5907(13) of the Regulations. The amount prescribed includes, inter alia, undistributed taxable surplus of CFA1 reduced by its net earnings in respect of the FAPI for the Last FA Year from the deemed disposition under paragraph 128.1(1)(b). Since CFA1’s taxable surplus will only include the amount from the deemed disposition of the shares of CFA2, that inclusion will be fully reversed by the net earnings from the same source, and the prescribed amount computed under subsection 5907(13) of the Regulations will be nil.
The formula in subsection 5907(13) of the Regulations also reduces the prescribed amount on account of a notional amount by which the underlying foreign tax of CFA1 in respect of Canco would have increased because of the gain or income that would have arisen if the disposition of CFA1’s assets deemed to occur under paragraph 128.1(1)(b) had actually occurred (referred to herein as the “notional UFT”). On the facts at issue, there will be no such further reduction on account of the notional UFT because the formula in subsection 5907(13) of the Regulations cannot result in a negative amount.
On an eventual actual disposition of the shares of CFA2, CFA1 will be liable to tax at 30% in Country B on the capital gain computed based on the pre-immigration cost of the shares of CFA2. As the shares of CFA2 will have a stepped-up ACB for Canadian tax purposes due to the application of section 128.1, CFA1 will not be subject to tax in Canada on the capital gain accrued prior to the immigration, and may not be able to benefit from a foreign tax credit under section 126 for the Country B tax paid on that accrued gain unless it has other qualifying income from sources in Country B. Further, since CFA1 ceases to be a foreign affiliate of Canco upon immigration, the Country B tax paid on the actual disposition of the shares of CFA2 will not be FAT in respect of Canco.
To sum up the conclusions reached above, as a consequence of the immigration of CFA1, the capital gain accrued on the shares of CFA2 prior to the immigration may be taxed in two different jurisdictions (Canada and Country B) in the hands of two different taxpayers (Canco and CFA1) without an offsetting FAT deduction being available in Canada for the foreign tax paid in Country B. The foreign tax paid in Country B by CFA1 after it becomes resident in Canada is subject to the foreign tax credit regime in section 126 instead. However, CFA1 may not be able to benefit from that regime if it does not have sufficient qualifying income in Country B.
The accrued gain on the non-excluded properties held by CFA1 at the time of immigration deemed realized under paragraph 128.1(1)(b) and included in computing its FAPI could only be reduced by the foreign tax actually paid by CFA1 while it is still a foreign affiliate of Canco. This is consistent with how the FAPI regime operates.
The fact that the deduction for the notional UFT available under subsection 5907(13) of the Regulations remains unused in this scenario is consistent with its purpose being limited to reducing the prescribed amount included in computing FAPI of a foreign affiliate under subparagraph 128.1(1)(d)(ii) (generally the undistributed surplus from prior taxation years of the foreign affiliate) and not the amount included in FAPI of CFA1 as a result of the application of paragraph 128.1(1)(b).
There is no provision for a “notional FAT” in the context of paragraph 128.1(1)(b). In other scenarios, we would expect the Canadian tax paid by Canco on the accrued capital gain realized on the immigration of CFA1 and included in computing its FAPI to be the ultimate tax paid on that capital gain because CFA1 ceased being subject to tax in its former country of residence (Country A) upon immigration and no foreign tax would be paid on that gain on an eventual actual disposition of the properties. Alternatively, CFA1’s former country of residence could have a deemed disposition on emigration which would have resulted in Canco being able to claim FAT in respect of the foreign tax paid by CFA1 on the pre-immigration accrued gain on the shares of CFA2. In the scenario at issue, the disconnect between the FAPI regime and the immigration regime arises due to the right of a third country (Country B) to tax that gain.
If circumstances were different (for example, if CFA1 or CFA2 had opening taxable surplus or if CFA1 had taxable earnings for the Last FA Year other than net earnings in respect of its FAPI), the notional UFT that is available under Regulation 5907(13) would be utilized to offset the prescribed FAPI under subparagraph 128.1(1)(d)(ii).
In addition, depending on the circumstances, CFA1 may be able to claim a foreign tax credit for the Country B tax paid on the actual disposition of the shares of CFA2 if it has qualifying income sourced in Country B and the conditions in section 126 are satisfied.
Because the amount of the accrued capital gain on the shares of CFA2 taxed in Canada on the immigration of CFA1 will not be subject to Canadian tax a second time as a result of the step-up to the ACB of the shares of CFA2, this scenario cannot be viewed as resulting in double taxation in Canada and is not a situation to which section 248(28) would apply.
In view of the clear wording of the provisions and their objective, the relief provided in subsection 5907(13) of the Regulations by means of the notional UFT does not extend to offset the amounts included in computing FAPI of CFA1 that arose from the application of paragraph 128.1(1)(b).
We hope this information is of assistance to you.
Yours truly,
Ina Eroff
Section Manager
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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