Foreign Affiliates And Controlled Foreign Affiliates: Canadian Income Tax Guide From A Toronto Tax Lawyer

Published: October 7, 2021
Last Updated: October 5, 2026

Overview – Foreign Affiliates and Controlled Foreign Affiliates

If you own 10% or more of a corporation outside Canada, alone or together with family members, the Income Tax Act may require you to file Form T1134 every year and may tax you on that corporation’s passive income before you receive a single dollar of it. The penalty for a single late T1134 can reach $2,500, and it escalates quickly where the CRA alleges gross negligence. This guide explains when a foreign corporation becomes a foreign affiliate or a controlled foreign affiliate, what has to be reported, how foreign accrual property income works, and how to fix missed filings before the CRA finds them.

Canadians who invest in a foreign corporation can be subject to special income inclusion and reporting rules if they own a big enough stake in the foreign corporation. These rules are among the most complicated in Canadian income tax law and can have dramatic consequences.

If a Canadian person owns 10% of a foreign corporation, that corporation will qualify as a foreign affiliate. Having a foreign affiliate means a Canadian taxpayer is required to file a special information return, form T1134, each year (for 2021 and later taxation years, within 10 months after the end of the taxation year), which provides the Canada Revenue Agency (CRA) with information about the foreign affiliate.

Canadian corporations that have a foreign affiliate are subject to a distinctive tax regime on the dividends they receive from their foreign affiliate where the foreign affiliate’s income is categorized into different surplus accounts and the tax treatment of the dividend is dependent upon which surplus account it is paid out of. This distinct dividend taxation regime is often significantly more favorable than the one that applies to non-foreign affiliates.

When a Canadian controls a foreign corporation (generally but not exclusively by owning more than 50% of its shares) then the foreign corporation is a controlled foreign affiliate of the Canadian taxpayer. A foreign corporation can also be a controlled foreign affiliate if the Canadian taxpayer and a distinctly specified small group of other Canadian taxpayers collectively own sufficient shares to control the foreign corporation. When a controlled foreign affiliate earns passive investment income, it will give rise to foreign accrual property income for its Canadian owners with respect to which it is a controlled foreign affiliate even though the controlled foreign affiliate has not paid a dividend or any other amounts to its Canadian owners.

The table below summarizes how the level of ownership changes the Canadian tax consequences of holding shares of a foreign corporation.

What is a Foreign Affiliate – Foreign Affiliates and Controlled Foreign Affiliates

For an entity to be a foreign affiliate of a taxpayer resident in Canada:

• the entity must be a corporation,
• the entity must not be a tax resident of Canada, and
• the taxpayer must meet an equity ownership requirement with respect to the entity.

Note that foreign affiliate status is a relational attribute: an entity is only a foreign affiliate or not with respect to a particular taxpayer resident in Canada. An entity can have multiple Canadian owners and be a foreign affiliate with respect to some of them but not others.

Classifying Foreign Entities as Corporations

The Canadian Income Tax Act does not provide detailed guidance as to what entities count as corporations so the advice of an expert Canadian tax lawyer is required. As potential foreign affiliates are typically entities defined under the law of a foreign jurisdiction which do not correspond exactly to the sort of business entities that exist under Canadian law, it can be quite complicated to determine if a particular foreign entity counts as a corporation.

The existing caselaw regarding classifying foreign entities has generally followed a two-step approach. The first step is to determine the characteristics of the foreign entity under the relevant foreign law. The second step is to then compare these characteristics with those of recognized Canadian entities and identify whether the foreign entity has the essential characteristics of a particular recognized Canadian entity. The CRA has applied the same two-step approach since 2008 and reconfirmed it at its 2022 STEP Canada and 2024 International Fiscal Association roundtables.

The case law applying the two-step test described above, including the Tax Court of Canada’s 2011 decision in Sommerer v. The Queen, 2011 TCC 212, has dealt with the essential characteristics of partnerships and trusts but not corporations. However, other caselaw, Canada Revenue Agency publications, and the secondary Canadian legal literature have indicated that the following are some of the key characteristics of corporations:

• corporations are artificial separate legal persons whose existence is enabled by a statute,
• corporations must register their constating documents (e.g. articles of incorporation) with the government in order to come into existence,
• corporations can exist indefinitely,
• corporations can own property separately from the owners of the corporation,
• corporations can have liability and obligations separate from their owners, and their owners are not liable for the debts of the corporation,
• corporations can engage in a wide variety of activities such as entering into contracts, carrying on a business, suing and being sued.

One classification point catches many cross-border investors. The CRA generally treats a U.S. limited liability company (LLC) as a corporation for Canadian income tax purposes, even where the LLC is disregarded or taxed as a partnership for U.S. purposes, and the CRA has stated that an entity’s classification for foreign tax purposes is generally not relevant under the two-step approach. As a result, a Canadian resident who holds a 10% interest in a U.S. LLC usually has a foreign affiliate and a T1134 filing obligation, even if the LLC earns nothing and distributes nothing in the year.

Canadian Corporate Tax Residence

Unless a statutory rule applies, the Canadian income tax residence status of a corporation is determined by a common law test which provides that a corporation is resident in Canada if that is where its actual place of central management and control is. Typically, this is where its board of directors meets or otherwise exercises its responsibilities. However, in circumstances where the central management and control is exercised by a shareholder resident and making decisions in another country, the corporation will be found to be resident where the shareholder resides.

Notwithstanding the common law test, a corporation whose jurisdiction of incorporation is in Canada will be deemed to be a tax resident of Canada. If a corporation would otherwise be a tax resident of both Canada and another country with which Canada has a tax treaty, tie-breaker rules will apply which designate the corporation as a resident of only one of the two countries. If these tie-breaker rules designate the corporation as not a tax resident of Canada for the purposes of the treaty, the corporation will also be deemed not to be a tax resident of Canada. This tie-breaker deeming rule will override both the common law test and the jurisdiction of incorporation deeming rule.

The Equity Ownership Requirement

For a non-resident corporation to be a foreign affiliate of a Canadian resident taxpayer:

• the Canadian resident taxpayer’s equity percentage in the non-resident corporation must be at least 1%; and
• the total of the equity percentages in the non-resident corporation of the Canadian resident taxpayer and of each person related to the Canadian resident taxpayer must be at least 10%.

The idea behind this requirement is, loosely speaking, that for a non-resident corporation to be a foreign affiliate of a Canadian resident taxpayer, the Canadian resident taxpayer needs to own 10% of the non-resident corporation. The actual requirements, however, allow for the 10% ownership threshold to be spread out across multiple persons so long as they are sufficiently closely connected (i.e. are “related” persons). The Income Tax Act also uses the notion of “equity percentage” to track ownership to account for the fact that shares of non-resident corporations are often owned indirectly through other corporations.

Resources: Foreign Pension Income Taxation – A Canadian Tax Lawyer Analysis

“Equity Percentage”

A person’s “direct equity percentage” in a corporation is intended to capture the percentage of the shares of the corporation that person owns directly (i.e. not through holding shares in other corporations).

A person’s “equity percentage” in a corporation includes that person’s direct equity percentage in that corporation but also includes indirect ownership through other corporations proportionate to the person’s ownership of the intermediate corporations. This is effectively done by multiplying the direct equity percentage of each intermediate corporation in the potential foreign affiliate by the person’s equity percentage in the intermediate corporation and adding up the resulting percentages. If there is more than one layer of intermediate corporations then the equity percentage definition needs to be applied recursively to the intermediate corporations.

“Related” Persons

As noted above, the 10% equity percentage can be spread out over multiple persons so long as those persons are “related”. The Income Tax Act contains highly detailed rules specifying when two persons are related to each other. Below is a non-exhaustive list of the rules which establish when two persons are related:

• Individuals connected by blood relationship, marriage, common law partnership, or adoption are related;
• A corporation and the person who controls it are related;
• A corporation and a person who is a member of a group of related persons that controls the corporation are related;
• Two corporations are related if they are controlled by the same person or group of persons; and
• If two corporations are each related to a third corporation, then they are deemed to be related to each other.

Applying these rules correctly is highly technical, so it is necessary to consult with an experienced Toronto tax lawyer in situations where these rules become relevant.

Consequences of Foreign Affiliate Status – Foreign Affiliates and Controlled Foreign Affiliates

T1134 Reporting Requirement

Canadian resident taxpayers who have a foreign affiliate are generally required to file a T1134 information return every year. For 2021 and later taxation years, the T1134 is due 10 months after the end of the taxation year, which is a different deadline from the income tax return itself. The form T1134 information return provides CRA with various information about the filer’s foreign affiliates including their names, the country in which they reside, and whether they are controlled foreign affiliates. Failure to file form T1134 on time will result in substantial tax penalties.

To prevent duplicative filings, the rules requiring taxpayers to file T1134 information returns effectively restrict the requirement to file to the lowest tier of Canadian taxpayers with foreign affiliates in a holding structure. This is done by only requiring T1134s from Canadian taxpayers with foreign affiliates using a modified version of the equity ownership requirement which effectively means that ownership of a potential foreign affiliate that runs through a Canadian resident intermediate corporation does not count towards the 10% equity percentage requirement.

A separate T1134 supplement is generally required for each foreign affiliate. The main relief is the dormant foreign affiliate exception. Where the total cost amount to the reporting entity of its interests in all of its foreign affiliates is less than $100,000, no supplement is required for a foreign affiliate that had gross receipts of less than $100,000 in the year and whose assets never had a total fair market value of more than $1,000,000 in the year. Gross receipts include non-revenue receipts such as loans, so an otherwise inactive company that receives a shareholder loan can lose dormant status.

The T1134 was substantially expanded for taxation years beginning after 2020. Reporting entities must now disclose, among other things, the adjusted cost base of their shares of each affiliate, revenue from non-arm’s length transactions, and whether foreign accrual property losses or foreign accrual capital losses have been carried over to reduce FAPI. A non-resident trust that is deemed resident in Canada under section 94 of the Income Tax Act is also treated as resident for the foreign affiliate reporting rules and may itself have to file Form T1134.

The penalty for simply filing a T1134 late is $25 per day, to a maximum of $2,500 per return, under subsection 162(7) of the Income Tax Act. Where the failure is knowing or amounts to gross negligence, subsection 162(10) imposes a penalty of $500 per month for up to 24 months, and a further penalty based on 5% of the cost of the taxpayer’s investment in the affiliate can apply after 24 months under subsection 162(10.1). Our detailed guide to Form T1134 covers the filing mechanics, the due diligence exception for missing information, and the first-year exemption for new residents.

Foreign Affiliate Shares and Form T1135

Shares of, and debts owed by, a foreign affiliate are excluded from specified foreign property, so they are not reported on Form T1135. Other foreign holdings still count toward the $100,000 T1135 threshold. A minority stake that falls below the foreign affiliate threshold, such as 5% of a foreign company or units in an offshore fund, generally must be reported on Form T1135 if the total cost of the taxpayer’s specified foreign property exceeds $100,000 at any time in the year. Our guide to specified foreign property and Form T1135 explains the simplified and detailed reporting tiers.

Minority holdings of this kind can also be caught by the offshore investment fund property rule in section 94.1 of the Income Tax Act, which can impute income to a Canadian investor even where the offshore entity distributes nothing.

Foreign Affiliate Dividends

Where a Canadian resident corporation receives a dividend from a foreign affiliate, a special tax regime applies. Under tax rules, the foreign affiliate needs to keep track of a number of different surplus accounts. When a dividend is paid, it is then treated as coming out of a particular surplus account with correspondingly different tax treatment.

Exempt Surplus

The exempt surplus account tracks the active business income earned in a designated treaty country (i.e. a country with a tax treaty or tax information exchange agreement with Canada). When a dividend is paid out of exempt surplus of a foreign affiliate, the Canadian corporation is entitled to a deduction for the entire amount of the dividend, but no deduction or credit is available for any non-resident withholding tax paid on the dividend. This treatment is usually very favorable for the taxpayer since Canada is effectively choosing not to tax the dividend at all.

Hybrid Surplus

The hybrid surplus account tracks gains realized from the sale by the foreign affiliate of shares of another foreign affiliate or certain other types of property. The treatment of hybrid surplus is intended to mimic how under Canadian income tax, only half of a capital gain is subject to income tax. A deduction is available to the Canadian resident corporation for half of the amount of the dividend (i.e. for the “non-taxable” half of the dividend) plus a deduction intended to offset the foreign income tax paid on the “taxable” half of the dividend. No deduction or credit is provided for non-resident withholding tax.

Taxable Surplus

This account tracks non-active business income or active business income earned by the foreign affiliate in a country that is not a designated treaty country. A deduction is provided intended to offset foreign income tax paid on this income. Another deduction is provided to offset non-resident withholding tax paid on the dividend.

Pre-Acquisition Surplus

This account effectively tracks the Canadian corporation’s capital investment or the cost of the shares of the foreign affiliate. A full deduction is available for amounts paid out of pre-acquisition surplus, although the Canadian corporation’s adjusted cost base in the shares of the foreign affiliate will be reduced by a corresponding amount.

Ordering Rules

An ordering rule governs out of which surplus account a dividend is treated as being paid. When a foreign affiliate pays a dividend, if there is exempt surplus available, the dividend will be considered to be paid out of exempt surplus. If no exempt surplus remains, the dividend will be considered to be paid out of hybrid surplus, then taxable surplus, and then finally pre-acquisition surplus. In some circumstances a top Canadian tax planning lawyer may advise that elections be made to opt for a dividend that would be paid out of exempt surplus to be paid out of taxable surplus or hybrid surplus instead (e.g. to take advantage of losses).

These surplus deductions are available only to corporations resident in Canada. An individual who owns foreign affiliate shares directly must include the full dividend in income and can generally claim only a foreign tax credit for the withholding tax, which is one reason the ownership structure matters so much.

Upstream Loans from Foreign Affiliates

Moving cash from a foreign affiliate to Canada by way of a loan instead of a dividend does not avoid Canadian tax. Under the upstream loan rule in subsection 90(6) of the Income Tax Act, a loan from a foreign affiliate to its Canadian shareholder, or to a person not dealing at arm’s length with that shareholder, is generally included in the Canadian taxpayer’s income unless it is repaid within two years, other than as part of a series of loans and repayments. An offsetting deduction may be available to the extent the affiliate has sufficient surplus that could have been paid as a deductible dividend.

What is a Controlled Foreign Affiliate: Foreign Affiliates and Controlled Foreign Affiliates

There are two tests that determine whether a foreign affiliate also counts as a controlled foreign affiliate of a Canadian resident taxpayer. Either test, if satisfied, is sufficient for qualifying as a controlled foreign affiliate. The first test examines whether the Canadian resident taxpayer directly or indirectly owns sufficient shares to be able to control the foreign affiliate. The second test examines whether the Canadian resident taxpayer together with a detailed specified group of other taxpayers directly or indirectly own enough shares to control the foreign affiliate.

Control Test for Foreign Affiliates

If the foreign affiliate is controlled by the Canadian resident taxpayer, then the foreign affiliate is a controlled foreign affiliate.

For the purposes of controlled foreign affiliate status, “control” means de jure control (i.e. formal legal control) not de facto control (i.e. control in fact as assessed by looking beyond the corporation’s share register and constating documents). Typically an entity has de jure control of a corporation if the entity has sufficient shares to elect a majority of the corporation’s board of directors. Typically owning more than 50% of a corporation’s shares is sufficient to do this.

See also Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS MLI) Signed

In the Canadian context the board of directors of the corporation by default will be responsible for and have the power to supervise the management and affairs of the corporation. This is why control of the board of directors typically results in de jure control. However, in some circumstances the constating documents of a corporation can change this, such as a unanimous shareholder agreement (which is a constating document of a corporation under many Canadian corporate statutes) which allows the shareholders of a corporation to manage it directly. In such circumstances, de jure control is analysed in terms of the specific corporate statutes and constating documents involved in that situation. Similarly, to the extent that a corporation incorporated in a foreign jurisdiction has a substantially different corporate law than Canada, the conditions necessary for de jure control will change accordingly.

Group Control Test

The second foreign affiliate test examines whether the Canadian resident taxpayer would control the foreign affiliate (in the manner described above) if the Canadian tax resident owned the following shares:

• All the shares in the foreign affiliate that are actually owned by the Canadian resident taxpayer,
• All of the shares of the foreign affiliate that are owned at that time by persons who do not deal at arm’s length with the Canadian resident taxpayer,
• All of the shares of the foreign affiliate that are owned at that time by persons (called “relevant Canadian shareholders”), in any set of persons not exceeding four (which set of persons shall be determined without reference to the existence of or the absence of any relationship, connection, or action in concert between those persons), who
  • Are resident in Canada;
  • Are not the Canadian resident taxpayer or a person not at arm’s length from the Canadian resident taxpayer;
  • Own shares of the foreign affiliate; and
• All of the shares of the foreign affiliate that are owned at that time by persons who do not deal at arm’s length with any relevant Canadian shareholder.

This effectively asks whether the foreign affiliate could be controlled by a small group of Canadian tax residents, specifically the Canadian resident taxpayer and any four other Canadian-resident shareholders, plus any non-arm’s length persons. If this small group could control the foreign affiliate, then the foreign affiliate is a controlled foreign affiliate. This test does not require that this small group is in fact acting in concert to collectively control the corporation.

Foreign Accrual Property Income” Foreign Affiliates and Controlled Foreign Affiliates

In the absence of Canada’s controlled foreign affiliate rules, the following tax planning idea would be tempting for Canadian taxpayers with substantial investment portfolios:

• Incorporate a corporation (“ForeignCo”) in a jurisdiction with no income tax or income tax rates lower than those that apply in Canada;
• Hold passive investments such as stocks, bonds, or real estate in ForeignCo; and
• Have ForeignCo reinvest the dividends, interest, rent and other investment income generated by the portfolio.

This approach would effectively allow Canadian taxpayers to defer paying Canadian tax indefinitely by only having the ForeignCo pay dividends to the Canadian taxpayer when necessary (e.g. to fund consumption). This would be a substantial tax advantage as it allows ForeignCo to reinvest and earn a return on money that would otherwise be paid to CRA.

The Income Tax Act’s way of preventing tax planning of the type described above is with the concept of foreign accrual property income (“FAPI”). Canadian income tax law will treat Canadian residents as having received income, FAPI, based on certain types of “passive” income earned by their controlled foreign affiliates even in the absence of the controlled foreign affiliate paying that money to the Canadian residents as dividends. If the controlled foreign affiliate subsequently pays dividends from income previously taxed as FAPI, an adjustment is available to prevent double taxation.

The FAPI rules only apply to “passive income” earned by controlled foreign affiliates, and not mere foreign affiliates or non-foreign affiliates in which a Canadian resident shareholder has a partial interest. Canadian income tax law also allows the equivalent of foreign tax credits to reduce foreign accrual property income based on the amount of foreign taxes paid on the controlled foreign affiliates income that is included in FAPI. That deduction is calculated using a relevant tax factor that is less generous for individuals than for corporations, so an individual who owns a controlled foreign affiliate directly often pays more Canadian tax on the same FAPI than a Canadian corporate shareholder would.

The full details of what sort of income earned by a controlled foreign affiliate counts as foreign accrual property income or not are highly complex and beyond the scope of this article and will typically require guidance from a top Canadian income tax lawyer. Briefly, the main types of income included in FAPI are income from property, which includes dividends, interest, rent, and royalties, as well as taxable capital gains from the sale of property that was not used in an active business. Income earned by the controlled foreign affiliate through running an active business is generally not included in foreign accrual property income. The Income Tax Act contains many deeming rules that exclude some amounts that would otherwise be FAPI or deem amounts to be FAPI that otherwise would not be included.

Income from an “investment business” is also FAPI, even though it is business income. A business carried on principally to earn income from property is generally an investment business unless it qualifies for one of the statutory exceptions, which require, among other things, that the affiliate employ more than five full-time employees in the active conduct of the business and deal principally with arm’s length persons. In Canada v. Loblaw Financial Holdings Inc., 2021 SCC 51, the Supreme Court of Canada held that a Barbados banking subsidiary qualified for the regulated financial institution exception, so its income was not FAPI. The decision confirms that these exceptions turn on their precise statutory requirements, which is why the facts supporting them need to be documented year by year.

Resources:

1. Components of foreign accrual property income: Explains the inclusions and exclusions in detail
2. How the FAPI regime applies to foreign corporations and foreign trusts: Covers the interaction with the non-resident trust rules.

Practical Implications: Common Foreign Affiliate Reporting Mistakes

The practical risk is rarely aggressive planning. It is more often an ordinary investor, entrepreneur or new resident who holds shares of a foreign company and never realized that the holding made him or her a reporting entity. The same holding can trigger several regimes at once, and clearing one test does not clear the others:

• Foreign affiliate status determines whether Form T1134 is required and whether the shares drop out of Form T1135.
• Controlled foreign affiliate status determines whether the affiliate’s passive income is taxed in Canada every year as FAPI.
• A non-controlled offshore holding may still be subject to Form T1135 reporting and to section 94.1.
• Dividends receive surplus treatment only when a Canadian corporation receives them.

The mistakes we see most often in foreign affiliate files are:

• Treating a U.S. LLC as a pass-through entity and filing no T1134.
• Overlooking indirect ownership through partnerships, trusts or other corporations when calculating equity percentage.
• Diarizing the T1134 for the income tax return deadline instead of the 10-month T1134 deadline, or the reverse.
• Claiming dormant status for an affiliate that received loans or other non-revenue receipts of $100,000 or more.
• Leaving a loan from the affiliate outstanding for more than two years without considering the upstream loan rule.

David J. Rotfleisch, founding tax lawyer and CPA at Rotfleisch & Samulovitch, and a Law Society of Ontario Certified Specialist in Taxation, explains where the real exposure usually lies:

“The files that cause the most trouble are not complex multinational structures. They are Canadian families who inherited or bought into a foreign company, filed nothing, and assumed that because no money came back to Canada there was nothing to report. By the time the CRA asks, several years of penalties may already have accrued.” — David J. Rotfleisch, Certified Specialist in Taxation Law (Law Society of Ontario)

Taxpayers who have missed T1134 filings or failed to report FAPI can still consider a voluntary disclosure. Under Information Circular IC00-1R7, which applies to applications received on or after October 1, 2025, an unprompted disclosure made before the CRA contacts the taxpayer about the specific issue qualifies for the broadest penalty and interest relief. We do not recommend the CRA’s pre-disclosure discussion service under any circumstances, because it creates a record of contact with the CRA without securing binding protection or an effective date of disclosure.

Takeaway: Foreign Affiliate and Controlled Foreign Affiliate Rules

Owning 10% of a foreign corporation, alone or with related persons, generally makes it a foreign affiliate and triggers annual T1134 reporting. Controlling it, alone or with a small group of other Canadian shareholders, makes it a controlled foreign affiliate and brings its passive income into Canadian tax each year as FAPI. Dividends from foreign affiliates receive favourable surplus treatment only in the hands of Canadian corporations. Each consequence is tested separately, the penalties for missed filings are significant, and the best voluntary disclosure relief is available only until the CRA makes contact.

Pro Tax Tips: Foreign Affiliates and Controlled Foreign Affiliates

The foreign affiliate system is highly complex and is essential to get advice from an expert Toronto tax lawyer before setting up any structure or business to which this system may apply. Some structures for your business may be significantly better or worse than others. For example, it is generally better for the shares of a foreign affiliate to be held by a Canadian resident corporation rather than an individual so as to qualify for the surplus regime summarized above.

Before the first filing deadline, prepare an ownership chart showing the direct and indirect equity percentages in every foreign corporation, together with the percentages held by related persons. That chart answers the foreign affiliate and controlled foreign affiliate questions, identifies which Canadian entity in a group is the reporting entity, and shows whether any holding falls outside the foreign affiliate rules and into Form T1135 or section 94.1 instead.

If a foreign affiliate relies on an active business exception, keep annual evidence of its employees, activities and arm’s length customers, since the CRA will ask for it in a tax audit. If filings have already been missed, speak with a knowledgeable Canadian tax lawyer about a voluntary disclosure before the CRA contacts you, because relief is materially reduced once a disclosure is prompted.

FAQs

What is a Foreign Affiliate?

In general terms, a non-resident Corporation is a foreign affiliate of a Canadian resident person when the Canadian resident person owns at least 10% of the non-resident Corporation. The Income Tax Act uses a detailed technical definition to account for indirect ownership and to allow the 10% ownership to be spread over multiple related taxpayers.

What is a Controlled Foreign Affiliate?

When a Canadian controls a non-resident corporation (often by owning more than 50% of its shares) then the foreign corporation is a controlled foreign affiliate of the Canadian taxpayer. A non-resident corporation can also be a controlled foreign affiliate if the Canadian taxpayer and a carefully specified small group of other Canadian taxpayers collectively own sufficient shares to control the foreign corporation.

When is Form T1134 due?

For 2021 and later taxation years, Form T1134 is due 10 months after the end of the reporting entity’s taxation year. For an individual with a calendar taxation year, that means October 31 of the following year, which is later than the individual’s income tax return deadline.

What is a dormant foreign affiliate for T1134 purposes?

A foreign affiliate whose gross receipts in the year were less than $100,000 and whose assets never had a total fair market value of more than $1,000,000 in the year. If the total cost of the taxpayer’s interests in all foreign affiliates is also under $100,000, no T1134 supplement is needed for a dormant affiliate, although it is still listed on the T1134 summary.

What are the penalties for not filing Form T1134?

A late T1134 attracts a penalty of $25 per day to a maximum of $2,500 per return. Knowing or grossly negligent failures attract $500 per month for up to 24 months, and additional penalties based on the cost of the investment can apply after that. Interest runs on the penalties.

Is a U.S. LLC a foreign affiliate?

Usually, if the ownership thresholds are met. The CRA generally treats a U.S. LLC as a corporation for Canadian tax purposes regardless of how it is classified for U.S. tax purposes, so a Canadian resident with a 10% interest generally has a foreign affiliate and must file Form T1134.

Do I report foreign affiliate shares on Form T1135?

No. Shares of, and debts owed by, a foreign affiliate are excluded from specified foreign property. Holdings in foreign corporations that are not foreign affiliates, and other foreign property, still count toward the $100,000 T1135 threshold.

What is foreign accrual property income (FAPI)?

FAPI is passive income of a controlled foreign affiliate, such as interest, dividends, rent, royalties, income from an investment business and certain capital gains, that is taxed in the hands of its Canadian shareholders each year in proportion to their interest, whether or not it is distributed.

Is FAPI taxed if the foreign corporation pays no dividends?

Yes. The point of the FAPI rules is to tax passive income as it is earned. The Canadian shareholder’s adjusted cost base in the shares is increased by the FAPI included, and a deduction is available when previously taxed FAPI is later paid out as a dividend, which prevents double taxation.

Is active business income of a foreign affiliate taxed in Canada?

Generally not until it is paid to Canada as a dividend, and a dividend paid to a Canadian corporation out of exempt surplus is fully deductible. Income that falls within the investment business definition or the base-erosion rules is FAPI even if it looks like business income.

How are dividends from a foreign affiliate taxed?

For a Canadian corporation, the tax treatment depends on the surplus account the dividend is paid from: exempt surplus is fully deductible, hybrid surplus is half deductible with relief for foreign tax, taxable surplus receives deductions for underlying foreign tax, and pre-acquisition surplus is deductible but reduces the adjusted cost base. Individuals do not get these deductions.

Should foreign affiliate shares be held personally or through a Canadian corporation?

It depends on the facts, but holding foreign affiliate shares through a Canadian corporation is often better because only corporations can use the surplus deductions and corporations receive a more generous deduction for foreign tax against FAPI. The right structure should be settled before the investment is made.

How does the CRA decide whether a foreign entity is a corporation?

The CRA uses a two-step approach. It first determines the entity’s characteristics under the foreign law and its constating documents, and then compares those characteristics with recognized Canadian categories such as corporations, partnerships and trusts. How the entity is taxed abroad is generally not relevant.

What if I never filed Form T1134 for my foreign company?

A voluntary disclosure may eliminate penalties and reduce interest if it is made before the CRA contacts you about the issue. Late T1134s, unreported FAPI and missing T1135s are often disclosed together so the application is complete.

Does a foreign trust have to file Form T1134?

A non-resident trust that is deemed resident in Canada under section 94 is treated as resident for the foreign affiliate reporting rules, so it may have to file Form T1134 for any foreign affiliates it holds. Certain non-resident trusts can also themselves be treated as foreign affiliates of Canadian beneficiaries.

Can I borrow money from my foreign affiliate instead of paying a dividend?

A loan from a foreign affiliate to its Canadian shareholder or a non-arm’s length person is generally included in the Canadian taxpayer’s income under the upstream loan rule unless it is repaid within two years, although a deduction may be available where the affiliate has sufficient surplus.

Does Form T1134 have to be filed by each company in a Canadian group?

Not always. The rules generally place the filing obligation on the lowest-tier Canadian entity that holds the foreign affiliate, and related Canadian entities may be able to file one T1134 package, but each reporting entity remains responsible for making sure its obligation is met.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.