www.pwc.com/ca/inprint
In Print
Reinstated Foreign Accrual Tax and the
Multi-Period Perspective
As originally published by the Canadian Tax Foundation.
Synopsis
Regulations 5907(1.5) and (1.6) facilitate certain deductions against
inclusions for foreign accrual property income, based on foreign tax
compensation payments made between companies in a group.
Adam Freiheit
2015
This article identifies challenges in interpreting these regulations and
explores the potential significance of their enactment relative to other
provisions of the Income Tax Act and regulations that compute amounts
based on foreign tax payments.
Contact:
Adam Freiheit
[email protected]
First published in Canadian Tax Journal (2015) 63:2, 521 - 42. Reproduced with
permission. Copyright remains with the author.
PwC refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership.
canadian tax journal / revue fiscale canadienne (2015) 63:2, 521 - 42
International Tax Planning
Co-Editors: Ken Buttenham and Michael Maikawa*
Reinstated Foreign Accrual Tax and
the Multi-Period Perspective
Adam Freiheit**
Regulations 5907(1.5) and (1.6) facilitate certain deductions against inclusions for foreign
accrual property income, based on foreign tax compensation payments made between
companies in a group. This article identifies challenges in interpreting these regulations
and explores the potential significance of their enactment relative to other provisions of
the Income Tax Act and regulations that compute amounts based on foreign tax payments.
Keywords: Foreign accrual property income n foreign taxes n reasonable
Contents
Introduction
Background: Foreign Accrual Tax
The FAT Reinstatement Regulations
The Legislative Process
The 2012 Explanatory Notes Example
Unchanging Canadian Taxpayer
Constant Members of the FA Group
FAPI-Year Losses
Whether FAPI-Year Losses Are Deducted Against Active Business Income
Pre-FAPI-Year Losses
The FAT Reinstatement Rules and the Multi-Period Perspective
Broad Statutory Language
CRA Interpretations Issued in 1997 and 2004
1991 CRA Memorandum
2015 CRA Interpretation
FAT Eliminated by a Multi-Period Perspective
Multi-Period Perspective Obviating the Need for Reinstatement
Conclusion
522
522
524
524
525
528
529
529
530
533
534
534
536
537
538
538
539
542
* Of PricewaterhouseCoopers LLP, Toronto.
** Of PricewaterhouseCoopers LLP, Toronto. I would like to thank Michael Maikawa, Melanie
Huynh, Eric Lockwood, and Alan Davis of PricewaterhouseCoopers LLP, Toronto for their
comments on earlier drafts of this article.
 521
522  n  canadian tax journal / revue fiscale canadienne
(2015) 63:2
Introduction
A taxpayer may increase the number of its foreign affiliates (fas)1 in a given country
for various reasons. For example, for business purposes, it may operate a real estate
platform via multiple entities to limit liability in respect of debts. It may also be
motivated by foreign tax objectives, such as qualifying companies as local real estate
investment trusts. Where an extended group of affiliates is controlled by a Canadianresident taxpayer, some members of the group may earn foreign accrual property
income (fapi)2 while others suffer losses from an active business. If the group computes income for local purposes on a consolidated basis, and the group’s members
make or receive tax compensation payments, the question becomes how to compute
foreign accrual tax (fat)3 in order to evaluate what deductions may be available to
the Canadian taxpayer to offset fapi inclusions. While fat can in some cases include
tax compensation payments, this fat can be reduced if, broadly, the fapi-earning
affiliate compensates a group company for the use of its active business losses. Recent amendments to the Income Tax Regulations aim to reinstate this denied fat
when the consolidated group later earns active business income.
This article first describes some complications that may arise in the application
of the fat reinstatement regulations. It then explores the significance of the enactment of these rules to the interpretation of other provisions in the Income Tax Act
and regulations that also require taxpayers to resolve what foreign taxes “reasonably” relate to.
Background: Foreign Accrual Ta x
A Canadian-resident taxpayer must include in income its participating percentage
of the fapi of its controlled foreign affiliates (cfas), pursuant to subsection 91(1).4
In certain circumstances, the taxpayer may deduct an amount under subsection 91(4)
equal to the fat applicable to this income inclusion multiplied by the taxpayer’s
relevant tax factor for the year.5 The deduction under subsection 91(4) must be
taken in the year of the income inclusion under subsection 91(1) or in any of the
taxpayer’s five following taxation years.
An fa’s fapi may be reduced by all or a portion of its foreign accrual property
loss (fapl) or foreign accrual capital loss (facl) for a taxation year.6 An fa’s fapl for
1 See the definition of “foreign affiliate” in subsection 95(1) of the Income Tax Act, RSC 1985,
c. 1 (5th Supp.), as amended (herein referred to as “the Act”). Unless otherwise stated,
statutory references in this article are to the Act.
2 “Foreign accrual property income” is defined in subsection 95(1).
3 “Foreign accrual tax” is defined in subsection 95(1).
4 “Controlled foreign affiliate” and “participating percentage” are defined in subsection 95(1).
5 “Relevant tax factor” is defined in subsection 95(1).
6 See the descriptions of F and F.1 in the definition of “foreign accrual property income” in
subsection 95(1).
international tax planning  n  523
a given year, as defined in regulation 5903(3), is essentially its negative fapi for the
period. Similarly, regulation 5903.1 defines an fa’s facl generally as its excess of
capital losses over capital gains for the year. The taxpayer elects to reduce fapi by
fapls or facls by designating amounts for the purposes of regulation 5903(1) (in
the case of fapls) or regulation 5903.1(1) (in the case of facls).
The fat applicable to an amount included in income in respect of a particular FA
is defined in subsection 95(1) to mean the total of the following:
1. income or profits tax “that may reasonably be regarded as applicable to that
amount” and that is paid by the particular fa (or certain other fas if the particular affiliate is fiscally transparent under the applicable foreign tax regime);
2. income or profits tax “that may reasonably be regarded as applicable to that
amount” and that is paid by another fa in respect of a dividend received directly or indirectly from the particular FA;7 and
3. amounts prescribed to be fat pursuant to regulations 5907(1.3) and (1.5).
With respect to the third component, if the fapi-earning fa belongs to a consolidated or loss transfer group, regulation 5907(1.3) can prescribe the particular fa’s
tax compensation payments to other members of the group to be fat. Regulation
5907(1.5) is discussed at length below.
Various provisions reduce or deny the fat otherwise determined, limiting
amounts deductible pursuant to subsection 91(4).8 In the remainder of this article,
I discuss rules that reinstate fat denied by one of these provisions, regulation
5907(1.4). Regulation 5907(1.4) reduces the amount otherwise prescribed to be fat
pursuant to regulation 5907(1.3) to the extent that the amount “can reasonably be
considered to be in respect of ” a loss or capital loss of another corporation, where
that loss or capital loss would not be a fapl of a cfa of a relevant person or partnership in respect of the taxpayer. “Relevant person or partnership,” as defined by
7 The reference to indirect dividends was added when the definition of “foreign accrual tax” was
amended in 2014; see infra note 15 and the related text.
8 The following FAT denial rules, although not directly relevant to this article, are summarized
here for completeness. First, as disclosed in explanatory notes issued in 2012, the Department
of Finance introduced subsections 91(4.1) through (4.7) with the foreign tax credit generator
rules in order to undermine “schemes” that “exploit asymmetry” between Canadian tax laws
and those of other jurisdictions. (Canada, Department of Finance, Explanatory Notes Relating to
the Income Tax Act, the Excise Tax Act and Related Legislation (Ottawa: Department of Finance,
October 2012) (herein referred to as “the explanatory notes”), at 294.) Subsection 91(4.1) can
exclude an amount from FAT where, broadly, investment in a relevant entity in the corporate
group is a hybrid instrument that is treated as equity for Canadian tax purposes and debt under
foreign law. Second, regulation 5907(1.7) reduces the amount otherwise prescribed to be FAT
by regulation 5907(1.3), where that amount can “reasonably be considered to be in respect of ”
a capital loss of another corporation, and the loss would not have been deductible by the
FAPI-earning affiliate in computing its FAPI for the year had it been incurred by that affiliate.
This provision aims to ensure that capital losses are streamed against capital gains.
524  n  canadian tax journal / revue fiscale canadienne
(2015) 63:2
regulation 5903(6), includes a Canadian-resident person not dealing at arm’s length
with the taxpayer or a partnership with such a non-arm’s-length member.
The explanatory notes to regulation 5907(1.4) clarify its purpose merely by stating that any resulting fat denial is “consistent with the fact that . . . active business
losses and capital losses resulting from the disposition of excluded property of a
foreign affiliate are not included in the computation of a fapl.”9 This can be interpreted to mean that, just as a stand-alone fa cannot use active business losses to
reduce fapi, so too an fa should not be able to generate fat by compensating a
separate entity for its active business losses. Regulation 5907(1.4) blocks a taxpayer
from increasing fat deductions on the reassignment of active business losses within
a consolidated group.
The FAT Reinstatement Regulations
The Legisl ative Process
On October 15, 2010, the Department of Finance issued a comfort letter (“the 2010
comfort letter”) in which it agreed to recommend amendments to allow fat that is
initially denied under regulation 5907(1.4) to be reinstated in the year in which the
“active business losses that caused the denial are fully utilized against active business
income in the group.”10 Regulations 5907(1.5) and (1.6) (“the fat reinstatement
regulations”) were then included in draft legislation released for public consultation
on August 19, 2011. These provisions were enacted without modification as part of
Bill c-48 in 2013,11 applicable to taxation years of fas beginning after November
1999—that is, those years to which regulation 5907(1.4) can apply.12
The fat reinstatement regulations prescribe an amount to be fat in the taxpayer’s taxation year that includes the last day of a “designated taxation year.” The
designated taxation year is defined in regulation 5907(1.6) to mean, generally, the
taxation year of the fapi-earning fa in which all losses of all members of the consolidated group for their taxation years ending in the fapi year13 would have been
fully deducted under local laws against non-fapi income. The taxpayer must demonstrate that no losses of these corporations for any other taxation year could also
9 Explanatory notes, supra note 8, at 129.
10 Department of Finance comfort letter dated October 15, 2010.
11 Bill C-48, Technical Tax Amendments Act, 2012; SC 2013, c. 34; royal assent June 26, 2013.
12 Many of the years beginning after November 1999 would have already been statute-barred at
the time the FAT reinstatement regulations were implemented on June 26, 2013. Section 53(b)
of Bill C-48 permitted the minister of national revenue to make adjustments for such statutebarred years to allow for FAT reinstatement, but only if the taxpayer elected in writing, by
December 26, 2013, to have the relevant provision of C-48 apply in respect of all its FAs.
13 “The FAPI year” is the taxation year of the taxpayer in which the taxpayer has a FAPI inclusion
pursuant to subsection 91(1), and corresponding FAT denied pursuant to regulation 5907(1.4):
regulation 5907(1.5).
international tax planning  n  525
reasonably have been deducted against this non-fapi income. The last day of the
designated taxation year must end in one of the five taxation years of the taxpayer
following the fapi year.14
In 2014, the fat reinstatement regulations were amended to apply in certain contexts in which the fapi-earning affiliate or other relevant fas are fiscally transparent.15
The rules were expanded at that time to apply not only in respect of consolidation
regimes but also in respect of loss transfer (group relief ) systems. For simplicity,
this article will focus on consolidation regimes made up of fiscally opaque entities
and will not discuss the 2014 amendments further.16
The 2012 Expl anatory Notes Ex ample
The October 2012 explanatory notes to regulations 5907(1.5) and (1.6) include an
example that is reproduced here (with minor changes in format) as figure 1 and
table 1 (“the explanatory notes example”).17 Canco (“the taxpayer” for the purposes
of the fat reinstatement regulations) is a Canadian-resident corporation that owns,
directly or indirectly, three cfas that form a consolidated group for us income tax
purposes. Table 1 shows the income and losses realized by these cfas over a fouryear period. fa 2 (“the particular affiliate” for the purposes of these regulations) makes
a compensation payment to fa 1 of $140 (see figure 1), which would be prescribed
to be fat pursuant to regulation 5907(1.3). However, Finance states that $105 of this
compensation payment would reasonably be considered to be in respect of fa 3’s
active business loss, and hence that regulation 5907(1.4) reduces the prescribed fat
by this amount.18 The explanatory notes conclude that in 2007 (the designated taxation year), $105 is prescribed under regulation 5907(1.5) to be fat, because fa 3’s
$300 of active business losses in 2004 would have been fully deducted against
fa 3’s aggregate active business income in 2006 and 2007. As a result, Canco would
be in a position to claim a FAT deduction in 2007 pursuant to subsection 91(4).
The following may be observed. First, if regulation 5907(1.5) reinstates fat, it
does so all at once—with prescribed fat in the taxpayer’s taxation year that includes the last day of the fa’s designated taxation year. Thus, if the explanatory notes
14 In a submission to Finance dated October 19, 2011, PricewaterhouseCoopers LLP had
recommended that the five-year window be extended. See PricewaterhouseCoopers LLP,
“Re: August 19, 2011 Amendments Regarding the Taxation of Foreign Affiliates,” submission
to the Department of Finance, October 19, 2011 (www.pwc.com/en_CA/ca/canadian-national
-tax-service/publications/2011-09-foreign-affiliate-amendments-2011-10-en.pdf ).
15 See Bill C-43, the Economic Action Plan 2014 Act, No. 2; SC 2014, c. 9; royal assent
December 16, 2014 (herein referred to as “the 2014 amendments”).
16 This article does not, for example, introduce the concept of “shareholder affiliate,” which is
relevant in applying the regulations to fiscally transparent entities.
17 Explanatory notes, supra note 8, at 129-30.
18 This assertion regarding the application of regulation 5907(1.4) is challenged below.
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Table 1 A
pplication of FAT Reinstatement Regulations—Example from Finance
Explanatory Notes
2004
2005
2006
2007
Designated
tax year
Active
FAPI business
Active
FAPI business
Active
FAPI business
FAPI year
Active
FAPI business
dollars
FA 1 . . . . . . . . . . . FA 2 . . . . . . . . . . . FA 3 . . . . . . . . . . . Prescribed FAT
(per Finance) . . 400
(300)
200
35a
150
105b
FA = foreign affiliate.
FAPI = foreign accrual property income.
FAT = foreign accrual tax.
a Pursuant to regulation 5907(1.3).
b Reinstatement pursuant to regulation 5907(1.5).
Source: Based on Canada, Department of Finance, Explanatory Notes Relating to the Income Tax Act,
the Excise Tax Act and Related Legislation (Ottawa: Department of Finance, October 2012), at 129-30.
FIGURE 1
Facts Used in the Explanatory Notes Example
Canco
(Canada)
$35 tax payment
to IRS
FA 1
(US)
$140 compensation
payment
“Taxpayer”
“Other corporation” referred
to in regulation 5907(1.3)(a)
$105 compensation
payment
FA 2
(US)
FA 3
(US)
“Particular affiliate”
(FAPI company)
“Other corporation” referred
to in regulation 5907(1.3)(a)
FA = foreign affiliate.
FAPI = foreign accrual property income.
IRS = Internal Revenue Service.
Source: Based on Canada, Department of Finance, Explanatory Notes Relating to the Income Tax
Act, the Excise Tax Act and Related Legislation (Ottawa: Department of Finance, October 2012),
at 129-30.
international tax planning  n  527
example is modified so that fa 3 earns active business income of $299 in 2006 and
$1 in 2007, the fat is still reinstated only in 2007, with no fat deduction in 2006.19
Second, the reinstated fat is prescribed to be applicable to “the fapi amount”20—
that is, Canco’s 2004 fapi inclusion under subsection 91(1) in respect of fa 2. As a
result, Canco can claim a fat deduction in 2007 under subsection 91(4), even if
there is no fapi inclusion in 2007, because it is in respect of 2004’s inclusion, with
2004 being one of the five taxation years of Canco immediately preceding 2007.
Third, Canco, pursuant to Finance’s approach, is viewed as having a fat reduction
in 2004 and therefore a net fapi income inclusion for that year. Canco’s deduction
in respect of reinstated fat, however, is delayed until 2007. A taxpayer may be prevented from carrying back a loss resulting from reinstated fat to the fapi year. As a
result, fat reinstatement may not permit a refund of taxes paid in respect of the fapi
year.21 The Joint Committee on Taxation of the Canadian Bar Association and the
Canadian Institute of Chartered Accountants (“the joint committee”) submitted, on
the basis of this consideration, that a taxpayer should be permitted upon reinstatement to amend the return that reflected the original fapi inclusion.22 Finance did
not follow this suggestion.
Fourth, under regulation 5907(1.6), 2007 is a designated taxation year of fa 2,
because the 2004 losses of the members of the consolidated group could “reasonably
be considered” to have been fully deducted in computing us taxable income in that
year. The local deductions in this context are hypothetical. Regulation 5907(1.6)(a)
requires a taxpayer to ignore all fapi earned by the members of the consolidated
group, whereas, in reality, fa 3’s losses are applied against fa 2’s fapi in 2004, and no
losses are available for carryover. Given that the carryover is imaginary, no foreign
tax authority issues an assessment that might assist in resolving disputes between the
taxpayer and the Canada Revenue Agency (cra) regarding how the local carryover
rules operate.
In evaluating the hypothetical carryover, the fat reinstatement regulations only
authorize the assumption that no fapi is earned by the relevant affiliates. All other
local prerequisites for loss carryovers must be applied, regardless whether they resemble those under the Act. The joint committee was unable to persuade Finance
to make fat reinstatement a function of cumulative local taxable income instead of
19 In its October 19, 2011 submission to Finance, supra note 14, PricewaterhouseCoopers LLP
had recommended that the FAT reinstatement regulations use a pro rata methodology, rather
than an all-or-nothing approach.
20 Defined in regulation 5907(1.5).
21 The delay in deducting the reinstated FAT could be relevant in other ways. For example, for
the purposes of computing a FAT deduction, the FAT is grossed up using the relevant tax
factor, and this factor can change over time.
22 See Joint Committee on Taxation of the Canadian Bar Association and the Canadian Institute
of Chartered Accountants, “Re: Submission in Respect of the August 19, 2011 Foreign Affiliate
Proposals,” submission to the Department of Finance, October 19, 2011, at 13(c), “Timing of
91(4) Deduction.”
528  n  canadian tax journal / revue fiscale canadienne
(2015) 63:2
local loss utilization rules, despite the possibility that local carryover rules can be
idiosyncratic.23
Fifth, in the explanatory notes, Finance extends the main example to one where
the us consolidated group has losses of $180 in 2008 that are eligible for carryback
to 2006, and only $20 of the 2004 losses are hypothetically applied against 2006
income.24 With only $150 of additional losses applied against income in 2007, the
group needs an additional $130 of non-fapi income in 2009 to consider the $300 of
2004 losses to have been “fully deducted” in that year. This demonstrates that a
taxpayer cannot be certain of its intended deduction for reinstated fat until it resolves its income and losses under local rules for each period that might have losses
that can be carried back to a relevant year.25
Additional considerations regarding the fat reinstatement regulations are discussed in the text that follows.
Unchanging C anadian Ta xpayer
Regulation 5907(1.5) can potentially apply only in respect of a taxpayer that has had
an income inclusion under subsection 91(1) in respect of a particular affiliate’s fapi.
The provision prescribes an amount to be fat applicable to this fapi inclusion,
thereby enabling the particular taxpayer to claim a corresponding fat deduction.
Thus, fat reinstatement is seemingly possible only if the fa that has earned the
relevant fapi remains an fa of the taxpayer. The requisite relationships may be lost
if, for example, the taxpayer transfers the fa to a parent or sister company.
The joint committee noted the above limitation and recommended that a rule be
introduced to deem a transferee of an fa to be the same taxpayer as a related transferor for the purposes of regulations 5907(1.3) through (1.7) and subsection 91(4).26
Finance did not act on this recommendation.27
23 See ibid., at 13(a), “Requirement To Deduct All Losses.”
24 Explanatory notes, supra note 8, at 130.
25 There can also be uncertainty and lack of immediate closure when FAT is claimed in respect of
a stand-alone FA. For example, in CRA document no. 9822835, November 27, 1998, the CRA
expects that a Canadian tax return will be refiled if a FAT deduction is claimed in the original
return and the FA’s liability is subsequently eliminated by virtue of a loss carryback. However,
in the context of reinstatement, the uncertainty can arguably be more pronounced, because a
greater number of foreign taxpayers and taxation years can be relevant. It is beyond the scope
of this article to consider a taxpayer’s obligation to amend a return that has been filed, without
negligent misrepresentation, on the basis of information available at the time of filing.
26 See the joint committee submission, supra note 22, at 13(b), “Application of Rules where FA
Transferred to Different Taxpayer.”
27 Subsection 91(4) only allows a taxpayer that has had a FAPI inclusion to claim the
corresponding FAT deduction, based on income or profits taxes paid by one of the taxpayer’s
relevant FAs. As a result, the FAT rules, even as they apply to stand-alone FAs, generally
require continuity in the identity of the Canadian taxpayer and its relationship with relevant
subsidiaries. However, other FA rules can be more flexible. For example, paragraph 87(2)(u)
international tax planning  n  529
Constant Members of the FA Group
fat can be reinstated only if the losses of all members of the consolidated group for
their taxation years ending in the fapi year are fully deducted against income of one
or more of those corporations. Limiting the hypothetical carryover to income earned
by those specific entities can be restrictive. An fa with fapi-year losses could for
example liquidate into a newly formed entity that continues to profitably operate its
active business. The fat reinstatement rules would seemingly ignore income earned
by the surviving parent.
The hypothetical carryover under the FAT reinstatement regulations does not seem
to ignore losses of entities that join the consolidated group, even while ignoring the
income of such entities. Regulation 5907(1.6)(a) authorizes only one assumption in
analyzing the carryover: that fapi is ignored. The hypothetical deductions are arguably prevented if income in periods following the fapi year is actually offset by
losses of entities that are newly formed or acquired. One could perhaps assert that
the losses of entities joining the group should be ignored in analyzing the hypothetical carryover, by arguing that they are irrelevant in judging what “reasonably” may
be considered to have been deducted for the purposes of the regulations. According
to this approach, in guiding the hypothetical carryover, the regulations are explicit
only about ignoring fapi, but permit additional, unstated assumptions by using the
word “reasonably.”
FAPI-Year Losses
In the 2010 comfort letter, Finance indicated that it would recommend that reinstatement be triggered “in the year in which the active business losses that caused
the [fat] denial are fully utilized against active business income of the group.”28
The legislation as enacted arguably does not reflect this perfectly.
First, regulation 5907(1.6) appears to require that “all losses” from the fa years
ending in the fapi year be fully deducted. “All losses” presumably includes capital
losses, fapls, and facls realized by the group companies.29 This broad interpretation of the expression “losses” is supported by the fact that regulation 5907(1.4)
refers to “a particular loss (other than a capital loss),” implying that capital losses
deems certain adjustments of adjusted cost base relative to shares held by a predecessor
company to have been made relative to shares held by the succeeding amalgamated company, to
permit the amalgamated company to claim dividends-received deductions under subsection
91(5). As a result, a change in the identity of the taxpayer resulting from an amalgamation does
not cause FAPI to be taxed a second time when distributed. The joint committee’s submission
(supra note 22) regarding FAT reinstatement may be viewed as part of a broader attempt to
encourage Finance to increase flexibility in the FAT regime.
28 Supra note 10.
29 While FAPLs realized by members of a consolidated group would not of themselves cause
regulation 5907(1.4) to reduce FAT, this provision can nonetheless apply when there are FAPLs
in a group if other members of the group realize active business losses in the year.
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(2015) 63:2
count as “losses” absent such a carve-out. Regulation 5907(1.4) furthermore refers
to the portion of a loss or capital loss that “would . . . not be a foreign accrual property loss . . . or a foreign accrual capital loss,” implying again that “losses” would
include fapls and facls absent explicit exclusions. Thus, while the comfort letter
stated that reinstatement would be triggered once certain active business losses
were deducted, the requirements in the regulations as enacted seem to be more
onerous since they require other kinds of losses to be used up.
Second, the comfort letter stated that the rules would require the full deduction
of active business losses to the extent that they caused fat denial. However, according to the enacted regulations, a taxpayer is eligible for fat reinstatement only if
losses for all taxation years ending in the fapi year are hypothetically deducted
against non-fapi income. The fapi year is a taxation year of the Canadian taxpayer.
The relevant fas might have several local taxation periods ending in this fapi year.
There could be situations where losses in some of the periods ending in the fapi
year did not “cause” the relevant fat denial.
Consider the scenario illustrated by table 2. fa 2 and fa 3 have the same income
and loss amounts in various years as in the explanatory notes example. However, in
this scenario, fa 1 has losses in an additional taxation year ending in the fapi year—
that is, the period ended June 30, 2004. Let us assume that fa 1’s losses for the period
ended June 30, 2004 are not available for carryforward under local rules, and that
fa 1 is not compensated by any member of the group for the use of these losses.
If we follow the approach that Finance took to regulation 5907(1.4) in analyzing
the explanatory notes example, then regulation 5907(1.4) can be treated as reducing
fat otherwise prescribed in respect of the period ended December 31, 2004 by
$105. The designated taxation year in this example arguably is no longer 2007.
fa 1’s losses from the period ended June 30, 2004 must be fully deducted against
appropriate income, even though these losses seemingly did not cause the taxpayer’s
2004 fat denial.
Whether FAPI-Year Losses Are Deducted
Against Active Business Income
According to the 2010 comfort letter, fat was to be reinstated when relevant losses
were fully deducted against “active business income of the group.” However, the
fat reinstatement regulations, as implemented, describe the relevant income somewhat differently. The losses in question must be fully deducted against any income
on the assumption that the relevant foreign corporations have no fapi. Thus, a
taxpayer could arguably fail to get fat reinstated even if the members of the group
have active business income that would offset the fapi-year losses, if those members
also have fapls in the relevant years.
In the example illustrated by table 3, fa 1 has a fapl of $200 in 2006. Seemingly,
no 2004 losses can be deducted hypothetically against fa 3’s 2006 active business
income because this income can be viewed as being already offset by fa 1’s fapl in
that year. It is submitted that the 2006 fapls should be ignored for the same reason
that any fapi would have been ignored.
(250)
(250)
Active
business
FA = foreign affiliate.
FAPI = foreign accrual property income.
FAPL = foreign accrual property loss.
a “FAPI amount” (regulation 5907(1.5)).
FA 1 . . . . .
FA 2 . . . . .
FA 3 . . . . .
FAPI
(FAPL)
June 30, 2004
400a
FAPI
(FAPL)
(300)
Active
business
December 31, 2004
12-Month taxation year of the taxpayer (FAPI year)
Table 2 Additional Losses in the FAPI Year
FAPI
(FAPL)
Active
business
dollars
2005
FAPI
(FAPL)
2006
200
Active
business
FAPI
(FAPL)
2007
150
Active
business
international tax planning  n  531
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(2015) 63:2
Table 3 FAPL After FAPI Year Preventing FAPI-Year Losses from Being Used Up
2004
2005
2006
2007
Designated
tax year
FAPI
Active
(FAPL) business
FAPI
Active
(FAPL) business
FAPI year
FAPI
Active
(FAPL) business
Passive
income
Active
business
dollars
FA 1 . . . .
FA 2 . . . .
FA 3 . . . .
(200)
400
(300)
200
150
FA = foreign affiliate.
FAPI = foreign accrual property income.
FAPL = foreign accrual property loss.
The members of the consolidated group might include non-fas, which by definition cannot earn fapi.30 As a result, one could arguably achieve reinstatement by
deducting fapi-year losses against passive income earned by non-fas, even if that
income would have been fapi had the non-resident entities been fas of the taxpayer.
If, in the example illustrated by table 3, nr, a non-fa in the consolidated group,
earns passive income of $1,000 in 2007, we should be able to view the 2004 losses
as having been fully deducted in 2007. This treatment seems appropriate. fat is
reduced under regulation 5907(1.4) if a fapi-earning fa compensates a non-fa for
any losses in a fapi year, including losses that would have been fapls were the nonfa an fa. If any losses of the non-fa in the fapi year can cause fat denial, then
arguably any income of the non-fa should facilitate reinstatement.
The fat reinstatement regulations seemingly permit losses to be used against
other kinds of non-active business income, such as passive income earned by fas for
local purposes that is excluded in computing fapi. For example, fapi only includes
the taxable portion (currently 50 percent) of gains arising on the disposition of
certain assets. Assuming that “income” for the purposes of regulation 5907(1.6)(a)
can include capital gains, one should arguably be able to deduct fapi-year losses
against 50 percent of an fa’s gains on the disposition of non-excluded property because the fa would still have such gains even assuming that it had no fapi.
As a further example, consider a case where a taxpayer has two wholly owned
fas—fa 1, which is a member of a US consolidated group, and fa 2, which is resident in the United Kingdom. fa 1 transfers excess cash to fa 2 in exchange for a
note denominated in British pounds. fa 1’s interest on the note is included in computing its fapi. After the fapi year, fa 2 repays its liability. fa 1 realizes a foreign
30FAPI is defined in subsection 95(1) only relative to FAs of a taxpayer. To illustrate, an FA (“US
Sub 2”) of a Canadian taxpayer (“Canco”) might be a member of a consolidated group that
includes non-FAs if Canco is wholly owned by a US parent (“USP”); USP directly owns all the
common shares of US Sub 1 and US Sub 2; USP, US Sub 1, and US Sub 2 form a consolidated
group; and Canco owns only all of the special shares of US Sub 2.
international tax planning  n  533
exchange gain relative to the Canadian dollar on the settlement of the note, but this
gain is deemed to be nil for fapi computation purposes pursuant to paragraph
95(2)(g). At the same time, fa 1 realizes a foreign exchange gain relative to the us
dollar for us tax purposes on this repayment. One could argue that fapi-year losses
should be deductible against the foreign exchange gain that fa 1 recognizes for us
tax purposes, since this gain is excluded in computing fa 1’s fapi.
There is one additional way in which the regulations may block reinstatement,
even in cases where the consolidated group arguably earns sufficient active business
income after the fapi year. The provision in regulation 5907(1.6)(a) requires losses
to be fully deducted
in the particular [designated taxation] year, or in the taxation year of the particular affiliate . . . (referred to in this paragraph as the “paty”) ending in the fapi year and one
or more taxation years of the particular affiliate . . . each of which follows the paty and
the latest of which is the particular year [emphasis added].
The regulation thus seems to require all the losses to be deducted either in one
year—the designated taxation year—or in a group of years that includes a paty. If a
particular affiliate has more than one taxation year ending in the fapi year, technically, it may not have a paty, because the provision presupposes in defining paty that
there is only one such year ending in the fapi year.31 In these circumstances, the
regulation, interpreted narrowly, permits fat reinstatement only if the relevant
losses are fully deducted in a single year that follows the fapi year. This seemingly
unintended limitation could be eliminated by amending regulation 5907(1.6)(a) so
that it refers to the deduction of losses in “the taxation year or taxation years of the
particular affiliate ending in the fapi year,” defining patys instead of paty.
Pre-FAPI-Year Losses
In the example illustrated by table 4, fa 1 compensates fa 2 in year 2 for the use of
its active business losses realized in year 1. FA 2 later earns active business income in
year 6. The fat in respect of fa 1 otherwise prescribed by regulation 5907(1.3) is
arguably reduced under regulation 5907(1.4) by the amount of fa 1’s compensation
payment to fa 2, since fa 2 is not being compensated for a fapl. However, this fat
seemingly cannot be reinstated, despite the active business income earned in year 6,
because regulations 5907(1.5) and (1.6) trigger such reinstatement only when fapiyear losses are hypothetically carried over, and in this example there are no fapi-year
losses whatsoever.
31 Prior to the 2014 amendments, regulation 5907(1.6) referred instead to “the particular
affiliate’s taxation year (referred to in this paragraph as the ‘PATY’) ending in the FAPI year
and one or more taxation years of the particular affiliate each of which follows the PATY and
the latest of which is the particular year.” While this obsolete version of the regulation still
referred to a single year ending in the FAPI year, it could perhaps have been interpreted as
allowing a taxpayer to choose one such year if there were several, given the separation between
the words “taxation year” and “the.”
534  n  canadian tax journal / revue fiscale canadienne
(2015) 63:2
Table 4 FAT Denial with No FAPI-Year Losses
Year 1
FAPI
(FAPL)
Active
business
Year 2
FAPI
(FAPL)
Active
business
Year 6
FAPI
(FAPL)
Active
business
dollars
FA 1 . . . . . . . . . . . . . . . . . FA 2 . . . . . . . . . . . . . . . . . Compensation payment
from FA 1 to FA 2 . . . . 100
(100)
100
36
FA = foreign affiliate.
FAPI = foreign accrual property income.
FAPL = foreign accrual property loss.
The FAT Reinstatement Rules and the
Multi-Period Perspective
This article thus far has introduced the fat reinstatement regulations and examined
certain potential applications. We now consider Finance’s general objective in introducing these rules, and what their enactment could mean relative to other provisions
that compute amounts based on foreign tax payments.
In the 2010 comfort letter, Finance agreed to recommend reinstatement rules so
that the fat denial rules would reflect a multi-period perspective. This perspective
permits a taxpayer to look at a series of fa years in determining what a tax payment
in a given year relates to. As the following will demonstrate, given the breadth of the
language in the Act and regulations, the cra had been appropriately using a multiperiod perspective even before the fat reinstatement regulations were enacted.
Broad Statutory L anguage
The provisions that include or exclude amounts in computing fat feature the words
“reasonably be considered” or “reasonably be regarded.” More specifically, “foreign
accrual tax” is defined in subsection 95(1) to include income or profits tax that may
“reasonably be regarded” as applicable to certain fapi inclusions. Regulation
5907(1.3) includes compensation payments that may “reasonably be regarded as
being in respect of income or profits tax that would otherwise have been payable by
the particular affiliate.” Finally, regulation 5907(1.4) reduces the fat otherwise
prescribed by regulation 5907(1.3) by an amount that can “reasonably be considered
to be in respect of ” certain losses of other corporations. As we will presently see,
this language is broad32—arguably, broad enough to be interpreted using the multiperiod perspective discussed below.
32For a discussion of the breadth of the language used in these provisions, see Michael G.
Bronstetter and Douglas R. Christie, “The Fickle Finger of FAT: An Analysis of Foreign
Accrual Tax,” International Tax Planning feature (2003) 51:3 Canadian Tax Journal 1317-39.
international tax planning  n  535
Subsection 20(12) permits a deduction for certain non-business-income taxes
paid, other than such taxes that “can reasonably be regarded as having been paid . . .
in respect of income” from a share of the capital stock of an fa. The Tax Court of
Canada interpreted these words in FLSmidth Ltd. v. The Queen.33 Paris J offered the
following background to support his conclusion that “in respect of ” must be given
a broad meaning:
In Nowegijick v. The Queen the Supreme Court of Canada held that the words “in respect of ” were “words of the widest possible scope” and went on to say:
They import such [meanings] as “in relation to,” “with reference to” or “in connection with.” The phrase “in respect of ” is probably the widest of any expression
intended to convey some connection between two related subject matters.34
The court furthermore held that the expression “can reasonably be regarded,” on
its own, “is a specific provision enabling the Minister to evaluate the economic
substance of a transaction regardless of its legal form.”35
The cra has historically applied the fat definition in a broad manner consistent
with the above. For example, in a 1998 technical interpretation,36 the cra held essentially that local taxation of gains on the disposition of property could constitute
fat in respect of a fapi inclusion in an earlier year. The cra stated:
The wording of the definition of fat in subsection 95(1) of the Act is very broad, (i.e.
“the portion of any income or profits tax that was paid . . . by the particular affiliate . . .
and may reasonably be regarded as applicable to” the fapi). It is a question of fact
whether tax paid by a foreign affiliate meets this test and it would be necessary to review the facts of an actual case in order to decide the issue. However, the Department
recognizes that because the fapi of a foreign affiliate is computed pursuant to the
provisions of the Act while the foreign taxes paid by a foreign affiliate are determined
in accordance with foreign tax law, there may result many reconciling items and timing differences between the fapi reported by a taxpayer and the foreign taxes paid by
the particular affiliate. The Act alleviates this problem with the above broad wording
defining fat and by providing, in subsection 91(4) of the Act, for a six year period to
match the foreign taxes paid with the fapi reported.37
33 2012 TCC 3.
34 Ibid., at paragraph 39.
35 Ibid., at paragraph 63. The Federal Court of Appeal dismissed the taxpayer’s appeal in
FLSmidth Ltd. v. Canada, 2013 FCA 160, holding that the Tax Court’s decision rested on its
interpretation of “in respect of ” and not its reading of “can reasonably be regarded.” The
Court of Appeal neither approved nor rejected the Tax Court’s interpretation of the former
expression, because doing so would not have altered its disposition of the case.
36 CRA document no. 9819355, December 15, 1998.
37 Ibid.
536  n  canadian tax journal / revue fiscale canadienne
(2015) 63:2
CR A Interpretations Issued in 1997 and 2004
We now consider two documents that demonstrate that the cra has been using a
multi-period perspective in analyzing fat for some time, based on the broad language referred to above.
A stand-alone fa could have two sources of income and losses: one generating
fapi or fapls, and the other generating income or losses from an active business.
Where an fa has income from both of these sources, quantifying fat can entail
resolving the extent to which taxes paid by the fa can “reasonably be regarded” as
“applicable” to the taxpayer’s fapi inclusion in respect of the fa.
The cra considered a hypothetical scenario involving such a stand-alone fa in
technical interpretations released in 1997 (“the 1997 ti”)38 and 2004 (“the 2004
ti”).39 The fa under consideration had fapi in each of three years. However, as
illustrated in table 5, its local taxable income (and therefore tax liability) in certain
periods was reduced by active business losses.
The cra accepted that the taxpayer could evaluate the extent to which the taxes
were “reasonably . . . applicable” to fapi inclusions by considering total fapi and
total taxable income over the three taxation years. The cra held that tax of $108
was applicable to the fapi over this period—that is, an amount equal to $300 (total
fapi) divided by $620 (total taxable income) multiplied by $223 (total taxes paid).
The cra’s perspective is multi-period, because the taxpayer is permitted to judge
what its tax payment each year relates to by considering taxable income in other
periods. Had the cra insisted on a single-year perspective, fa 1 would arguably still
be viewed as having fat of $18 in year 1—that is, the taxes paid in respect of the
year. However, fa 1 would have fat of only $36 (at most) in year 3, because its local
tax liability in year 3 would be viewed as being a function of its current year’s taxable
income.
Pursuant to subsection 91(4), a fat deduction in respect of a given year’s fapi
inclusion cannot exceed the amount of that inclusion. As a result, it is crucial in analyzing fat to identify which year’s income the fat applies to. The 1997 and 2004
tis both treated taxes paid in year 1 as being entirely applicable to that year’s fapi
inclusion. The appropriateness of that allocation is discussed immediately below.
The technical interpretations differed, however, in how they viewed taxes paid in
respect of year 3. The 1997 ti treated the remaining $90 of fat paid in year 3 as
being entirely applicable to year 3’s fapi inclusion of $100, implicitly limiting the
fat deduction in year 3 under subsection 91(4) to that amount. However, the 2004
TI concluded that fat paid in year 3 “pertains to” the fapi inclusions in all three
years—without suggesting a detailed breakdown.40 The approach in the 2004 ti
38 CRA document no. 9719055, October 29, 1997.
39 CRA document no. 2002-0134201I7, March 25, 2004.
40 In this respect, the 2004 TI followed the approach advocated by Bronstetter and Christie,
supra note 32, at 1335.
international tax planning  n  537
Table 5 C
omputation of Foreign Accrual Tax—CRA Interpretations of 1997 and 2004
Year 1
Year 2
Year 3
Totals
Active
FAPI business
Active
FAPI business
Active
FAPI business
Active
FAPI business
dollars
FA . . . . . . . . . . . . . Taxable income . . . Taxes paid to
local revenue
authorities
(@36%) . . . . . . . FAT per CRA . . . . 100
(50)
50
100
(130)
[NOL of $30
carried forward
to year 3]
18
18
100
500
570
205
90
300
320
620
223
FA = foreign affiliate.
FAPI = foreign accrual property income.
FAT = foreign accrual tax.
NOL = net operating loss.
Source: Based on Canada Revenue Agency, CRA document nos. 9719055, October 29, 1997,
and 2002-013420I7, March 25, 2004.
may allow for greater fat deductions—for example, if a deduction can be taken in
year 3 in respect of year 2’s fapi inclusion.
The cra’s basis for concluding that taxes paid in year 1 are entirely allocable to
fapi is not self-evident. Using a multi-period perspective, only 300/620 (the ratio
described above) × $100 (the fapi in year 1) × 36% (the local tax rate)—or
$17.42—should arguably be viewed as fat applicable to year 1’s fapi inclusion. The
CRA may have taken the view that the FAT deduction taken each year should be
based only on information available at the time of filing.
The 1997 and 2004 tis do not state that the fas under consideration ceased to
exist after year 3. While the cra’s overall message was that the taxpayer should look
at a series of years, the cra did not offer guidance on how to constrain the relevant
period.41
1991 CR A Memor andum
The cra had applied a multi-period perspective in an even earlier head office memorandum (“the 1991 memo”)—albeit in a less detailed way—in interpreting the fat
definition and regulation 5907(1.3).42 Table 6 provides a specific example of the
41 Bronstetter and Christie, ibid., had pointed out this ambiguity relative to a series of years in
discussing the 1997 TI. However, the CRA chose not to expand on this aspect of the analysis in
the 2004 TI.
42 CRA document no. 901876, March 6, 1991.
538  n  canadian tax journal / revue fiscale canadienne
(2015) 63:2
general scenario discussed in this document. fa 1 and fa 2 are fas of a Canadian
taxpayer; fa 1 is the head company of a consolidated group that includes fa 2. The
table shows the income and losses earned by each entity in years 1 and 2, as well as
fa 2’s tax compensation payments. The cra accepted that fa 2’s compensation payment in year 1 could constitute fat in respect of its fapi in year 2 if the consolidated
group could hypothetically carry back the active business loss from year 2 to offset
its active business income in year 1. The cra stated:
The argument would be that the total amount paid in respect of income taxes in the
period was in excess of the amount of taxes that would have been paid on the net active
business income for the period and therefore, the excess relates to the fapi.43
Thus, in the 1991 memo, the cra accepted that a multi-period perspective can
be adopted even when analyzing fat in a scenario involving consolidated groups
and regulation 5907(1.3).
2015 CR A Interpretation
The cra recently issued a document analyzing a scenario similar to that illustrated
in figure 1 (“the 2015 interpretation”).44 Using for simplicity the facts from the
explanatory notes example, the cra essentially held that fat is indeed denied in
2004, because regulation 5907(1.4) must be applied on the basis of information
available at the time of filing—that is, facts associated with the fapi year and, if applicable, preceding taxation years.45 Under this approach, active business income
earned in 2006 and 2007 is not relevant in analyzing 2004’s fat denial. The income
from those subsequent years can potentially trigger fat reinstatement only in a later
year pursuant to regulations 5907(1.5) and (1.6). The 2015 interpretation thus denies
the appropriateness of the retrospective approach approved in the 1991 memorandum. However, it implicitly accepts that fat reinstatement may not be needed if
there is no fat denial in the first place owing to the application of a multi-period
perspective involving the fapi year and preceding years.
FAT Eliminated by a Multi-Period Perspective
A taxpayer could find its FAT eliminated retroactively under a multi-period perspective. For example, consider an fa that pays $36 of local income taxes on $100 of fapi
in year 1. In year 2, fa pays no local tax because it has a fapl of $100 and active
business income of $100. Under a multi-period approach, one could argue that fa
has no fat in year 1, even if its taxes are not refunded, because it has no gross fapi
43 Ibid.
44 CRA document no. 2004-0542281E5, February 6, 2015.
45 The CRA did not provide guidance regarding how many preceding years may be considered
relevant.
international tax planning  n  539
Table 6 Computation of Foreign Accrual Tax—CRA Memorandum of 1991
Year 1
FAPI
(FAPL)
Year 2
Active
business
FAPI
(FAPL)
Active
business
100
(100)
dollars
FA 1 . . . . . . . . . . . . . . . . . . . . . . . . . .
FA 2 . . . . . . . . . . . . . . . . . . . . . . . . . .
Compensation payment from
FA 1 to FA 2 . . . . . . . . . . . . . . . . . .
Taxes paid to revenue authority . . . .
100
36
36
FA = foreign affiliate.
FAPI = foreign accrual property income.
FAPL = foreign accrual property loss.
Source: Based on Canada Revenue Agency, CRA document no. 901876, March 6, 1991.
over the two-year period. This example shows that whether or not the multi-period
perspective is “taxpayer-friendly” depends on the facts.
Multi-Period Perspective Obviating
the Need for Reinstatement
Table 7 contains a modified version of the scenario discussed in the 1997 and 2004
tis. The relevant active business losses are realized not by fa 1, but by a related company, fa 2, which is the head company of a consolidated group that includes fa 1.
fa 1 makes a $36 tax compensation payment to fa 2 in each year. These payments
would each be treated as fat pursuant to regulation 5907(1.3) if the regulations had
no fat denial rules.
The fat reinstatement regulations operate only if there has been a fat reduction
pursuant to regulation 5907(1.4). Assuming an approach consistent with the 1997
and 2004 tis, fa 1 should be treated as having total fat of $108 over the three-year
period. It could therefore be argued that regulation 5907(1.4) should not apply to
deny any fat because, with hindsight, it would not be reasonable to consider any portion of fa 1’s compensation payments to fa 2 as being in respect of fa 2’s losses.46
In discussing the explanatory notes example illustrated earlier (figure 1 and table 1),
Finance assumed that regulation 5907(1.4) applied in respect of the 2004 compensation payment, reducing fat by $105. Finance seems to have used a single-period
perspective in applying regulation 5907(1.4), and relied on the new fat reinstatement regulations to achieve the multi-period perspective. When this approach is
46 See, for example, the analysis relating to figure 15 in Firoz K. Talakshi, “The Foreign Affiliate
Regime: Some Practical Issues” (2003) 16:1 Canadian Petroleum Tax Journal, where the author
suggests generally that the multi-period perspective from the 1997 TI should be reflected in
evaluating whether compensation payments generate FAT in a consolidation scenario where
regulation 5907(1.3) operates.
540  n  canadian tax journal / revue fiscale canadienne
(2015) 63:2
Table 7 Example of a Scenario Where Reinstatement Is Arguably Not Required
Year 1
Year 2
Year 3
Totals
Active
FAPI business
Active
FAPI business
Active
FAPI business
Active
FAPI business
dollars
FA 1 . . . . . . . . . . . . . . 100
100
FA 2 . . . . . . . . . . . . . . (50)
100
(130)
300
500
320
FA 1’s compensation
payment to FA 2 . . .
36
36
36
108
Group taxable
income . . . . . . . . . . 50
[NOL of $30
carried forward
to year 3]
570
620
Taxes paid by
consolidated
group (@36%) . . . . 18
205
223
FA 1’s compensation
in respect of FA 2
active business
losses (single-year
perspective) . . . . . . 18
36
FA = foreign affiliate.
FAPI = foreign accrual property income.
used to analyze the scenario in table 7, $18 of fa 1’s compensation payments in respect
of year 1 and $36 of the payments in respect of year 2 can be viewed as compensating fa 2 for its losses. The taxpayer would be expected to have this amount of fat
reinstated in year 3 under the fat reinstatement regulations.
One could argue that the scenario in table 7 should be approached in a way that
more closely follows the analysis in respect of the non-consolidation scenario in
table 5, and that FAT should not be denied in the first place. One response could be
that a stand-alone entity does not actually pay tax until it has taxable income after
applying loss carryovers. For this reason, there is no fat in year 2 in the scenario in
table 5. However, a member of a consolidated group can make compensation payments to related companies even in respect of years in which the consolidated group
has no taxable income. One could reason that fat recognition should not be based
simply on compensation payments, because they are analogous to shifting cash between pockets in a single garment. Thus, fat should not be recognized in year 2 in
the scenario illustrated by table 7, even if fa 1 makes a compensation payment to
fa 2. This argument would seem to lead to the conclusion that fat should be recognized in a consolidation scenario on the basis of when payments are actually made to
the revenue authorities. However, as we have seen, the fat reinstatement regulations
prescribe fat based on hypothetical loss deductions, regardless whether the group
international tax planning  n  541
makes payments to the revenue authorities. Furthermore, where a fapi-earning fa
compensates another fa for the use of the latter’s fapls, there may be fat despite a
lack of tax payments to the revenue authorities on behalf of the consolidated group.
An alternative explanation of Finance’s single-period analysis of regulation
5907(1.4) in the explanatory notes example could be that, by introducing the reinstatement rules, Parliament sought to overturn the approach previously taken in
analyzing fat. In particular, Parliament may have wished to narrow the perceived
breadth of the expression “can reasonably be considered,” and to render the 1997
and 2004 tis obsolete. One could support this approach by pointing out that Parliament sought to codify how the multi-period perspective should be applied and thus
to constrain the more open-ended analysis undertaken previously. For example, the
fat reinstatement regulations reinstate fat all at once in the designated taxation
year, arguably rendering obsolete approaches that permit fat recognition over a
span of years. Furthermore, under the new regulations, one cannot look at just any
years in applying the multi-period perspective, but rather must restrict the focus to
the fapi year and the five years that follow.
It is not obvious that Parliament sought to be revolutionary in this manner. The
legislature did not choose to amend the entire fat regime, but only to address fat
denial in group taxation scenarios. One could therefore contend that Parliament did
not seek to disturb longstanding interpretations of other related provisions, such as
the fat definition, which use similar language. One could argue that the legislature
merely sought to clarify one application of the multi-period perspective in a scenario
that is especially complicated.47 Furthermore, the reinstatement rules come into
play only when fat is denied under regulation 5907(1.4), arguably without altering
how regulation 5907(1.4) itself is to be applied. One would have expected Parliament to process changes to regulation 5907(1.4) itself if the intention had been to
ensure that this provision was applied using a single-period perspective.
In the 2015 interpretation, the cra accepts that fat denial rules can be applied
using a multi-period perspective. However, the cra implicitly justifies the approach
taken by Finance in the explanatory notes example by suggesting that taxpayers
must limit themselves to facts known at the time the fat denial rules are applied.
The cra might therefore agree that the explanatory notes example would be inapplicable relative to the facts that it discusses if the tax return for 2004 were filed
so late that information regarding 2006 and 2007 was already known.
It may be suggested further that the fat reinstatement regulations were introduced mainly to clarify the application of the multi-period perspective in multiple
company scenarios. If the facts reflected in table 1 are modified so that fa 1 (and not
fa 3) earns the active business income in 2006 and 2007, it may be argued that fa 2’s
47 In the 2004 TI, supra note 39, the CRA stated the following with respect to the multi-period
example it discussed: “While we consider this is a reasonable determination in the circumstances,
this fact pattern is relatively straightforward and other fact patterns can be much more problematic
[emphasis added].” It is understandable that a taxpayer would seek the codification of
reinstatement rules to settle the outcome in a problematic scenario.
542  n  canadian tax journal / revue fiscale canadienne
(2015) 63:2
compensation payment in respect of 2004 is indeed in respect of fa 3’s loss for that
year, even when a multi-period approach is taken. The group’s subsequent active
business income is earned by a different entity, which may or may not compensate
fa 3 for a hypothetical use of fa 3’s losses. The fat reinstatement rules ensure that
taxpayers can take deductions for fat in these types of cases.
Conclusion
Many provisions in the Act and regulations require a taxpayer to determine whether
income or profits taxes can “reasonably be considered” to have been paid “in respect
of ” income from a specific source.48 Where a taxpayer has different sources of income
for local purposes in various years, the challenge is to determine in what respects a
multi-period perspective can be adopted in determining what the taxes reasonably
relate to. In the fa context, certain rules depend on compensation payments between
related companies that are subject to group taxation regimes. Here, the task is to
determine in what respects the group’s circumstances in more than one year should
be considered.
For some time, the cra has respected a multi-period perspective in analyzing
some of these broad provisions. Whether or not this perspective triggers results that
are taxpayer-friendly depends on the facts. In implementing regulations 5907(1.5)
and (1.6), Parliament codified an application of the multi-period perspective—but
only in the context of fat denial rules applicable to consolidated groups. The fat
reinstatement regulations were intended to permit fat deductions when active business losses causing fat denial are hypothetically deducted against active business
income earned in subsequent years.
The fat reinstatement regulations do not seem to achieve their expected objectives perfectly. As illustrated by the examples considered above, the regulations could
be interpreted as requiring fapi-year losses to be used up even when those losses
have arguably not caused fat to be reduced. Furthermore, the rules may be viewed
as preventing fapi-year losses from being deducted against appropriate active business income, while permitting such losses to be used against non-active-business
income.
It is not clear whether the legislature, in enacting the fat reinstatement regulations, sought to change how the multi-period perspective was already being applied.
Parliament may have merely been clarifying how to apply the multi-period perspective in more difficult, multiple company scenarios.
One way or the other, a taxpayer that has had fat reduced under regulation
5907(1.4) should examine the circumstances under which that fat may be reinstated
under the fat reinstatement regulations.
48 See, for example, the definition of “business-income tax” in subsection 126(7); subsections
20(11) and (12), 92(2), and 138(8); various definitions in regulation 5907(1), including
subparagraph (a)(iii) of the definition of “exempt earnings”; and regulation 5907(14).