At a glance
- New rules affect CCPCs earning investment income through foreign subsidiaries.
- Reduced tax factor increases current Canadian tax on FAPI.
- Changes apply retroactively to taxation years after April 2022.
- Changes could increase cash flow pressures and impact cross-border planning.
In March 2026, the federal government passed income tax legislation that will generally increase the amount of Canadian tax a Canadian-controlled private corporation (CCPC) will pay on investment income earned in a foreign company it controls, also known as a controlled foreign affiliate (CFA). These changes align the Canadian taxation of investment income earned through a foreign affiliate with the taxation that would apply if the income were earned directly by the CCPC.
These rules apply for taxation years that begin after April 6, 2022, even though the legislation was enacted in March 2026.
This article outlines who is impacted, the income within scope, and the key changes that may require Canadian business owners to recognize tax sooner than expected on certain foreign investments. It also includes an example demonstrating how the new rules apply in practice, using a U.S. real estate scenario.
Part 2 of this article, to be released next month, will outline a new elective rule that can mitigate the impact of the general changes in the right circumstances.
Given the technical complexity of CCPC foreign affiliates taxation, this article presents general concepts rather than a detailed review. In practical terms, some owners may face earlier corporate tax and cash flow pressure when no cash has been repatriated from the foreign affiliate.
Who is affected?
These rules are targeted at CCPCs who control foreign corporations that earn investment income or active income that is deemed for income tax purposes to be passive income. The new rules also apply to corporations known as substantive CCPCs, which are private corporations, other than CCPCs, that are effectively controlled by Canadian residents. In this article, any references to CCPC can also be read as referring to a substantive CCPC.
What type of income is affected?
Although these changes can affect any CCPC with a CFA, this article concentrates on the effect on CCPCs where the CFA earns investment income such as rent, royalties, or interest, or is engaged in real estate development. Note that certain income earned in a CFA from real estate development is considered passive income.
Canadian income tax legislation requires a CCPC to report investment income earned in a CFA in the year it is earned by the foreign company, rather than in the taxation year the income is repatriated to the CCPC as a dividend. This investment income is known as foreign accrual property income (FAPI).
Example: A CCPC that owns a U.S. corporation
The appendix summarizes the tax results under the former and new rules using the following simplified fact pattern:
- Jackson and Amelia live in Toronto where they run a successful real estate development business, CanRealCo.
- CanRealCo has eight full-time employees and is jointly owned by Jackson and Amelia.
- CanRealCo is a CCPC.
- Jackson and Amelia used funds from CanRealCo to incorporate USInvestCo, a U.S. corporation wholly owned by CanRealCo.
- CanRealCo funded the U.S. corporation with equity from after-tax funds on hand.
- USInvestCo also develops real estate, but only needs two people to manage the business.
- USInvestCo earns $1,000 of net income before U.S. corporate income taxes.
Assume there are no material differences in the computation of taxable income between Canada and the U.S., and that there are no foreign exchange differences.
What are the Canadian tax consequences of this structure?
Because the income earned in USInvestCo is income from property (i.e. FAPI), Canadian tax rules require the net property income earned by USInvestCo to be taxed in the hands of CanRealCo in the same year the income is earned. If USInvestCo earned active business income instead of property income—and provided certain other conditions were met—there would generally be no taxable income inclusion in Canada (in CanRealCo) from its investment in USInvestCo, until USInvestCo pays a dividend to CanRealCo.
Does CanRealCo get credit for U.S. tax, or is there double taxation?
There is a system of deductions in CanRealCo for the U.S. taxes paid on the current-year rental income that is designed to avoid double tax. The former rules imposed current Canadian income tax if the foreign income tax (in this case, the U.S. tax) is significantly lower than an effective rate of 25%. The current-year U.S. income tax paid on the rental income in USInvestCo is called the foreign accrual tax (FAT).
As shown in the appendix, we assume USInvestCo needs to pay $210 in U.S. tax. Under the previous law, this would be multiplied by a relevant tax factor of 4, and the result is a deduction of $840 (4 × $210) against the FAPI of $1,000 included in CanRealCo' s taxable income. For simplicity, we have not considered the impact of foreign exchange or any differences in tax depreciation in determining the amount of FAPI.
Under this set of assumed facts, there will be $80 in additional Canadian income tax under the previous law in the year that USInvestCo earns the net income.
What has changed?
The main change is a reduction in the relevant tax factor from 4 to 1.9. Under the new rules, the deduction against the $1,000 of FAPI is $399 (1.9 × $210) rather than $840. This leaves $601 of residual taxable income in CanRealCo, resulting in current-year Canadian income tax of approximately $302 (using Ontario 2026 corporate tax rates). This is an increase of $222 of income tax.
No deferral
The Canadian tax will be due even though there has been no income received by CanRealCo from USInvestCo. This may create a cash flow problem and CanRealCo will need to fund this tax in other ways, for example:
- using other sources of income within CanRealCo;
- by a loan or additional share investment in CanRealCo by Jackson and Amelia;
- with a bank loan; or
- by a dividend payment or loan from USInvestCo.
Taxation in CCPC after payment of dividend
There will generally be Canadian tax implications for a CCPC in the year following receipt of a dividend from a foreign corporation.
In the case of USInvestCo to CanRealCo, there will likely be withholding tax of 5% that is levied by the U.S. on the payment of the dividend. There is no additional Canadian tax to be paid because a deduction is allowed for the income previously taxed when the income was accrued, and for the withholding tax. In fact, the statutory deductions will create a loss that can be carried back to reduce the Canadian corporation tax paid in year one. This is the case under both the former and the current rules.
Dividend to Canadian individuals
To see the final comparison between the former and the current law, it is important to see the total after-tax income that will be received by the shareholders, Jackson and Amelia.
The total taxes paid are approximately the same once the net profits of USInvestCo are paid to CanRealCo by dividend, and CanRealCo has distributed its net funds from FAPI to Jackson and Amelia by way of dividend (the amount of the difference in any given situation will be dependent on its facts). Under the former law, the payment of a dividend will trigger a dividend refund to the corporation, and the benefit of this refund has been reflected in the net funds paid to the individual. The after-tax profits received by Jackson and Amelia are approximately 45% of the net income earned in USInvestCo under the former and the current law, and assuming U.S. corporate taxes of 21% in both situations.
The changes to FAPI are focused on reducing the deferral of Canadian tax and not on increasing the total Canadian tax. For this reason, the changed rules will allow a portion of the dividend paid to Jackson and Amelia to be received tax-free, thereby reducing the total taxable dividend they would receive from CanRealCo.
What this means for your investment structure decisions
The deferral advantage of using a CCPC to hold a controlling interest in a foreign corporation earning passive investment income characterized as FAPI has been significantly curtailed.
Despite the changes to the Canadian tax rules, there are often other factors that must be considered when determining whether it makes sense to hold investments in a foreign company, particularly with respect to real estate. For example, some benefits of using a foreign corporation to own investments include managing U.S. estate tax exposure, foreign withholding tax considerations, the ability to obtain external financing (if necessary) to make the investment, and managing liability concerns that come with the ownership of the foreign investment.
Part 2 of this article will discuss elections that may be available to restore the higher relevant tax factor and restore the deferral that was previously available.
In the interim, please contact your BDO advisor for assistance in determining how these changes will affect you.
Appendix: FAPI vs. after-tax funds comparison
The table below compares the Canadian tax treatment of FAPI and after-tax amounts received by an individual shareholder.
| Distribution of funds to Canadian parent company (year 1) | Current law | Proposed law |
|---|---|---|
| Income earned in foreign affiliate (year 1) | $ 1,000 | $ 1,000 |
| Net FAPI earned in foreign affiliate | $ 1,000 | $ 1,000 |
| Foreign income taxes (FAT) 1 | $ (210) | $ (210) |
| Net income after tax in foreign affiliate | $ 790 | $ 790 |
| FAPI in Canadian parent company | $ 1,000 | $ 1,000 |
| Relevant tax factor (RTF) | 4.0 (RTF) | 1.9 |
| FAT x RTF | $ (840) | $ (399) |
| Canadian FAPI earned in year | $ 10,000 | $ 10,000 |
| Less: FAT x RTF | $ (160) | $ (601) |
| Canadian tax on FAPI& | $ 80 | $ 302 |
| Effective total tax rate before distribution | 29% | 51% |
| Distribution of funds to Canadian parent company (year 2) | Current law | Proposed law |
|---|---|---|
| Income available for distribution | $ 790 | $ 790 |
| Dividend withholding tax 2 | $ (40) | $ (40) |
| Recovery of Part I tax on distribution 3 | $ -79 | $ -38 |
| Distribution of funds to individual shareholder | ||
| Tax-free capital dividend | $ n/a | $ 225 |
| Taxable dividend to individual shareholder | $ 751 | $ 423 |
| Total dividend | $ 751 | $ 648 |
| Tax on dividend at top Ontario tax rate | $ 295 | $ 202 |
| Net funds to individual | $ 455 | $ 446 |
| Effective total tax rate | 55% | 55% |
1 Assumed a foreign tax rate of 21%.
2 Assumed a 5% rate of withholding tax.
3 Assumed the non-capital loss arising on dividend repatriation to the Canadian taxpayer, after statutory deductions, will be carried back to year 1, resulting in Part I tax recovery.
The information in this publication is current as of April 17, 2026.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.