Foreign Accrual Property Income, usually known as FAPI, is a tax term meaning the government will tax foreign earnings, regardless of tax treaties, if it deems the source of earning to only be "investment activity". It is a law applied in countries such as Canada.
Definition
Let's say you're a Canadian and you buy bonds from Hong Kong. The interest you receive from those bonds are considered a profit to you, and so would be taxed by the Canadian government. What if you want to avoid those taxes?
You would set up a foreign company, let’s say in Barbados, to buy bonds for you; what then? Barbados' corporate tax rate is 2.5%, compared with Canada's 35% tax rate. And, since there is a Double Taxation Avoidance Agreement (DTAA) between Canada and Barbados, your profit is repatriated in the form of tax free dividends. Therefore, instead of paying 35% on profit to the Canadian government, you only pay 2.5% on profit to the Barbados government. So the question to ask is: why would the Canadian government allow that?
Well, the simple answer is it doesn't. If the sole purpose of you setting up that company in Barbados is to avoid Canadian taxation, your operation is deemed a sham. In this case, the Canadian government will treat the Barbadian income as Canadian income, and will tax it at 35%, even though there is a DTAA with Barbados. This is called the FAPI regulation.
Avoiding FAPI
But the reality is that companies are running front operations in countries such as Barbados or Ireland for the purpose to save on taxes. And so, how do they do it? The answer is beyond the scope of this article, but the simple answer to avoiding FAPI is this: you must set up an "economic business" and not an "investment business". |
