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November 12, 2012
No. 334
Canada's Experience with Territorial Taxation
By
Tax Foundation Staff
This is the first case study in a series on territorial tax systems in other countries. The intent of the study is
to see what lessons the U.S. can learn from other countries' experiences and to evaluate the validity of some
of the fears critics express when discussing what would result if the U.S. were to move to a territorial system.
't is important to ensure that Canada s system of international taxation continues to promote the competitiveness of
Canadian businesses internationally and to attract new foreign investment to Canada. Advisory Panel on Canada's
System of International Taxation, 2008
Canada generally exempted all foreign source income from tax until 1976,1 when it adopted foreign affiliate
rules that exist, though modified, to this day. These rules fully exempt from tax all dividends derived from
active income earned by an affiliate if the affiliate resides in a country with which Canada maintains a tax
treaty.2 Because the treaty network now encompasses 91 countries and all major trading partners, the
Canadian system is, in practice, a territorial system. Figure I. Unemployment Rate
It is often referred to as a hybrid system, however, 2%
because income earned in non-treaty countries is
taxed on a current basis3 10% -
All passive income is treated as Foreign Accrued
Property Income (FAPI), which is a classification
modeled after U.S. Subpart F. As the primary base-
erosion measure, FAPI rules classify interest,
royalties, rent, other passive investment income, and
income of unincorporated foreign branches as
8%
6% ~ioal
4% '
Source: OECD
1 The rules were adopted in 1972 but were not implemented until 1976. See Advisory Panel on Canada's System of International
Taxation, Enhancing Canada International Tax Advantage, at 13, hup-i/ww apcie--gcrn fi.caiO7icp-dc/pdJfia] Repor -ng.pdf.
2 Under new legislation, the exemption also applies to affiliates residing in a country with which Canada shares a Tax Information
Exchange Agreement (TIEA). See Advisory Panel on Canada's System of International Taxation, Enhancing Canada ' International
Tax Advantage, at 13-14, hrpt./! .d-c __r__acO_[p __pddi nR ort cpdf.
Michael Smart, Repatriation taxes and foreign direct investment: Evidence from tax treaties, at 2,
http:/,'w,,-.sbs.ox.ac.. ikiCENTRES!TAXISYMPOSiA/Doocumnents2 0] 10i05 %20Smart.pdf.
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