Difficult to Apply and Hard to Avoid: Canada’s Foreign Investment Entity (FIE) Rules

In response to a perceived increase in the use of offshore investment structures to avoid Canadian income tax, the Department of Finance first introduced complex tax legislation that governs the treatment of direct or indirect investments in certain foreign entities by Canadian taxpayers (the FIE Rules) in 2001. A fifth draft of the proposed legislation was released in July 2005 and, although this legislation has not yet come into force, the rules are intended to apply for taxation years beginning after 2002.

The FIE Rules are an anti-deferral mechanism designed to prevent Canadian taxpayers from earning passive income offshore without paying Canadian tax. In the absence of these rules, Canadians could potentially invest in offshore corporations which do not pay Canadian tax on investment income as it is earned. The Canadian investor would only pay Canadian tax when he or she sold or received a dividend on the shares of the offshore corporation.