LLC, which is wholly-owned by Canco, sell an intangible to the ultimate Canadian parent of Canco, thereby giving rise to a capital gain. Could that capital gain generate income from a business other than an active business under s. 95(2)(a.1)? The Directorate responded:
Since capital gains are also income within the meaning of section 3, you are wondering whether it might be possible to argue that this capital gain is income from, that is incident to, or that pertains to, a business other than an active business [under s. 95(2)(a.1)(iv).] …
Variable B of the FAPI definition applies specifically to capital gains, whereas income from a business other than an active business, such as income from the sale of property which meets the conditions of paragraph 95(2)(a.1), would fall under variable A of that definition. Although the FAPI definition does specifically contemplate some overlap between variables A and B, that overlap is with respect to gains on income account and not capital gains. As such, given that the capital gains rule is more specific, it is our view that capital gains of a foreign affiliate must be tested for inclusion under variable B and that they are not within the scope of variable A.