I uncovered this when playing around with -XTypeInType:

{-# LANGUAGE DeriveFunctor, TypeInType #-}
module CantEtaReduce1 where

import Data.Kind

type ConstantT a b = a
newtype T (f :: * -> *) (a :: ConstantT * f) = T (f a) deriving Functor

This fails because it thinks that you can't reduce the last type variable of T, since it mentions another type variable (f):

    • Cannot eta-reduce to an instance of form
        instance (...) => Functor (T f)
    • In the newtype declaration for ‘T

But it should be able to, since ConstantT * f reduces to *, and the equivalent declaration newtype T (f :: * -> *) (a :: *) = ... eta-reduces just fine.

I marked this as appearing in GHC 8.1 since you need -XTypeInType to have kind synonyms, but this can also happen in earlier GHC versions with data families:

{-# LANGUAGE DeriveFunctor, PolyKinds, TypeFamilies #-}
module CantEtaReduce2 where

type ConstantT a b = a
data family T (f :: * -> *) (a :: *)
newtype instance T f (ConstantT a f) = T (f a) deriving Functor

I believe the fix will be to apply coreView with precision to parts of the code which typecheck deriving statements so that these type synonyms are peeled off.