2014-0534251I7 Indian Tax Exemption - Settlement Payments

Principal Issues: Whether federal settlement payments from a First Nation to its members would be considered income.

Position: Likely not.

Reasons: Appears to be a gift and not an enforceable obligation.

Author: Merrigan, Lori
Section: 81(1)(a); 149(1)(c); 75(2); 104(2); 104(13)

                                                                                                                                       August 29, 2014

      Individual Returns and Payments                                                                            HEADQUARTERS
        Processing Directorate                                                                                           Income Tax Rulings
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      Room 816, Tower C                                                                                                 Lori Merrigan
      Vanier Towers                                                                                                          (613) 957-9229
      Ottawa ON  K1A 0L5           
      Attention: Sheila Barnard                                                                                         2014-053425

         Indian Taxation – Specific Claim Payments

This is in response to your correspondence of June 2, 2014, asking for our comments with respect to the tax treatment of monies paid by the XXXXXXXXXX (“First Nation”) as a per-capita distribution (“PCD”) to its members, from monies received as Specific Claim payments to the First Nation.

Initial PCDs

It is our understanding that Canada settled a Specific Claim with the First Nation in XXXXXXXXXX. Subsequently, the First Nation made a payment of $XXXXXXXXXX to each of its members, holding the remainder of the settlement in trust for use by the First Nation.

You are enquiring as to whether the $XXXXXXXXXX PCD would be taxable to each member and whether any entitlements under any social assistance, old age pension or income supplements would be affected by this PCD from the First Nation. Our comments here are only with respect to the initial PCD from the First Nation to its members and do not consider income earned on those monies.

It is our understanding that the members did not have an exclusive or legally enforceable claim to the PCDs, but it is merely the choice of the First Nation to make such payments. It is our view that, generally, payments made under the proposed circumstances would not be included in calculating the members’ income under Part I for purposes of paragraph 3(a) of the Income Tax Act (the “Act”).

As a result, land settlement payments such as these would generally not affect tax benefits provided for under Part I of the Act. For example, these PCDs would not be included in the determination of the amounts described as “adjusted income” in subsection 180.2(1) or section 122.6 for the purpose of calculating old age security repayments or the Canada child tax benefit respectively.

Trusts – General Taxation

In some cases, these initial PCDs, or additional distributions may be paid from a trust. We understand that the First Nation will hold the remainder of the settlement, after payment of the initial PCDs, in trust for use by the First Nation. How the amounts are treated will depend on the terms of the trust.

For income tax purposes, a trust is deemed to be an individual under subsection 104(2) and is taxed as such; however, a trust is not entitled to personal income tax credits. In general, where income from a trust has been paid or becomes payable in the year to a beneficiary of a trust, that income shall be included in the beneficiary’s income in accordance with subsection 104(13). The amount may be deducted in computing the trust’s income for that year as provided by subsection 104(6). Any remaining income will generally be income of the trust and will be taxed in the trust. We note that the fact that a trust is derived from a Specific Claim with Canada does not, in and of itself, make the trust exempt from tax, it would depend on the terms of the trust agreement.

Application of Subsection 75(2)

Income earned on and gains from the disposition of property held in a trust will be attributed to the person who contributed the property to the trust where any of the conditions described in subsection 75(2) apply. The definition of “person” in subsection 248(1) includes any corporation and any entity exempt from tax under Part I because of subsection 149(1). If the Band is exempt from tax pursuant to subsection 149(1) (for example, where paragraph 149(1)(c) applies), it is a person in accordance with subsection 248(1), and is therefore a person for the purpose of subsection 75(2).

Subparagraph 75(2)(a)(i) provides that where the terms of a trust are such that the property held by the trust may revert to a person who directed or contributed the property to the trust, any income or loss from that property, and any taxable capital gains or allowable capital losses from the disposition of any of the property contributed by that person to the trust, will be deemed to be the income or loss, or the capital gain or capital loss, as the case may be, of this person and not of the trust. In our view, where subsection 75(2) attributes income to a person who has directed or contributed property to a trust, that income was never income of the trust for tax purposes. Accordingly, it is not taxed in the trust but is included in the beneficiary’s income under 104(13) when paid or payable to the beneficiary. Subsection 75(2) only applies to first generation income.

Subsection 75(2) does not apply to second generation income, as this income is not earned on property contributed by a person. Thus, second generation income will not be attributable to the person who contributed the property to the trust and will generally be taxable in the trust to the extent that it is not paid or payable to the beneficiaries of the trust. Where an amount has become payable in the year to a beneficiary, the trust may claim a deduction under subsection 104(6) in computing its income for that year. Such income would be included in the beneficiary’s income under subsection 104(13).

Distributions out of the Trust

As mentioned above, the First Nation may be a tax exempt entity under subsection 149(1) if it is determined to be a public body performing a function of government within the meaning of paragraph 149(1)(c). Whether any income of the trust will be attributed back to the First Nation because of subsection 75(2), as described above, will depend on the terms of the trust. If subsection 75(2) does apply, any income attributed back to the First Nation may then be exempt from tax in accordance with paragraph 149(1)(c). Any income that is paid or payable to the First Nation as a beneficiary of the trust, and that is included in its income under subsection 104(13), may also be exempt from tax pursuant to paragraph 149(1)(c).

Income (i.e., first or second generation income) that is paid or payable to an individual member of the First Nation as a beneficiary of the trust may be included in the member’s income under subsection 104(13) and may be taxable. However, where this income is property situated on a reserve within the meaning of section 87 of the Indian Act (the “IA”), and the member is an Indian as that term is defined as in subsection 2(1) of the IA, the income may be exempt from tax by virtue of section 87 of the IA and paragraph 81(1)(a) of the ITA, which excludes such amounts from taxable income.

It is always a question of fact whether particular income is property situated on a reserve. In the case of income from a trust, several factors are taken into account, including how and where the trust generates its income, the residence of the trustees (or those controlling the trust property), and the residence of the beneficiaries. The first of these factors is usually given the most weight.

We trust that our comments will be of assistance.

Roger Filion, CPA, CA
Manager|
Non-Profit Organizations and Aboriginal Issues Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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