2015-0585751E5 Indian Employment Income

Principal Issues: Whether employment income of Indian owner/manager is exempt from income tax?

Position: Question of fact.

Reasons: See below.

Author: Meers, Rob
Section: 87 Indian Act; 81(1)(a) Income Tax Act

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                                                                2015-058575
                                                                R. Meers
                                                                (613) 670-9037

October 26, 2015

Dear XXXXXXXXXX:

Re: Tax Exempt Status of Indian Employment Income

This is in response to your fax dated April 30, 2015, inquiring whether the income of an Indian, as that term is defined in section 2 of the Indian Act, would be situated on a reserve and thus exempt from tax for purposes of section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act (the “Act”). In particular, you have asked us to comment on whether the income paid to the XXXXXXXXXX sole shareholders and directors of a XXXXXXXXXX company (the “Employer”), as employment income, is exempt from tax according to the Indian Act Exemption for Employment Income Guidelines (“Guidelines”). You have also expressed concern that the examples given under Guideline 2 of the Guidelines contradict each other.

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations. The confidentiality provisions of the Act prevent CRA officials from discussing a taxpayer’s affairs with a third party without the taxpayer’s written authorization. Therefore, we cannot comment on the tax implications to the taxpayers referenced in your submission. Although we cannot comment on their specific situation, we are able to provide the following general comments, which may be of assistance.

The location of the duties of employment is usually the key factor in determining whether an Indian’s employment income is situated on a reserve and exempt from tax. However, the courts have recognized that employment income may be situated on a reserve, even where many or all of the duties of employment are carried on off-reserve, as long as other connecting factors of significant weight connect the employment income to a reserve. These factors may include the circumstances surrounding the employment, the residence of the employer and the residence of the employee.

In consultation with other government departments as well as interested Indian groups and individuals, the Canada Revenue Agency identified a number of connecting factors that can be used to determine whether a person’s employment income is situated on a reserve. This initiative resulted in the development of the Guidelines. The Guidelines are an administrative tool intended to approximate the “connecting factors test” described by the Supreme Court of Canada in Williams v. The Queen, 92 DTC 6320. The Guidelines were intended to apply in common employment situations to assist Indian employees to determine whether their employment income was taxable.

Unlike the connecting factors test, each Guideline relies on only 2 or 3 elements, which are implicitly given significant weight, in determining whether the employment income is exempt. In situations where the Guidelines would apply, Guideline 2 is the Guideline that is most often referred to with respect to situations where duties of employment are completed off-reserve. Guideline 2 relies on only two factors:  the residence of the employer and the residence of the employee. For purposes of the Guidelines, “employer is resident on a reserve” means that the reserve is the place where the central management and control over the employer organization is actually located.

Generally, we do not consider a situation where the owner-operators are also the sole employees to be a common employment situation to which the Guidelines would apply. Therefore, determining whether the income is property situated on a reserve would require a review of the relevant connecting factors to determine whether that income is situated on- or off-reserve.

The courts have concluded that although an employer’s residence on a reserve is a connecting factor to a reserve, that factor will have minimal weight if the location of the employer has no tangible significance to the reserve. Generally, the courts have indicated that weight should be given to the location of an employer on a reserve only where the scope of the employer’s activities on a reserve, or the direct benefits flowing to a reserve, indicate a clear nexus between the employer and the reserve (see Shilling v. The Queen, 2001 FCA 178, The Queen v. Monias, 2001 FCA 239, Horn et al v. The Queen et al, 2007 FC 1052, GooGoo v. The Queen, 2008 TCC 589, McIvor et al v. The Queen, 2009 TCC 469, etc.). Therefore, Guideline 2 is a reasonable approximation of the connecting factors test only where the location of the employer on a reserve provides direct, significant benefits to the reserve. In determining whether a benefit to a reserve is provided, the CRA will take into account whether the location of the employer benefits the particular reserve or reserves where the employees reside.

Furthermore, the courts have also stated that connections that are artificial should not be given weight in determining the location of income for purposes of the exemption. In the Supreme Court of Canada (“SCC”) decision Bastien Estate v. Canada, 2011 SCC 38, the judge stated in paragraph 62 that,

“Of course, in determining the location of income for the purposes of the tax exemption, the court should look to the substance as well as to the form of the transaction giving rise to the income. The question is whether the income is sufficiently strongly connected to the reserve that it may be said to be situated there. Connections that are artificial or abusive should not be given weight in the analysis...”

Similarly, the Federal Court of Appeal agreed and commented on the SCC decision in Bastien in Her Majesty the Queen and Ronald Robertson and Roger Saunders, 2012 FCA 94, noting in paragraphs 41 and 42 that,

“The Crown has not suggested that the Appellants have attempted an artificial manipulation of the connecting factors in order to bring their fishing income within the exemption from tax provided by section 87. The various connections between the Reserve and the Appellants’ income from fishing are indisputably bona fide and not motivated by tax avoidance considerations. This was also the situation in Bastien (see para. 62).

However, in order to avoid potentially abusive or artificial manipulation of the connecting factors in other cases, a degree of flexibility must be maintained in the selection and weighing of the connecting factors, and in the emphasis given to those that provide a substantive basis for situating property on a reserve.”

Consequently, weight will only be given to the employer being resident on a reserve where the employer is in fact resident on a reserve and there is clear nexus with the reserve, that is, it is not simply a manipulation of the connecting factors test or the Guidelines. It is unclear from the information provided whether there is a clear nexus with the reserve, or the scope of the Employer’s activities on the reserve, or whether there is a benefit flowing to the reserve from the presence of the Employer. Whether the Employer or the employee is resident on a reserve is a question of fact to be determined after a review of the relevant facts.

With respect to your concern that the examples provided under Guideline 2 in the Guidelines contradict themselves, we do not believe this to be the case.

*     The first example (Mrs. H) outlines a scenario where the taxpayer lives on a reserve and is employed by a logging company that is resident on a reserve. Since she lives on a reserve and her employer is resident on a reserve, her employment income is exempt from tax under Guideline 2.

*     The second example (Mr. I) describes another scenario where, except for short periods spent living near the construction sites, the employee lives on a reserve and the employer is resident on a reserve. Therefore, Guideline 2 applies.

*     In the third example (Ms. J) the employee lives on a reserve but works at the head office of a bank located off-reserve. While the bank has a branch on a reserve, it is not resident on a reserve. As a result, Guideline 2 does not apply because the employer is not resident on a reserve.

*     The fourth example (Mr. K) deals with an employee leasing situation. Mr. K lives on a reserve and the employment agency has an office on the reserve, but the agency carries out very few of its business activities on the reserve. As mentioned previously, the Guidelines only apply in common employment situations. We do not consider employee leasing situations to be part of the common employment situations to which the Guidelines apply. One must therefore do an analysis of the connecting factors. In this case, the residence of the employer would have little weight as a connecting factor. The only other substantive factor connecting Mr. K’s employment income to a reserve is the location of his residence, which is not sufficient to bring the employment income within the exemption. The business for which the employee is performing regular duties is not resident on a reserve.

As outlined above, the examples provided address four separate scenarios and it is our belief that the conclusions reached do not contradict themselves.

We trust that these comments will be of assistance.

Yours truly,

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

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