2016-0659651E5 Indian Employment Income and the Proration Rule

Principal Issues: Clarification of the Proration Rule

Position: General comments provided

Reasons: See below

Author: Townsend, Ann
Section: 81(1)(a)

XXXXXXXXXX                                                                                                                              2016-065965
                                                                                                                                                      Ann Townsend
December 28, 2016

Dear XXXXXXXXXX:

Re:   Indian Act Exemption for Employment Income Guidelines (the “Guidelines”) and the Proration Rule

This is in response to your letter of July 27, 2016 requesting clarification of the “proration rule” contained in the Guidelines with respect to what is considered to be a change in circumstances that would require completion of a new TD1-IN, Determination of Exemption of an Indian’s Employment Income.

This technical interpretation provides general comments about the provisions of the Income Tax Act (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 70-6R7, Advance Income Tax Rulings and Technical Interpretations. Although we cannot comment on your specific situation, we are able to provide the following general comments that may be of assistance.

OUR COMMENTS

Generally, Indians, as that term is defined in section 2 of the Indian Act, are taxable in Canada on the same basis and in the same manner as non-Indians. However, paragraph 81(1)(a) of the Act together with paragraph 87(1)(b) of the Indian Act exempt from income tax the personal property of an Indian situated on a reserve. Income, including income from employment, has been held by the Supreme Court of Canada (“SCC”) to be personal property for the purposes of section 87 of the Indian Act. Therefore, the employment income of an Indian may qualify for an exemption from income tax if the income is determined to be situated on a reserve.

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 a 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 SCC 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. The Guidelines are summarized as follows:

*     Guideline 1 exempts the employment income of an Indian when at least 90% of the employment duties are performed on a reserve. When less than 90%, but more than an incidental proportion of the duties are performed on a reserve, and none of the other Guidelines apply, the exemption is prorated to apply to the portion of income related to the duties that are performed on a reserve (the proration rule).

*     Guideline 2 exempts the employment income of an Indian employee when the employer is resident on a reserve and the Indian lives on a reserve. The term “employer is resident on a reserve”, as used in the Guidelines, means that the reserve is the place where the central management and control over the employer organization is actually located.

*     Guideline 3 exempts the employment income of an Indian employee if more than 50% of the employment duties are performed on a reserve and either the employer is resident on a reserve or the Indian lives on a reserve.

*     Guideline 4 requires that the employer be resident on a reserve.  It also requires that the employer be an Indian band that has a reserve, or a tribal council representing one or more Indian bands that have reserves, or an Indian organization controlled by one or more such bands or tribal councils, if the organization is dedicated exclusively to the social, cultural, educational, or economic development of status Indians who for the most part live on a reserve, and that the duties of employment are in connection with the employer’s non-commercial activities carried on exclusively for the benefit of Indians who for the most part live on reserve.  These elements must all be satisfied in order for Guideline 4 to apply. 

Form TD1-IN reflects the Guidelines and it is used by employers to help determine whether an Indian’s employment income is exempt from income tax. The instructions for completing the TD1-IN state that where an employee’s circumstances change, the employee will be required to fill out a new TD1-IN.

Whether there has been a change in an employee’s circumstances that requires completion of a new TD1-IN is a question of fact. Generally, a change in an employee’s circumstances is considered to take place when there is a change that impacts the application of the Guidelines, for example:

*     A change in the location of the employment duties as the result of a new position with the same employer.

*     A change in the employee’s residence, on or off a reserve.

*     A change in the employer’s residence, on or off reserve.

On the other hand, the following are examples that are not considered to be a change in employee circumstances and do not require a new TD1-IN to be completed:

*     Seasonal work where an employee works every year for the same period on reserve (for example: snow removal, landscaping)

*     Where the duties of employment are performed is dependent on the location of the clients/customers (for example: home repair services, social worker, or personal service worker).

In the above employment situations, it is possible for an employee to perform a portion of their duties on a reserve for only part of the year. The fact that an employee works primarily on reserve for one part of the year and primarily off reserve for another part of the year, does not in and of itself reflect a change in circumstances. Usually in these situations, the proration rule will apply to exempt the portion of employment income related to the duties performed on a reserve.

In your letter you have provided a hypothetical example where an employee works on a reserve greater than 50% of the time for the first 6 months of the year and then enters into an interchange assignment and works off-reserve the remainder of the year.  You have asked whether it would be appropriate to prorate the income earned throughout the entire year, or to prorate the income based on a shorter interval within a calendar year arising from a change in the employee’s circumstances.

Although you have not provided any information on the interchange assignment, it is our understanding that an interchange assignment is a temporary assignment of an employee to a position with a different organization in order to facilitate professional development of the employee.  Additionally, the employee will work temporarily for the new organization while remaining employed by the current employer.  Based on the above, an interchange assignment is considered to be a change in an employee’s circumstances and completion of a new TD1-IN is required.  Where a new TD1-IN is completed the calculation of the number of days worked on a reserve throughout the year for purposes of the Guidelines and the proration rule, is based on the number of days during the period that the TD1-IN is applicable. Therefore, in your example, the percentage of duties performed on a reserve will be calculated based on the 6 month period prior to the interchange assignment.  A new TD1-IN will be required for the remainder of the year and will apply to the period during which the employee is on the interchange assignment. Similarly the percentage of days worked on a reserve will be calculated based on the total number of days worked in this period.

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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