2016-0663231E5 Indian employment income

Principal Issues: Whether the employment income of a particular Indian employee would be exempt from income tax.

Position: It depends, but not likely.

Reasons: See below.

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

XXXXXXXXXX                                                                                                                     2016-066323
                                                                                                                                             R. Meers
                                                                                                                                             (613) 670-9037
November 29, 2016

Dear XXXXXXXXXX:

Re: Tax Exempt Status of Indian Employment Income

This is in response to your e-mail dated August 25, 2016, inquiring whether the income of an employee who is an Indian, as that term is defined in section 2 of the Indian Act, is situated on a reserve and thus exempt from income 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 a new employee of XXXXXXXXXX (the “Employer”) would be exempt from income tax.

It is our understanding that:

*     The Employer is resident on a reserve.

*     The Employer has hired a new employee who is an Indian.

*     The employee does not reside on a reserve.

*     The employee performs most of their duties off reserve; approximately 10% of their duties are performed on a reserve and 90% off reserve.

Our Comments

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 IC70-6R7, Advance Income Tax Rulings and Technical Interpretations. Although we cannot comment on your specific situation, we are able to provide the following general comments, which may be of assistance.

Generally, Indians 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 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 Indian Act Exemption for Employment Income Guidelines (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, together with our comments, 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).

Based on the facts provided, the employee would not qualify for the full exemption as less than 90% of their duties are performed on a reserve. The employee would likely qualify for a pro-rated exemption on their employment income. Please consult the examples we have on our website dealing with the proration rule to better understand how this rule could apply in your situation (www.cra-arc.gc.ca/brgnls/gdlns-eng.html#pro).

*     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 2 would not apply as the employee does not live on a reserve.

*     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.

As the Employer is resident on a reserve, Guideline 3 would apply if more than 50% of the employment duties are performed on a reserve. Based on the information provided, only 10% of the employment duties are performed on a reserve, therefore, Guideline 3 would not apply.

*     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 reserves, 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.

All of these conditions must be met for Guideline 4 to apply. As the employment duties appear to relate to commercial activity, not all of the conditions would be met and, therefore, Guideline 4 would not apply.

As the Guidelines were developed as an administrative tool, they do not constitute a definitive test. There may be unique situations in which the Guidelines do not apply but income is found to be situated on a reserve and exempt from tax as a result of significant connecting factors not taken into account by the Guidelines. The determination of whether there are sufficient connecting factors to situate income on a reserve is always a question of fact.

You have also asked for our comments on the requirements of the Employer to withhold source deductions with respect to Indian employees. Under subsection 153(1) of the Act, every person making a payment of salary or wages or other remuneration is required to withhold source deductions. CRA’s guide T4001, Employers’ Guide - Payroll Deductions and Remittances, provides information for employers in determining which deductions are to be made for Indians. Form TD1-IN helps employers determine the appropriate tax treatment for employees and suggests that the form be completed by the employer, in the presence of the employee. Where an employer determines that the income of an Indian is exempt or partially exempt from tax under section 87 of the Indian Act, and the employee requests withholdings to be reduced, the employer may grant the waiver requested by the employee. If the waiver is granted, the employer must maintain this form on file for the employee. More information regarding payroll deductions for Indians can be found on our website at http://www.cra-arc.gc.ca/brgnls/stts-eng.html#hdng13.

An employer is liable for appropriate source deductions with respect to its employees. Consequently, unless an employer is comfortable that employment income of an Indian is wholly or partially exempt from income tax, the employer should generally withhold. If amounts have been withheld and remitted for an employee whose income is later determined to be exempt from income tax, the employee may file an income tax return to claim a refund of the appropriate portion of these amounts.

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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