2020-0869971E5 Indian Act exemption and employees of XXXXXXXXXX

Principal Issues: Is the employment income exempt under Guideline 4 or a connecting factors test?

Position: No.

Reasons: Guideline 4 does not apply as the Employer is not dedicated exclusively to the social, cultural, educational, or economic development of Indians who for the most part live on-reserve. In addition, there are not enough additional significant factors that connect the income to a reserve.

Author: Townsend, Ann
Section: 81(1)(a), 87(1)(a) of the Indian Act

XXXXXXXXXX                                                                  2020-086997
                                                                                          Ann Townsend

November 15, 2021

Dear XXXXXXXXXX:

Re: Employment income and the income tax exemption under section 87 of the Indian Act

This is in reply to your correspondence asking whether the employment income earned by certain employees of the XXXXXXXXXX (“Employer”) is exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act.

The following is our understanding of the facts:

* The employees in question are registered under the Indian Act and perform their duties of employment on XXXXXXXXXX (“Employees”).

* The Employer is owned and operated by the XXXXXXXXXX, which is controlled by all XXXXXXXXXX.

* XXXXXXXXXX.

* XXXXXXXXXX. The mission of the Employer is to enhance the quality of life, and to preserve, protect, and interpret the history, language, culture, and artistic heritage of First Nations.

* The Employer has XXXXXXXXXX.

* The Employer is considered to be resident on a reserve XXXXXXXXXX.

Our Comments

This technical interpretation provides general comments about the provisions of the Income Tax 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 70-6R11, Advance Income Tax Rulings and Technical Interpretations.

Employment income earned by an individual who is registered or entitled to be registered under the Indian Act, is exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act only if the income is situated on a reserve. The courts have established that determining whether income is situated on a reserve, and thus exempt from tax, requires identifying the various factors connecting the income to a reserve and weighing the significance of each factor. This is referred to as the “connecting factors test”.

To simplify the application of this connecting factors test with respect to common employment situations, the Canada Revenue Agency (“CRA”) together with interested First Nations organizations, developed the Indian Act Exemption for Employment Income Guidelines (“Guidelines”). There are four Guidelines and they only apply to employees who are registered or entitled to be registered under the Indian Act.

Guideline 1

This guideline exempts from income tax all of the employment income of an employee if at least 90% of their 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 proportion of the income related to the duties that are performed on a reserve (the proration rule).

Based on the facts provided, the Employees do not perform any of their duties on a reserve, and thus no part of their employment income would be exempt from income tax under Guideline 1.

Guideline 2

This guideline exempts from income tax all of the employment income of an employee if the employee lives on a reserve and their employer is resident on a reserve.

In your situation, since the Employer is resident on a reserve, Guideline 2 will apply to exempt from income tax the employment income of those Employees who live on a reserve, even though they do not perform their duties of employment on a reserve.

Guideline 3

This guideline exempts from income tax all of the employment income of an employee if more than 50% of their employment duties are performed on a reserve and either the employer is resident on a reserve or the employee lives on a reserve.

Although the Employer is resident on a reserve, Guideline 3 likely will not apply to exempt from tax the employment income of the Employees because they do not perform any of their employment duties on a reserve.

Guideline 4

This guideline exempts from income tax all of the employment income of an employee regardless of where their employment duties are performed and where they live, if all of the following conditions are met:

a) The employer is resident on a reserve;

b) The employer is:

* an Indian band which has a reserve, or a tribal council representing one or more Indian bands which 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 Indians who for the most part live on reserves; and

c) 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 reserves.

In the situation you have described, the Employer appears to meet condition a. The Employer also meets the first part of the second bullet in condition b, however, to meet the second part of the second bullet of condition b, the employer must be exclusively dedicated to the social, cultural, educational, or economic development of individuals registered or entitled to be registered under the Indian Act. Furthermore, these individuals, for the most part, must live on reserves. In your situation, the Employer provides educational opportunities to First Nations and non-First Nations students.

Accordingly, the Employer fails to meet the exclusivity test in the second part of condition b. Additionally, even if the students were all registered under the Indian Act, there is no certainty that most of them would be resident on reserves such that the “for the most part” test would be met. Therefore, Guideline 4 does not apply to exempt the employment income of the Employees from income tax.

As noted above, the Guidelines are an administrative tool created to address the most common employment situations. However, there may be situations where there are other connecting factors that may result in employment income being treated differently than under the Guidelines. In such situations, it is necessary to apply the connecting factors test as established by the courts. In this regard, you have argued that the fact that the Employer provides education services to strengthen the lives of First Nations people by enhancing their quality of life could connect the Employees’ employment income to a reserve.

Connecting factors that have been considered and given weight by the courts in employment income situations include:

* the residence of the employee,

* the residence of the employer,

* the location where the work is performed,

* the nature of the services performed, and

* the special circumstances in which they were performed.

The courts have established that the weight assigned to each connecting factor is determined by considering the purpose of the exemption, the type of property in question, and the nature of the taxation of the property.

The courts have stated that the purpose of the tax exemption is to protect the property of First Nations people that they acquire, hold, and use on a reserve, from erosion by taxation. For example, the Federal Court of Appeal (“FCA”) discussed the policy of section 87 of the Indian Act in Monias v. The Queen (2001 DTC 5450) (“Monias”) and stated:

“Rather, like the companion provision in section 89, the more limited and specific purpose of section 87 is to protect reserve lands, and Indians’ personal property on a reserve, from erosion, so that the Bands are able to sustain themselves on the reserves as economic and social units. Hence, it is fully consistent with legislative policy to apply section 87 to income that is earned by Indians who reside on a reserve from work that is performed on a reserve.” (footnote 1)

In employment income situations, the courts have concluded that where employment duties were not performed on a reserve, but benefited First Nations people who lived on reserves, this fact alone is not enough to situate the employment income on a reserve. In Monias, the FCA stated:

“That the work from which employment income is earned benefits Indians on reserves, and indeed may be integral to maintaining the reserves as viable social units, is not in itself sufficient to situate the employment income there. It is not the policy of paragraph 87(1)(b) to provide a tax subsidy for services provided to and for the benefit of reserves. Rather, it is to protect from erosion by taxation the property of individual Indians that they acquire, hold and use on a reserve, although in the case of an intangible, such as employment income, it is the situs of its acquisition that is particularly important.” (footnote 2)

In Naponse v. The Queen, 2001 DTC 414 (“Naponse”), the Tax Court of Canada (“TCC”) considered whether the employment income earned by a college professor, who taught programs off-reserve that were geared towards First Nations students who lived on reserve, was exempt from income tax under section 87 of the Indian Act. The professor argued that her income was situated on a reserve because her employment benefited and strengthened reserves and her work could only have been done by an individual familiar with the traditions and cultures of First Nations. The TCC concluded that these factors were not sufficient to situate her income on reserves. One of the main reasons cited was that her employment did not exclusively benefit individuals who were resident on reserves and the training the students received did not limit them to just jobs on reserves.

Further in Desnomie v. The Queen (footnote 3) (“Desnomie”), the TCC considered whether the employment income earned by an individual whose employment benefited First Nations students who left reserves for post-secondary education, was exempt from tax. The employer was an organization that was controlled by all the First Nations of Manitoba and funded by the Federal government. The purpose of the organization was to assist students that had to leave their home reserves to obtain post-secondary education in the city of Winnipeg. The TCC concluded that the fact that the students who benefited from the appellant’s employment came from reserves was not relevant in the connecting factors test. The TCC stated:

“…It should also be stressed that it is Mr. Desnomie’s personal property that has to be “situated on a reserve” and not the personal property of native students. Expressed in a slightly different manner, the “erosion of the entitlement of an Indian qua Indian on a reserve” has to be determined by reference to the person whose income is involved and not by reference to the different reserves that are benefiting directly or indirectly from the services of this person.” (footnote 4)

Desnomie appealed to the FCA (footnote 5) . One of the arguments raised on appeal was that the off-reserve location of the employer should be given little weight because the services would have been provided on a reserve, if it was possible. In response, the FCA stated:

“…The implication of the appellant’s argument is that as long as an Indian is performing work for an Indian employer and for Indians from reserves, his employment income should be tax exempt, irrespective of where he, his employer, or the place of the employment is located, or where he is paid. There is no doubt the nature of the appellant’s work is related to assisting reserve Indians when they move off the reserve. There is also no doubt that his employer is an Indian organization. The problem is that these considerations do not connect the appellant’s employment income to any particular reserve....” (footnote 6)

Consistent with these cases, it is our view that the fact that the Employer provides education services to strengthen the lives of First Nations people by enhancing their quality of life is insufficient to situate the employment income of the Employees on a reserve. Thus, their employment income is not exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act.

As you know, every person making a payment of salary or wages or other remuneration (i.e., employment income) is required to withhold income tax under subsection 153(1) of the Income Tax Act. However, if an employee’s employment income is exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act, then the employer is not required to withhold income tax from that employment income. Form TD1-IN, Determination of Exemption of an Indian’s Employment Income, may be used by employers to determine the appropriate income tax withholdings for their employees. This form should be completed by the employer and the employee. In a situation where an employer fails to withhold the amounts required from an employee’s employment income and remit those amounts to the Receiver General as required by subsection 153(1) of the Income Tax Act, the employer is liable to a penalty and interest under subsections 227(8) and 227(8.3) of the Income Tax Act, respectively.

We trust that these comments will be of assistance.

Yours truly,

Nerill Thomas-Wilkinson, CPA, CA
Manager
Non-Profit Organizations and Indigenous Issues
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Par. 23, FCA Monias
2 Par. 66, FCA Monias
3 Desnomie v The Queen TCC 98 DTC 1744
4 Par. 23, TCC Desnomie
5 Desnomie v The Queen FCA, 2000 DTC 6250
6 Par. 21, FCA Desnomie

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2022

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2022