2021-0917401E5 Section 87 exemption and pension income

Principal Issues: Does the minimum threshold for proration apply to employment income or pension income?

Position: The minimum threshold for proration applies to employment income.

Reasons: It is the CRA’s long-standing position that in determining the amount of pension benefits that is exempt from income tax under section 87 of the Indian Act, it is reasonable to consider the tax treatment of the employment income received during the period in which pension contributions were made or pension benefits accrued (pensionable years of service). Based on this position, if the employment income is exempt from income tax at a certain percentage, then the pension income will also be exempt from tax at that percentage.

Author: Gauthier, Michel
Section: Indian Act s.87; 81(1)(a)

XXXXXXXXXX                                                                 2021-091740
                                                                                         M. Gauthier

November 30, 2023

Dear XXXXXXXXXX:

Re:   Section 87 Indian Act Exemption and Pension Income

This is in reply to your email dated November 15, 2021, asking for clarification of the interpretation provided in Technical Interpretation E2004-0067371E5, dated July 6, 2004. Specifically, you asked whether the 10% minimum threshold for proration referenced in that document applies to employment income or pension income. We apologize for the delay in responding.

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 IC70-6R12, Advance Income Tax Rulings and Technical Interpretations.

Technical Interpretation E2004-0067371E5 states, in part:

“As with the proration of employment income, the proportion of exempt pension income must be more than incidental to the pension itself in order to constitute a meaningful connecting factor. Generally anything below 10% would be considered incidental and would not receive proration treatment.”

The Canada Revenue Agency’s (CRA) “Indian Act Exemption for Employment Income Guidelines” (footnote 1) (Guidelines) apply to common employment situations and help employees and employers to determine whether employment income is fully or partially exempt from income tax under section 87 of the Indian Act. The Guidelines describe the Proration Rule as:

“When less than 90% of the duties of an employment are performed on a reserve and the employment income is not exempted by another guideline, the exemption is to be prorated. The exemption will apply to the portion of the income related to the duties performed on the reserve.”

Before discussing whether the 10% minimum threshold for proration applies to employment and/or pension income, it is important to note that this threshold is not explicitly part of the Guidelines. However, where the percentage of employment duties performed on a reserve is below 10%, each situation is examined on a case-by-case basis in light of the duration and the nature of those employment duties. The closer the percentage is to nil, the greater the likelihood that the duties performed on reserve would be considered incidental and the proration rule would not apply. The closer the percentage of employment duties performed on reserve is to 10%, the greater the likelihood that the proration rule would apply to the related employment income.

The CRA’s Guidelines and webpage entitled “Information on the tax exemption under section 87 of the Indian Act” (footnote 2) both confirm that the Indian Act tax exemption applies to pension benefits in the same manner as the employment income that gave rise to the benefits. The webpage states:

“Employment Insurance benefits, Canada Pension Plan benefits, Quebec Pension Plan benefits, registered pension plan benefits, retiring allowances, and wage-loss replacement plan benefits you receive are treated in the same way as the employment income that gave rise to the particular income. In other words, if your employment income is exempt from income tax under section 87 of the Indian Act, your employment-related income will also be exempt. If part of your employment income is exempt, any employment-related income arising from that exempt income will also be exempt from income tax.”

It is the CRA’s long-standing position that in determining the amount of pension benefits that is exempt from income tax under section 87 of the Indian Act, it is reasonable to consider the tax treatment of the employment income received during the period in which pension contributions were made or pension benefits accrued (pensionable years of service). In other words, if the individual’s employment income during that period was 100% exempt from income tax under the Indian Act, then 100% of the pension benefits will also be exempt. If part of the employment income was exempt, any benefits received arising from that exempt employment income will also be exempt from income tax. For example, if the individual’s employment income was 50% exempt during that period, then 50% of the pension benefits will be exempt.

Where an individual has had different percentages of exempt employment income during their pensionable years of service, it is the CRA’s long-standing position that reference must be made to the taxability of employment income in each year of employment during the individual’s pensionable years of service.

Based on this position, if the employment income was exempt from income tax at a certain percentage during the pensionable years of service, then the pension income will be exempt from tax at that same percentage.

For example, consider a situation where an individual earned a salary of $100,000 each year during their three pensionable years of service. In year 1, the individual did not have any exempt income because only an incidental amount of their duties of employment was performed on a reserve. In years 2 and 3, the individual performed 13.5% of their duties on a reserve and had $13,500 of exempt employment income in each of those years. Since nine percent ($27,000/$300,000) of the individual’s employment income was tax-exempt during their three pensionable years of service, nine percent of the resulting pension benefits would also be exempt from tax.

We trust that these comments will be of assistance.

Yours truly,

Ms. Nerill Thomas-Wilkinson, CPA, CA
Manager
Non-Profit Organizations and Indigenous Issues
Specialty Tax 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 https://www.canada.ca/en/revenue-agency/services/indigenous-peoples/indian-act-exemption-employment-income-guidelines.html

2 https://www.canada.ca/en/revenue-agency/services/indigenous-peoples/information-indians.html

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