2023-0959911E5 Indian Act tax exemption and Employment Income

Principal Issues: 1. Do Guidelines 1, 2 or 3 of the Indian Act Exemption for Employment Income apply to the employment income of the Society’s employees? 2. Does Guideline 4 of the Indian Act Exemption for Employment Income Guidelines apply to the employment income of the Society’s employees? 3. Does the fact that the employer provides services that benefits First Nations individuals sufficient to situate the employment income on a reserve for the purposes of section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act?

Position: 1. Depends on the individual circumstances of each employee. 2. No. 3. Not likely.

Reasons: 1. Guidelines 1, 2, or 3 may apply to the employee’s income depending on factors such as residency of the individual employee or the amount of time that the employee is required to perform their duties of employment on a reserve. 2. Guideline 4 would not apply as the employer is not an organization that is directly controlled by one or more First Nations bands with reserves or a tribal council representing such bands. In addition, the services provided do not appear to be dedicated exclusively to First Nations individuals who for the most part live on reserves. 3. A connecting factors test would need to be applied separately to each employee who works off-reserve. However, consistent with jurisprudence, the fact that the Society is providing XXXXXXXXXX to First Nations individuals and that the employment duties of the employees may benefit First Nations individuals is not a factor that is given significant weight in a connecting factors test.

Author: Gauthier, Michel
Section: 81(1)(a); 153(1); 227(8); 227(8.3), 87(1)(b) of the Indian Act

XXXXXXXXXX                                                                        2023-095991
                                                                                                 M. Gauthier

April 4, 2024

Dear XXXXXXXXXX:

Re: Indian Act Tax Exemption and Employment Income

This is in reply to your letter dated January 4, 2023, and subsequent submission dated September 29, 2023, requesting our comments on the application of the income tax exemption under section 87 of the Indian Act to employees of the XXXXXXXXXX (Society).

Based on the information you provided:

* The Society is a not-for-profit corporation providing XXXXXXXXXX to Indigenous clients (First Nations, Inuit, and Métis).

* The Society’s head office is located on a reserve.

* The Society’s board of director meetings are held either in-person from the on-reserve head office or by connecting via remote platform from on-reserve locations.

* The Society’s constitution states that it has five board members consisting of three members appointed by each of the XXXXXXXXXX (ORG#1), the XXXXXXXXXX (ORG#2) and the XXXXXXXXXX (ORG#3). The final two board members are jointly appointed by these organizations.

* The employees are registered under the Indian Act (Staff) and may or may not live on-reserve. Some Staff work partially on-reserve, and partially off-reserve, and you attribute this to the fact that the places where their employment duties are performed are typically located off-reserve. In addition, some Staff may work remotely from home offices, which are located either on-reserve or off-reserve.

Our Comments:

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 70-6R12, 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 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 income 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 the 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

Under this guideline, when at least 90% of an employee’s employment duties are performed on a reserve, all of their income from that employment will usually be exempt from income tax. 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 and will exempt the proportion of the income related to the duties that are performed on a reserve (the proration rule).

Based on our understanding of the information provided, none of the Staff perform 90% or more of their duties on a reserve, and therefore, Guideline 1 does not apply, and their employment income would not be fully exempt from income tax. However, where none of the other Guidelines apply, the proration rule applies to those Staff who perform less than 90% but more than an incidental proportion of their duties on a reserve, and the portion of their income related to the duties that were required to be performed on a reserve would be exempt from income tax.

Guideline 2

Under this guideline, when the employee lives on a reserve and their employer is resident on a reserve, all of their employment income will usually be exempt from income tax.

Whether the Society is resident on a reserve is a question of fact. However, based on the information provided, the Society is likely resident on a reserve because its head office is located on a reserve and the board of director meetings are held either in-person from the on-reserve head office or by connecting via remote platform from on-reserve locations.. Therefore, Guideline 2 will apply to those Staff who live on a reserve, and all of their employment income will be exempt from income tax, regardless if they perform their duties of employment off-reserve.

Guideline 3

Under this guideline, when more than 50% of the employment duties are performed on a reserve and either the employer is resident on a reserve or the employee lives on a reserve, all the employment income of the employee will be exempt from income tax.

Although the Society is likely resident on a reserve, as noted above, Guideline 3 likely will not apply because you indicated that most, if not all, of the Staff perform less than 50% of their duties of employment on a reserve.

Guideline 4

Under this guideline, all the employment income of an employee will be exempt from income tax regardless of where their employment duties are performed or where they live, if all of the following conditions are met:

1. The employer is resident on a reserve

2. The employer is:

a. a First Nations that has a reserve (FNR), or a tribal council representing one or more FNRs; or

b. an organization controlled by one or more such FNRs or tribal councils, if the organization is dedicated exclusively to the social, cultural, educational, or economic development of First Nations individuals who for the most part live on reserves; and

3. The duties of employment are in connection with the employer’s non-commercial activities carried on exclusively for the benefit of First Nations individuals who for the most part live on reserves.

It is the CRA's view that Guideline 4 is a generous interpretation of the connecting factors test established by the courts. Therefore, it is appropriate to restrict the application of Guideline 4 to situations that squarely fit the criteria. In other words, all of the conditions of Guideline 4 must be satisfied in order for it to apply.

As noted above, the Society is likely resident on a reserve, but it is not an FNR or a tribal council representing one or more FNRs. Despite this, Guideline 4 may still apply if the Society is an organization that is controlled by one or more FNRs or tribal councils representing one or more FNRs.

You stated that the Society is a non-share capital corporation incorporated under the XXXXXXXXXX. In theses situations, it is the CRA’s view that where an FNR or tribal council has the ability to replace the directors of a corporation, it is considered to control the corporation. The control contemplated in Guideline 4 is direct control by one or more FNRs or tribal councils, as opposed to indirect control through tiered organizations. Based on our understanding of the information provided, the Society is directly controlled by ORG#1, ORG#2 and ORG#3, which are not FNRs or tribal councils representing one or more FNRs. Therefore, the Society does not meet condition 2(b) of Guideline 4.

Further, the Society does not appear to be dedicated exclusively to the social, cultural, educational, or economic development of First Nations individuals who for the most part live on reserves. The term “for the most part” has been interpreted to mean greater than 50 per cent. Although the Society believes that greater than 50% of the First Nations individuals whom they serve, live on reserve, the Society could not substantiate this with reliable data.

Also, in the present case, the Society’s services are being provided to First Nations individuals, as well as Inuit or Métis individuals. As stated above, Guideline 4 should be restricted its application to situations that fit squarely within it. Therefore, where the services are also being provided to the broader Indigenous community (i.e., Inuit and Métis), it is our view that the Society is not dedicated exclusively to the social, cultural, educational, or economic development of First Nations individuals who for the most part live on reserves.

Therefore, for the above reasons, Guideline 4 does not apply, and consequently the employment income of the Staff who do not live on-reserve or perform their duties of employment on-reserve, is not fully exempt from income tax.

However, the Guidelines are an administrative tool created to address the most common employment situations. 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.

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

* the location where the work is performed,

* the residence of the employee,

* the residence of the employer,

* 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 stated that the purpose of the tax exemption is to protect the property of First Nations individuals that they acquire, hold, and use on a reserve, from erosion by taxation (endnote 1) . For example, the Federal Court of Appeal (FCA) discussed the policy of section 87 of the Indian Act in Monias v. The Queen (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.”

In employment income situations, the courts have concluded that where employment duties were not performed on a reserve, but benefited First Nations individuals who lived on reserves, this fact alone is not enough to situate the employment income on a reserve. In Monias, the FCA further 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.” [Our emphasis]

In Naponse v. The Queen (endnote 2) (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 (endnote 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.” [Our emphasis]

Desnomie appealed to the FCA (endnote 4) . 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....” [Our emphasis]

Consistent with the above cases, the fact that the Society is providing services that benefit First Nations individuals and reserves is not sufficient in and of itself to situate the employment income of the Staff on-reserve.

Therefore, absent the identification of additional connecting factors, the employment income of the Staff who perform their employment duties off-reserve is not situated on a reserve and is not exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Act. However, as discussed above, for the Staff who perform some of their employment duties on-reserve or who live on-reserve, Guidelines 1, 2, or 3 may apply, and all or a portion of their related employment income would be exempt from income tax.

For your information, 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 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 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 Act, the employer is liable to a penalty and interest under subsections 227(8) and 227(8.3) of the Act, respectively.

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

ENDNOTES

1 The Queen v Monias, 2001 DTC 5450 (FCA)

2 Naponse v The Queen, 2001 DTC 414 (TCC)

3 Desnomie v The Queen, 98 DTC 1744 (TCC)

4 Desnomie v The Queen, 2000 DTC 6250 (FCA)

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