2023-0969631E5 Employment Income and the Indian Act tax exemption

Principal Issues: Whether the employment income earned at an off-reserve worksite by members of the XXXXXXXXXX (FN) is exempt from tax.

Position: Likely no, based on the connecting factors identified by the FN.

Reasons: Connecting factors test can only be applied on a case-by-case basis.

Author: Townsend, Ann
Section: Paragraph 81(1)(a) - ITA, Section 87 - Indian Act

                                                                                    January 29, 2024

XXXXXXXXXX                                                           Ann Townsend
                                                                                   2023-096963

Dear XXXXXXXXXX:

RE: Off-reserve employment income and the tax exemption under section 87 of the Indian Act

This is in response to your enquiry asking whether the income tax exemption under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act (ITA) exempts the employment income earned by members of XXXXXXXXXX (FN) working at XXXXXXXXXX (GS). All the FN members working at the GS are registered under the Indian Act (FN employees).

The following is our understanding of the facts:

* The GS is the first XXXXXXXXXX had been fully developed. (footnote 1)

* The GS was built between XXXXXXXXXX and is not located on a reserve.

* The construction of the GS caused damage to the traditional territory of the FN.

* In XXXXXXXXXX and the FN entered into a settlement agreement to compensate the FN for the harm caused by the construction of the GS.

* XXXXXXXXXX promises to promote and support the equitable representation of Indigenous people in its workforce. (footnote 2)

Our Comments:

This technical interpretation provides general comments about the provisions of the ITA 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 ITA, 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 the connecting factors test in common employment situations, the Canada Revenue Agency (CRA) together with interested First Nations organizations, developed the Indian Act Exemption for Employment Income Guidelines (Guidelines). (footnote 3)   Under the Guidelines, employment income will generally be tax-exempt if the employment duties are fully or partially performed on a reserve or the employer or the employee is resident on a reserve.

You acknowledge that Guideline 1 or 3 will apply to exempt from tax, the FN employees’ employment income related to their duties of employment performed at on-reserve worksites. However, none of the Guidelines apply to the FN employees performing their duties at the GS (i.e., off-reserve).

Although the Guidelines cover most common employment situations that are subject to the Indian Act tax exemption, there may be situations where there are connecting factors other than those reflected in the Guidelines, which would situate the income on a reserve. In such situations, it is necessary to apply the connecting factors test as established by the courts.

The connecting factors test is a two-step analysis. First, potentially relevant connecting factors that would situate the income on a reserve are identified and then each factor is given weight in light of three considerations: the purpose of the Indian Act tax exemption, the type of income, and the taxation of that income. The courts have concluded that the purpose of the exemption is to ensure the protection of reserve lands and property on those lands, from erosion by the government through taxation. Its purpose is not to confer a general economic benefit to individuals registered under the Indian Act.

Connecting factors that have been considered and given significant 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. (footnote 4)

It is your view that XXXXXXXXXX commitment to increase the number of FN employees at the GS, is a factor that should be given significant weight in a connecting factors test. In support of this argument, you've included a letter dated January 22, 2008, from the CRA that gave significant weight to an agreement the FN had with the XXXXXXXXXX School (School), in determining whether the employment income of FN members working at the off-reserve School was situated on a reserve.

There are key differences between your members’ situation and the School situation. In the latter, there were two former schools in the vicinity: one located off-reserve and one on the FN’s reserve. The province closed both schools and replaced them with a larger School built in 1960 off-reserve to accommodate the expected increase of students resulting from the influx of families for employment during the construction of the GS. After the completion of the new School, approximately 90% of the students were FN members who were transported from the reserve to the School by school bus. Furthermore, the FN had an arrangement with the School that gave the FN influence over the hiring and evaluation processes for teachers and principals and required the FN to reimburse the education costs for students from the reserve on a cost recovery basis.

In that 2008 letter, the CRA opined that the FN members who lived on a reserve and worked at the School had similar connecting factors as those identified in Folster v. the Queen (FCA) (1997) 3 FCA 269 (Folster). In the Folster case, the taxpayer resided on the Norway House Indian Reserve and was employed by Health and Welfare Canada as an administrator at the Norway House Hospital. The hospital was originally located on the reserve but was rebuilt off-reserve following a fire. The hospital primarily serves the residents of the reserve, with 80 to 90 per cent of the patients residing on the reserve. The Federal Court of Appeal determined that the taxpayer’s employment income was exempt from tax and stated:

“...on the facts of this case, the residence of the taxpayer, the nature of the service performed, the history of the institution in question, and the circumstances surrounding the employment all received greater weight in the purposive interpretation of section 87.”

Regarding the FN members working at the School but not living on a reserve, the CRA gave significant weight to the connecting factors identified by the FN, and opined that the employment income of these employees was also situated on a reserve. These connecting factors included the FN’s reimbursement of the education costs for students residing on the reserve, and the influence and control that the FN had over the hiring and evaluation of the principal, teachers and other school staff. In the CRA’s view the FN had sufficient control with respect to the staff so as to conclude that the FN itself was the employer.

In the current situation, the significant connecting factors identified in the Folster case and the School situation are not present. In particular, the GS was never located on a reserve and does not primarily serve residents of the reserve. Furthermore, the FN does not appear to have the same degree of influence or control over the operations of the GS as it had over the School. Based on the information you provided and absent the identification of any other connecting factors, it is our view that the employment income of FN employees working at the GS or receiving training at other off-reserve worksites, is not situated on a reserve, and consequently, it is not exempt from tax under section 87 of the Indian Act and paragraph 81(1)(a) of the ITA.

We trust that these comments will be of assistance.

Yours truly,

Ms. Nerill Thomas-Wilkinson, CPA, CA
Manager
Non-Profit Organizations and Indigenous Issues Section
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 Generating stations (XXXXXXXXXX)

2 XXXXXXXXXX

3   https://www.canada.ca/en/revenue-agency/services/indigenous-peoples/indian-act-exemption-employment-income-guidelines.html

4 Par. 13 Naponse v the Queen [2001] 2 CTC 2582; Par. 9 Desnomie v. The Queen [1998] 4 CTC 2207

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