2023-0973981E5 Connecting factors test - employer’s residence

Principal Issues: Is the employer’s residence a significant factor in a connecting factors test to situate on a reserve the employment income earned off-reserve by employees who are registered under the Indian Act and who live on-reserve, and thus exempt the income from tax under section 87 of the Indian Act?

Position: Not in this situation.

Reasons: Based on the facts provided and under a connecting factors test, the income earned off-reserve does not appear to be situated on a reserve.

Author: Mahendran, Ananthy
Section: 81(1)(a) of the Income Tax Act and 87 of the Indian Act

XXXXXXXXXX                                                                    2023-097398
                                                                                           Ananthy Mahendran

December 10, 2024

Dear XXXXXXXXXX:

Re: Whether the employment income of certain employees of a limited partnership would be situated on a reserve and exempt from income tax under the Indian Act

This is in response to your correspondence of May 3, 2023, in which you provided two hypothetical scenarios (Scenario 1 and Scenario 2) and asked whether the income tax exemption under section 87 of the Indian Act would apply to the employment income of employees who are registered under the Indian Act (Employees) and live on a reserve, if their employer (a limited partnership, herein referred to as LP) is determined to be resident on a reserve. We apologize for the delay in responding.

You indicated that LP is the employer of the Employees (some who live on-reserve and some who live off-reserve) and that the Employees perform less than 50% of their employment duties on-reserve.

The following is our understanding of the information presented in the two scenarios.

Scenario 1

A limited partnership (FNP) is created by a First Nation band (99.9% interest) and a general partner (a corporation indirectly owned by the First Nation band) (0.1% interest). FNP is located on a reserve and holds 50.5% of the voting partnership interest in LP. A non-First Nations corporation resident off-reserve (NFNC) holds 48.5% of the voting partnership interest in LP. The general partner of LP is a corporation (GPC) that holds 1% of the voting partnership interest. The common shareholders of GPC are FNP (51%) and NFNC (49%).

GPC is resident off-reserve and is authorized with full power and authority to administer, manage, control, and operate LP’s business. NFNC has an operating agreement with GPC under which NFNC makes day-to-day operating decisions of LP. However, any decisions about financing, management changes, management compensation, project proposal, and acceptance etc. must be reviewed and approved by the board of GPC. More than 50% of LP’s business activities are carried on off-reserve. All LP’s offices are located off-reserve except for its registered office which is located on-reserve. All the Employees consider LP’s registered on-reserve office as their reporting office even though less than 50% of their employment duties are performed on-reserve.

Scenario 2

Scenario 2 is essentially the same as Scenario 1 except for the following: (1) all the offices of LP, including its registered office, are located off-reserve, and (2) all the Employees consider LP’s registered off-reserve office as their reporting office.

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”.

Application of the Indian Act Exemption for Employment Income Guidelines

To simplify the application of the connecting factors test for common employment situations, the Canada Revenue Agency together with interested First Nations organizations, developed the Indian Act Exemption for Employment Income Guidelines (footnote 1) (Guidelines). There are four Guidelines, and they only apply to employees who are registered or entitled to be registered under the Indian Act.

As stated in the Guidelines, they are an administrative tool created to address common employment situations. You stated that LP is the employer in both hypothetical scenarios; however, GPC is authorized with full power and authority to administer, manage, control, and operate LP’s business. Furthermore, there is an operating agreement between NFNC and GPC under which NFNC makes day-to-day operating decisions for LP. In such a case, a complete review of the limited partnership agreement and the operating agreement would be required to determine who is the actual employer.

Whether LP or one of its partners (that is, GPC or NFNC) is the employer is a question of fact. It is dependent on factors such as who issues the letter of employment, who is legally liable for the remuneration, and who controls the employees, although none of the factors is in and of itself conclusive. Given this complex structure, it is our view that the employment situation presented in your scenarios is not a common employment situation to which the Guidelines apply. Therefore, it is necessary to apply the connecting factors test established by the courts.

Connecting factors test

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.

Generally, where employment duties are performed on a reserve, the income from that employment is tax-exempt. Conversely, where employment duties are performed off-reserve, the income from that employment is not tax-exempt unless there are other factors connecting the income to a reserve. However, it should be noted that an employee’s on-reserve residence generally will not be given much weight, in and of itself, in connecting their employment income to a reserve.

Whether the employer is resident on a reserve

Whether LP is resident on a reserve is a question of fact. Consistent with jurisprudence, the Guidelines define the term “employer is resident on a reserve” to mean “that the reserve is the place where the central management and control over the employer organization is actually located.” As noted in the Guidelines, “[T]he central management and control of an organization is usually considered to be exercised by the group that performs the function of a board of directors of the organization. However, it may be that the real management and control of an organization is exercised by some other person or group. Generally, management and control is exercised at the principal place of business, but it is recognized that this function may be legitimately exercised in a place other than the principal administrative office of the organization.” There must be sufficient control exercised from a reserve for an organization to be considered to be resident on a reserve. It is a question of fact where the actual central management and control is exercised. A review of all the facts, including the minutes of the board of directors’ meetings and resolutions or by-laws passed at the meeting, would be required to determine whether LP is resident on a reserve.

In determining whether an organization is resident on a reserve, there are always some concerns where the head office of the organization is located on a reserve, but its main business activities are carried on off-reserve.

Even if it was determined that the employer is LP and that LP is resident on a reserve, the courts (footnote 2) have concluded that such a connecting factor would have minimal weight if the location of the employer has no tangible significance to the reserve. The courts (footnote 3) have also stated that connections that are artificial should not be given weight in determining if income is situated on a reserve for purposes of the exemption. Generally, the courts (footnote 4) have indicated that weight should be given to an employer’s residence on a reserve only where the scope of the employer’s activities on a reserve, or the direct benefits flowing to a reserve, indicate a clear nexus between the employer and the reserve.

Based on our understanding of the hypothetical scenarios presented, the following factors indicate that there is no clear nexus between LP and a reserve:

* LP’s business activities are primarily carried on off-reserve.
* The day-to-day business decisions of LP are made off-reserve by the senior management of NFNC that is not owned by the First Nation and that is resident off-reserve.
* The Employees perform 50% or more of their employment duties off-reserve.
* The human resources management of LP is performed at LP’s off-reserve office.
* At least 48.5% of the profits of LP would be flowing to NFNC, a corporation that is not owned by the First Nation and that is resident off-reserve. Further, NFNC will receive a fee for the services provided under its operating agreement with GPC and this fee will not benefit the reserve.
* In Scenario 1, LP has an office on-reserve, but (as is the case in Scenario 2) it will conduct its board meetings virtually. All board directors except the Chief will attend the meetings virtually from off-reserve locations.

Consistent with the court cases, it is our view that even if LP was determined to be the employer and resident on a reserve, that factor would likely be given minimal weight in a connecting factors test as there does not appear to be any direct and significant benefits flowing to the reserve from LP’s business activities.

Based on our understanding of the hypothetical scenarios presented and absent the identification of any other connecting factors, it is our view that the employment income of the Employees who perform all their duties of employment off-reserve, is not situated on a reserve, regardless of where they live. As a result, section 87 of the Indian Act will not apply to exempt the employment income of those Employees. However, where an Employee performs more than an incidental proportion of their duties of employment on-reserve, the portion of their employment income related to those duties would be situated on a reserve and exempt from income tax under section 87 of the Indian Act.

We trust the above 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 Shilling v. The Queen, 2001 FCA 178

3 Bastien Estate v. Canada, 2011 SCC 38, and The Queen v. Ronald Robertson and Roger Saunders, 2012 FCA 94

4 Horn et al v. The Queen, 2007 FC 1052 and GooGoo v. The Queen, 2008 TCC 589

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