2023-0976441E5 Significance employer residence connecting factors

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 the Reserve, and thus exempt the income from tax under section 87 of the Indian Act?

Position: Not in this situation.

Reasons: Based on the hypothetical situation provided and under a connecting factors test, the income does not appear to be situated on a reserve.

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

XXXXXXXXXX                                                     2023-097644
                                                                             Ananthy Mahendran


August 15, 2024


Dear XXXXXXXXXX:

Re: Whether the employment income of certain employees of a 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 17, 2023, in which you provided a hypothetical situation 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, live on a reserve, and perform their employment duties off-reserve (“Employees”), if their employer (a general partnership) is determined to be resident on a reserve. We apologize for the delay in responding.

The following is our understanding of the hypothetical situation you provided:

- A Co, a taxable Canadian corporation, enters into a general partnership (“GP”) with a corporation wholly-owned by a First Nation (“B Co”), with A Co having a 49% partnership interest and B Co having a 51% interest.

- B Co’s head office is located on a reserve, as defined in subsection 2(1) of the Indian Act (“Reserve”).

- Both B Co and the GP have registered business addresses on the Reserve.

- The GP operates a service business (“Business”) and carries out its activities off-reserve.

- Approximately 25% of the GP’s workforce is comprised of First Nations individuals who reside on the Reserve.

- The majority of the board of directors of the GP is comprised of members of the board of directors of B Co or appointed by B Co, with the remainder being members of A Co’s board of directors. All board meetings of B Co and decisions of the board of the GP are made on the Reserve.

- Under the partnership agreement and service agreement between A Co and the GP, A Co provides non-operational support services to the GP.

- The GP manages the day-to-day operations of the Business. Day-to-day decisions of the Business are made off-reserve by the project manager, who is an employee of the GP.

- All operational employees are employed by the GP.

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 for common employment situations, the Canada Revenue Agency 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.

As stated in the Guidelines, they are an administrative tool created to address common employment situations. You stated that all the operational Employees in the hypothetical situation are employed by the GP; however, there is a service agreement between A Co and the GP to provide non-operational support services to the GP. In such a case, a complete review of the service agreement is required to determine who is the actual employer of the Employees.

Whether the GP, A Co, or B Co is the employer of the Employees 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 this hypothetical employment situation 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 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.

Based on the hypothetical situation provided, the GP operates its Business off-reserve and all of the employment duties of the its operational employees are likely performed off-reserve, despite the fact that 25% of them may reside on-reserve.

Whether the GP 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 the 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 of 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 the GP is resident on a reserve.

In determining whether an organization is resident on a reserve, there is always some concerns where the head office of the organization is located on a reserve, but its main business activities are carried out off-reserve. Based on the hypothetical situation provided, we are unable to determine if the GP would be resident on a reserve.

However, even if it was determined that the employer of the Employees is the GP and the GP is resident on a reserve, the courts (footnote 1) have concluded that this connecting factor will have minimal weight if the location of the employer has no tangible significance to the reserve. The courts (footnote 2) 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 3) 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.

In the hypothetical situation, the following factors indicate that there is no clear nexus between the GP and the Reserve:

- The GP’s Business activities are carried out off-reserve.

- The majority (i.e., 75%) of GP’s workforce is comprised of individuals who reside off-reserve.

- The day-to-day business decisions of the GP are made off-reserve by the project manager of the GP.

- At least 49% of the profits of the GP would be flowing to A Co, a corporation that is not owned by the First Nation and that is resident off-reserve. Further, A Co will receive a fee for the services provided under its service agreement with the GP and this fee will not benefit the Reserve.

- The GP has a registered business address on the Reserve and conduct its board meetings from the office of B Co, but it does not appear to have an operational office on the Reserve.

Consistent with the court cases, it is our view that even if the GP is determined to be the employer of the Employees and is resident on the Reserve, that factor will 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 the GP’s Business activities.

Based on the limited information provided about the hypothetical situation and absent the identification of any other connecting factors, it is our view that the employment income of the employees of the GP who are registered under the Indian Act and perform their duties of employment off-reserve, is not situated on a reserve, regardless of where the employees live. As a result, section 87 of the Indian Act will not apply to exempt the employment income of those employees.

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 Shilling v. The Queen, 2001 FCA 178

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

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

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