2024-1034651E5 Indian Act Tax Exemption - Retroactive salary

Principal Issues:

Whether a lump-sum payment for retroactive salary increases received is exempt under section 87 of the Indian Act and paragraph 81(1)(a) of the Act.

Position:

It depends. Where the retroactive payment relates to previous employment income that was tax exempt under paragraph 81(1)(a) of the Act and section 87 of the Indian Act, the portion of the retroactive payment that relates to that employment income would similarly be exempt from income tax.

Reasons:

For Section 87 Exemption purposes, a lump-sum retroactive salary payment, attributable to past work, should be taxed in the same manner as income earned during that past work period, irrespective of current employment situation.

Author: Chiu, Phyllis
Section: ITA para. 81(1)(a); IA s. 87

XXXXXXXXXX                                                                       Phyllis Chiu
                                                                                               2024-103465

February 7, 2025

Dear XXXXXXXXXX:

RE:   Lump-sum payment for retroactive salary increase

This is in response to your email correspondence asking whether a lump-sum retroactive salary increase (Retroactive Payment) paid to an employee (Employee) of the XXXXXXXXXX (Employer) is exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act (Act).

Our understanding of the information provided is as follows:

- The Employee lives on-reserve.

- The Employer is resident off-reserve.

- Prior to March 16, 2020, the Employee performed their duties of employment at one of the Employer’s off-reserve locations.

- Due to workplace restrictions imposed during the COVID-19 pandemic, the Employee performed their employment duties at their on-reserve home office from March 16, 2020, to August 31, 2020, and January 1, 2021, to June 30, 2021 (COVID period).

- After June 30, 2021, the Employee returned to work at one of the Employer’s off-reserve locations.

- The Memoranda of Settlement reached XXXXXXXXXX, provided remedies in the form of retroactive compensation to affected employees.

- As an affected employee, a Retroactive Payment was received by the Employee on July 26, 2024, for the period of September 1, 2019, to June 28, 2024, with the result that a portion of it relates to the period when the Employee performed their employment duties at their on-reserve home office.

We assumed that the Employee is registered under the Indian Act and that XXXXXXXXXX employment income earned during the COVID period was not taxable as you stated that you followed the Guidance on the application of the Indian Act Exemption for Employment Income Guidelines to issues raised by the COVID-19 crisis.

Our Comments

This technical interpretation provides general comments about the provisions of the 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.

In this situation, it is necessary to apply the connecting factors test to determine whether the Retroactive Payment is situated on a reserve and exempt from tax under the Indian Act. The courts have concluded that a payment is situated on a reserve where there is a work period relevant to the determination of that payment and the employment income earned in that work period was situated on a reserve (for example, the employment duties were performed on a reserve during the work period). In other words, the payment should be taxed in the same manner as the previous employment income earned during that work period.

It is our understanding that the amount of the Retroactive Payment is determined based on work performed in the past (Past Work). Consequently, the Retroactive Payment will be taxed on the same basis as the employment income earned in the Past Work period. In the case of the Employee, the Retroactive Payment related to the COVID period in which the Employee performed their duties on a reserve, will likely be situated on a reserve. Therefore, the Retroactive Payment related to the COVID period will likely be exempt under section 87 of the Indian Act and paragraph 81(1)(a) of the Act.

We trust 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

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