2 May 2014 External T.I. 2012-0434151E5 - Indian Act Exemption - Guideline 2

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether Guideline 2 will apply such that the employment income is exempt where the employees are leased through an on-reserve employer?

Position: Generally the Guidelines do not apply in an employee leasing situation.

Reasons: See discussion.

XXXXXXXXXX
2012-043415
Lori Merrigan
(613) 957-9229

May 2, 2014

Dear XXXXXXXXXX:

Re: Exemption from Taxation Pursuant to Section 87 of the Indian Act

This is in reply to your letters of January 23, 2012, August 22, 2012, and our previous conversations (Merrigan/XXXXXXXXXX) of June 6, 2012, and March 12, 2013, in which you requested a technical interpretation as to whether certain employment income of members of a particular First Nation would be property of an Indian, as that term is defined in section 2 of the Indian Act (the "IA"), situated on a reserve for purposes of section 87 of the IA and thus exempt from tax pursuant to paragraph 81(1)(a) of the Income Tax Act (the "Act"). Although we have not received any additional information from you as requested in our last conversation, we are able to provide the following 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 70-6R5, Advance Income Tax Rulings.

The location of the duties of employment is usually the key factor in determining whether an Indian's employment income is situated on a reserve and exempt from tax. However, the courts have recognized that employment income may be situated on a reserve, even where many or all of the duties of employment are carried on off-reserve, as long as other connecting factors of significant weight connect the employment income to a reserve. These factors may include the residence of the employee, the circumstances surrounding the employment and the residence of the employer.

In consultation with other government departments as well as interested Indian groups and individuals, the Canada Revenue Agency (the "CRA") identified a number of connecting factors that can be used to determine whether a person's employment income is situated on a reserve. This initiative resulted in the development of the Indian Act Exemption for Employment Income Guidelines (the "Guidelines"). The Guidelines are an administrative tool intended to approximate the "connecting factors test" described by the Supreme Court of Canada in Williams v. The Queen, 92 DTC 6320. The Guidelines were intended to apply in common employment situations to assist Indian employees to determine whether their employment income was taxable. Unlike the connecting factors test, each Guideline relies on only 2 or 3 elements, which are implicitly given significant weight, in determining whether the employment income is exempt.

Guideline 2 is the Guideline that is most often referred to with respect to situations where duties of employment are completed off-reserve. Guideline 2 relies on only two factors: the residence of the employer and the residence of the employee. The courts have concluded that although an employer's residence on a reserve is a connecting factor to a reserve, that factor will have minimal weight if the location of the employer has no tangible significance to the reserve.

"Employee leasing" arrangements are arrangements where an Indian is employed through an on-reserve employment agency but works off-reserve for an off-reserve organization.

The Federal Court of Appeal and the Tax Court of Canada have considered these arrangements and, in the majority of cases, have concluded that the employment income at issue was not exempt from tax under section 87 of the Indian Act. As with all employment situations, the factors connecting the income to a reserve must be identified and weighed on a case-by-case basis to determine if the employment income is taxable or exempt. The location of the employer on a reserve is not a connecting factor strong enough, on its own, to exempt the employment income from tax. As a result, when an employee is "leased" by an on-reserve employer, but carries on duties of employment off-reserve, section 87 of the Indian Act (and Guideline 2 of the Indian Act Exemption for Employment Income Guidelines) will not apply to exempt the employment income unless:

1. other factors connect the income to a reserve; or

2. there is specific evidence that would give greater weight to the employer as a connecting factor.

Generally, the courts have indicated that weight should be given to the location of an employer 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 (see Shilling v. The Queen, 2001 FCA 178, Horn et al v. The Queen, 2007 FC 1052, GooGoo v. The Queen, 2008 TCC 589, McIvor et al v. The Queen, 2009 TCC 469). This is particularly true for employee leasing situations. Thus, Guideline 2 is a reasonable approximation of the connecting factors test only where the location of the employer on a reserve provides direct, significant benefits to the reserve. In determining whether a benefit to a reserve is provided, the CRA will take into account whether the location of the employer benefits the particular reserve or reserves where the employees reside.

Furthermore, the courts have also stated that connections that are artificial should not be given weight in determining the location of income for purposes of the exemption. In the Supreme Court of Canada ("SCC") decision Bastien Estate v. Canada, 2011 SCC 38, the judge stated in paragraph 62 that,

"Of course, in determining the location of income for the purposes of the tax exemption, the court should look to the substance as well as to the form of the transaction giving rise to the income. The question is whether the income is sufficiently strongly connected to the reserve that it may be said to be situated there. Connections that are artificial or abusive should not be given weight in the analysis..."

The Federal Court of Appeal commented on that SCC decision in Her Majesty the Queen v. Ronald Robertson and Roger Saunders, 2012 FCA 94, noting in paragraphs 41 and 42 that,

"The Crown has not suggested that the Appellants have attempted an artificial manipulation of the connecting factors in order to bring their fishing income within the exemption from tax provided by section 87. The various connections between the Reserve and the Appellants' income from fishing are indisputably bona fide and not motivated by tax avoidance considerations. This was also the situation in Bastien (see para. 62).

However, in order to avoid potentially abusive or artificial manipulation of the connecting factors in other cases, a degree of flexibility must be maintained in the selection and weighing of the connecting factors, and in the emphasis given to those that provide a substantive basis for situating property on a reserve."

The Guidelines have always expressly stated that there may be situations in which employment income appears to fall within a particular Guideline but is determined not to be exempt. Whether the employer or the employee is resident on a reserve and the extent to which the Guidelines apply in specific situations are determinations that can only be made by the CRA in the course of an audit.

We trust that these comments will be of assistance.

Yours truly,

Roger Filion, CPA, CA
Manager
Non-Profit Organizations and Aboriginal Issues
Financial Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch