28 June 2013 Internal T.I. 2013-0474311I7 - Indian - employment income

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: 1. Is the employment income of Indian employees exempt under Guideline 4?
2. If not exempt under Guideline 4, will another Guideline or connecting factors apply?

Position: 1. No.
2. Guidelines 1, 2 and 3 may apply to a few employees. Overall, for most employees, the employment income is likely not connected to a reserve and is taxable.

Reasons: 1. The income does not meet the criteria in Guideline 4.
2. For the most part, this is an employee leasing situation. There does not appear to be sufficient benefits flowing to the reserve from the employers to connect the income to a reserve. One company does not appear to be resident on a reserve.

June 28, 2013

Employer Compliance Audit Headquarters
XXXXXXXXXX TSO Income Tax Rulings
Directorate

P. Burnley
Attention: XXXXXXXXXX (613) 957-8961

2013-047431

Employment Income of Indians - Guideline 4 and Employee Leasing

This is in response to your request asking for our comments on the taxation of employment income earned by certain individuals who are Indians, as that term is defined in section 2 of the Indian Act, and who are employees of XXXXXXXXXX ("Company One"). Company One is claiming that Guideline 4 of the Indian Act Exemption for Employment Income Guidelines (the "Guidelines") is applicable to exempt the employment income earned by the Indian employees.

You have also asked our views on whether the employment income earned by Indian employees of two other related companies, XXXXXXXXXX ("Company Two") and XXXXXXXXXX ("Company Three"), is exempt from tax pursuant to any of the Guidelines. Throughout the letter, we will refer to the Indian employees of any of the Companies as the "Employees".

FACTS

You have provided us with information regarding all three Companies, which we will briefly summarize.

XXXXXXXXXX ("Company One")

• Company One is wholly-owned by XXXXXXXXXX, which in turn, is wholly-owned by the XXXXXXXXXX (the "First Nation").
• The head office address of Company One is in XXXXXXXXXX, however the mailing address and all operations are off reserve in XXXXXXXXXX. Books and records are kept in XXXXXXXXXX.
• Company One was incorporated in XXXXXXXXXX to handle the payroll for employees that work on XXXXXXXXXX project (the "Project") on First Nation traditional land and potentially other projects on First Nation traditional land or in the vicinity. Company One took over the payroll from Company Two of all employees on the Project that were working for a contractor, XXXXXXXXXX (the "Contractor"). These employees are both Indian and non-Indian.
• Some of the Indian employees may live on a reserve, although this is not certain.
• The employment income of the Employees is treated as exempt under Guideline 4 when being paid by Company One. Previously, when the employees were being paid by the Contractor, the income was considered taxable. The duties of employment and the location of the duties of employment did not change.
• When the employees were being paid by the Contractor directly, or later by Company One, the Contractor had the ability to hire and fire employees and controlled how and when the employees were paid. Company One waited for approval of timesheets from the Contractor before paying employees. The Contractor reimbursed Company One for payroll allowances paid out to employees.
• In XXXXXXXXXX, Company One entered into a "XXXXXXXXXX" (the "Agreement") with XXXXXXXXXX (Payroll Services Company), an unrelated non-First Nation owned business. The Agreement outlines the responsibilities of Payroll Services Company and the services that Payroll Services Company will perform, which is all of the payroll services for Company One.
  • The Agreement indicates that Payroll Services Company has significant discretion over the direction and resources of Company One. Payroll Services Company has the authority to manage all personnel, labour, and capital for and on behalf of Company One that is necessary to complete the work and deliver the services unless otherwise agreed.
  • Payroll Services Company has essentially all responsibility for the activities of Company One, has exclusive signing authority and has indemnified the sole director of Company One of responsibility.
  • The Agreement also dictates that Company One will not be involved in any other type of enterprise other than the supply of payroll services.
  • Payroll Services Company is entitled to XXXXXXXXXX% of the profits of Company One, apparently after its own expenses in relation to its responsibilities.
  • All decisions relating to the Agreement are to be made by a committee made up of an equal number of representatives from Company One and from Payroll Services Company.
  • The Agreement provides that Company One will receive from their customer, all employee costs including but not limited to all remittances which may or may not include the identified union rate, inclusive of all government remittances, such as union dues and travel. Payroll Services Company, for and on behalf of Company One, shall charge back to Company One's customers the total cost of labour above + XXXXXXXXXX% premium for employee management, unless otherwise agreed to in writing.
  • Any dividends declared and paid must fully be agreed upon by both Company One and Payroll Services Company.

XXXXXXXXXX - "Company Two")

• Company Two is wholly-owned by XXXXXXXXXX.
• The head office address is in XXXXXXXXXX and the field office is in XXXXXXXXXX (off reserve). The books and records are kept in XXXXXXXXXX.
• The board of directors meetings are held both on and off reserve.
• XXXXXXXXXX, the company's business activities are XXXXXXXXXX.
• Some employees work on site in XXXXXXXXXX. Other employees work on various projects off reserve. Some employees may have worked for a period of time on a project that was partially on reserve (the XXXXXXXXXX project in XXXXXXXXXX). XXXXXXXXXX of the employees travelled to XXXXXXXXXX to XXXXXXXXXX there.
• Some of the Indian employees may live on a reserve, although this is not certain.
• In XXXXXXXXXX, the payroll for employees of Company Two working at the Project was transferred to Company One. This included both Indian and non-Indian employees.
• XXXXXXXXXX
• XXXXXXXXXX (XXXXXXXXXX - "Company Three")
• Company Three is a wholly-owned subsidiary of Company Two.
• The head office address is in XXXXXXXXXX and the field office is in XXXXXXXXXX (off reserve).
• Some employees do XXXXXXXXXX work in XXXXXXXXXX (off reserve). Other employees do XXXXXXXXXX work on sites XXXXXXXXXX and these sites are located off reserve.
• In XXXXXXXXXX, XXXXXXXXXX T4s were filed, with XXXXXXXXXX showing exempt income in box 71. XXXXXXXXXX of these employees lived off reserve; XXXXXXXXXX showed a Post Office box for a residence address.

ANALYSIS

Guideline 4

Guideline 4 allows an exemption for the employment income of an Indian where certain conditions are met. Specifically, Guideline 4 requires that:

a) The employer is resident on a reserve; and

b) The employer is:

• an Indian band which has a reserve, or a tribal council representing one or more Indian bands which have reserves; or
• an Indian organization controlled by one or more such bands or tribal councils, if the organization is dedicated exclusively to the social, cultural, educational, or economic development of Indians who for the most part live on reserves; and

c) The duties of employment are in connection with the employer's non-commercial activities carried on exclusively for the benefit of Indians who for the most part live on reserves.

All of these conditions must be met for Guideline 4 to apply.

In the situation you are reviewing, employees were paid by the Companies owned indirectly by the First Nation for various employments. Whether any of the Companies were resident on a reserve remains to be determined and we comment on this further in this letter. However, even if the Companies are found to be resident on a reserve, in our view, Guideline 4 will not apply to exempt the employment income earned by any of the Employees.

Firstly, none of the Companies are either an Indian band, or a tribal council. Even if any of the Companies qualified as an organization controlled by an Indian band, none of the Companies are dedicated exclusively to the social, cultural, educational, or economic development of Indians who for the most part live on reserves. Additionally, none of the duties of employment were in connection with an employer's non-commercial activities carried on exclusively for the benefit of Indians who mostly lived on reserves. In our view, all of the Companies, including Company One, are commercial ventures with the intent to earn profit. The Employees' duties of employment relate to XXXXXXXXXX, etc., off reserve and they are not carried on exclusively for the benefit of Indians who for the most part live on reserves.

Conclusion

Therefore, we agree with you that none of the employment income of the Employees is exempt under Guideline 4.

Additional Comments

Guidelines 1, 2 and 3 and Employee Leasing

Although your question specifically asked whether Guideline 4 would apply, we have also reviewed the application of the other Guidelines in the event that one of them may be applicable to an Employee to exempt or partially exempt his or her employment income from tax. Additionally, because the structure and intent of Company One, and for a period of time Company Two, appears to be an "employee leasing" arrangement, we have reviewed Guideline 2 in particular, and whether there appear to be additional factors connecting the employer or the income to a 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.

Guideline 2

Guideline 2 is the Guideline most relied upon when the duties of employment are carried out off reserve. Guideline 2 exempts employment income of an Indian employee when:

• the employer is resident on a reserve; and
• the Indian lives on a reserve.

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. This is particularly true for employee leasing situations. Therefore, Guideline 2 is a reasonable approximation of the connecting factors test in an employee leasing situation only where other factors connect the income to a reserve or there is specific evidence that would give greater weight to the employer as a connecting factor. This may be the case 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 Canada Revenue Agency (CRA) will take into account whether the location of the employer benefits the particular reserve or reserves where the employees reside.

Whether Guideline 2 may apply depends in part on whether the "employer is resident on a reserve".

Employer is resident on a reserve

The term "employer is resident on a reserve", as used in the Guidelines, means that the reserve is the place where the central management and control over the employer organization is actually located. The central management and control of a corporation is usually considered to be exercised by the group that performs the function of a board of directors of the corporation. (It is not the residency of the individual directors that is relevant, but the location at which major organizational decisions are made.) However, it may be that the real management and control of an organization is exercised by some other person or group. This is the key consideration, whether an organization has a formal board of directors, is managed by another group of persons, or is managed by one individual.

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. It should be noted that satisfaction of the requirement that the employer be resident on a reserve is always of some concern where the head office of an organization is located on a reserve but its main place of business is located off reserve. Maintaining a mailing address on reserve is not sufficient to satisfy the definition of "employer is resident on a reserve" for purposes of the Guidelines.

Where an organization, which would otherwise not be considered to be resident on reserve, is asserting that it satisfies the definition because it holds its board of directors meetings on reserve, it should generally be considered to satisfy the definition where significant management and control over the organization is legitimately exercised during those meetings. Where significant management and control is exercised over a series of meetings, occurring both on and off reserve, it would be reasonable to require that most of such meetings take place on reserve in order to establish residency on reserve.

A review of all of the facts surrounding a situation including the minutes of the board of directors meetings and resolutions or by-laws passed at the meeting would be required to conclusively resolve this question of fact. There must be sufficient control exercised from a reserve in order for the organization to be considered to be resident there.

Based on our understanding of the corporate structure, Company One appears to be controlled and managed by Payroll Services Company having de facto control, or at the very least, controlled by its directors in conjunction with Payroll Services Company. The Agreement between Company One and Payroll Services Company requires a committee with XXXXXXXXXX members from each of Company One and Payroll Services Company to manage all issues related to the Agreement, which is essentially the entire business of Company One. Additionally, Company One appears to be based off reserve in XXXXXXXXXX, and may have an address in XXXXXXXXXX simply for the purpose of appearing to be "resident on a reserve". We also saw no evidence that any meetings took place on reserve. Based on the information we reviewed, in our view, Company One is likely not resident on a reserve.

You have indicated that, from the board of directors meetings of Company Two that you reviewed, the meetings appear to take place at various locations, both on and off reserve. From the few minutes of board of director meetings provided to us for Company Two, it appears that the board of directors made some significant decisions regarding the operations of Company Two. This may indicate that the board has management and control of that corporation. This may also be evidenced by the fact that XXXXXXXXXX. If you determine that the board of directors did have management and control of Company Two, the location of most of the board of director meetings may indicate whether it was resident on a reserve.

We do not have any evidence as to where Company Three was resident. The operations and head office are off reserve and you stated that you did not see any minutes. It is possible that it is controlled by Company Two, as sole shareholder, but it is also possible that the sole director who lives off reserve in XXXXXXXXXX was making the controlling decisions. Since the operations and management of Company Three was off reserve, without any evidence to the contrary, it would appear that Company Three was not resident on a reserve. This is a question of fact that you will have to determine.

Employee Leasing

As mentioned, in an employee leasing situation, we must look at the benefits to the reserve to be able to give significant weight to the employer's location to apply Guideline 2.

Based on the information that we have been given relating to the Companies under audit, there was no indication that any significant benefits are flowing to the reserve from the employment arrangement that would connect the income to the reserve so that the CRA would accept that Guideline 2 could apply. This is particularly the case in Company One where the corporation does not appear to be resident on a reserve and one-half of the profits of the corporation are destined to an off reserve company (Payroll Services Company) and location.

Indian lives on a reserve

We cannot provide any confirmation as to whether any particular employee will be considered to live on a reserve for purposes of the Guidelines. This is a question of fact that must be ascertained for each individual employee. However, we can offer some general comments.

Where an employee is absent from the reserve for short periods of time while temporarily residing near the work site off reserve, this will not, in and of itself, mean that the employee resides off reserve. For example, an employee who resides at a work camp for periods and who then returns to the reserve or a nearby city, would not be resident at the work camp but would instead be resident, for purposes of the Guidelines, at his or her usual home.

An address on a reserve (e.g., a P.O. box) is not adequate for an individual to be considered to live on a reserve if that individual does not have a home on the reserve where he or she habitually lives.

Conclusion: Because Company One does not appear to be resident on a reserve, Guideline 2 would not apply to the Employees of Company One to exempt their employment income from tax. Even if Company One was determined to be resident on a reserve, there do not appear to be any significant tangible benefits to the reserve from the employee leasing arrangement and therefore the location of the employer on a reserve would not be a significant connecting factor to exempt the income.

It has not been determined if Company Two or Company Three are resident on a reserve. If Company Two is determined to be resident on a reserve and an Employee who works directly for Company Two lives on a reserve, the employment income of the Employee may be exempt under this Guideline. This would also be the case for an Employee of Company Three. However, if an Employee of either Company was employed by the Company only in the employee leasing arrangement (e.g., the Employee was paid by one of the Companies, but effectively worked for the Contractor or another employer), the employment income would likely not be exempt from tax. Again, this is the case because there does not appear to be significant tangible benefits to the reserve in the employee leasing arrangement that would give the location of the employer on reserve greater weight.

Guidelines 1 and 3

Guideline 1 exempts all of the employment income of an Indian when at least 90% of the employment duties are performed on a reserve. When less than 90%, but more than an incidental proportion of the duties are performed on a reserve, and none of the other Guidelines apply, the exemption is prorated to apply to the portion of income related to the duties that are performed on a reserve (the proration rule).

For the purpose of the proration rule, it is the general position of the CRA that when time spent on the reserve is minimal such that it is considered incidental in relation to the employee's employment duties off reserve, this time will not be considered to have a strong connection to the reserve for purposes of determining the exemption from tax.

Guideline 3 exempts all of the income of an Indian if two conditions are met:

• More than 50% of the employment duties must be performed on a reserve, and
• Either the employer must be resident on a reserve, or the Indian must live on a reserve.

Conclusion: It appears that most of the duties of employment of the Employees are not carried out, even to the extent of 50% of the duties, on a reserve, nor do most employees live on a reserve. Therefore, it is unlikely the Guideline 3 would apply to them. However, if an Employee does live on a reserve and carried out more than 50% of duties of employment on a reserve, the Employee's income may be exempt under Guideline 3. Similarly, if an Employee carried out more than 50% of duties of employment on a reserve and worked for one of Company Two or Three (and that Company is determined to be resident on a reserve), the employment income may be exempt under Guideline 3.

You have indicated that XXXXXXXXXX travelling to the reserve to XXXXXXXXXX. If none of the other Guidelines apply, a portion of the employment income of XXXXXXXXXX may be exempt based on the proration rule. Any other Employees that actually performed duties of employment on a reserve (e.g., the XXXXXXXXXX project, part of which was on a reserve) may also have some exempt employment income based on the proration rule, if no other Guidelines apply.

We trust that our comments will be of assistance.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 952-1361. In such cases, a copy will be sent to you for delivery to the taxpayer.

Yours truly,

Roger Filion
Manager
Non-Profit Organizations and Aboriginal Issues Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch