Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: In the Recalma decision, in identifying and assessing the various connecting factors which are relevant, the Courts placed considerable emphasis on whether the income generating activity of an on-reserve financial institution, the financial institution is part of the commercial mainstream. If an on-reserve financial institution’s income generating activity arises from loans to Indians and Indian businesses situated on reserve, should an Indian be exempt from taxation on his or her investment income because more than 90% (i.e., “all or substantially all” test) of the on-reserve financial institution’s income is “intimately connected” to the reserve? Should an Indian’s investment income earned in an on-reserve financial institution be taxed in proportion to the income earned by the financial institution off-reserve?
Position: Question of fact that is determined by evaluation of connecting factors.
Reasons: Based on Court’s comments in Recalma decision.
July 15, 1999
Brian Watkins HEADQUARTERS
Individual Returns and Payments G. Moore
Processing Division 952-1506
400 Cumberland, 9th Floor
7-991164
Investment Income of Status Indians
We are writing in reply to your correspondence of April 27, 1999, in which you asked for our opinion concerning the Department’s position regarding the tax treatment of investment income of status Indians.
Our Comments
In general terms, it is section 87 of the Indian Act, along with paragraph 81(1)(a) of the Income Tax Act (the “Act”) that establish the exemption from taxation for status Indians. Section 87 of the Indian Act exempts from taxation the personal property of an Indian situated on a reserve, and the courts have previously concluded that the reference to personal property includes income. In determining whether the income earned by an Indian is situated on reserve and thus exempt from taxation, the approach taken by the Supreme Court of Canada in the 1992 case of Glenn Williams v. The Queen, 92 DTC 6320, is followed. This approach requires the examination of all factors connecting income to a reserve to determine if the income is located on the reserve. The Supreme Court also indicated that the ultimate question is to determine to what extent each connecting factor is relevant in determining whether taxing the particular kind of property in a particular manner would erode the entitlement of an Indian to personal property situated on a reserve. One general direction provided in Williams was that an overly rigid test which identified one or two factors as having controlling force would be open to manipulation and abuse. The Supreme Court rejected the situs of the debtor test as the sole test for determining whether the personal property of an Indian or band was situated on a reserve.
Based on Williams, in our view, the location of a savings account on a reserve would not, in itself, be sufficient to exempt the interest income earned thereon. Where a bank account is considered to be situated at a location on reserve, this is one factor to weigh in determining whether interest earned on deposits in that account is exempt from taxation. There could be other factors that would connect the income to a location off reserve.
In the case of Arnold Recalma v. The Queen, 96 DTC 1520, 98 DTC 6238, the Tax Court of Canada, as confirmed by the Federal Court of Appeal, considered the taxability of income earned by an Indian living on reserve, from investments purchased from an on-reserve branch of a bank. In Recalma, the following were considered in determining the situs of the investment income:
a) the residence of the taxpayer;
b) the origin or location of the capital used to buy the securities;
c) the location of the bank branch where the securities were bought;
d) the location where the investment income is used;
e) the location of the investment instruments;
f) the location where the investment income payment is made; and
g) the nature of the securities and in particular
(i) the residence of the issuer;
(ii) the location of the issuer’s income generating activity from which the investment is made;
(iii) the location of the issuer’s property in the event of a default that could be subject to potential seizure.
In Recalma, the courts placed considerable emphasis on the location of the bank’s income generating activity. The investments in Recalma were bankers acceptances and mutual fund units and the income generated from these was earned in the economic mainstream and was connected to a reserve. Basically, the Court concluded that income from these investments started with companies off the reserve and was passed through a bank on reserve to the taxpayers. It was held that the investment income of the taxpayer was not personal property situated on a reserve. The Court concluded that in making these investments, the taxpayer chose to invest in the economic mainstream of normal business conducted off the reserve. Consequently the Department’s position is that income earned in the economic mainstream is so strongly connected to a location off reserve that it generally outweighs other factors that connect it to a reserve.
In Recalma, in addressing the issue of the concept of “commercial mainstream”, Justice J.A. Linden indicated that:
“We should indicate that the concept of “commercial mainstream” is not a test for determining whether property is situated on a reserve; it is merely an aid to be used in evaluating the various factors being considered. It is by no means determinative. The primary reasoning exercise is to decide, looking at all the connecting factors and keeping in mind the purpose of the section, where the property is situated, that is, whether the income earned was “integral to the life of the Reserve”, and whether it should be protected to prevent the erosion of the property held by Natives qua Natives.”
“To hold otherwise would open the door to wealthy Natives living on reserves across Canada to place their holdings into banks or other financial institutions situated on reserves and through these agencies invest in stocks, bonds and mortgages across Canada and the world without attracting any income tax on their profits. We cannot imagine that such a result was meant to be achieved by the drafters of section 87. The result may, of course be otherwise in factual circumstances where funds invested directly or though banks on reserves are used exclusively or mainly for loans to Natives on reserves.”
In discussing the income generating activities of on-reserve financial institutions, the Federal Court of Appeal has used the term “exclusively”. Since it may not be possible to trace the investment income earned by an Indian to funds invested by a financial institution directly on a reserve, unless as a minimum, an Indian’s investment income can be identified as exclusively generated on the reserve, it is the Department’s position that an Indian’s investment income is generally taxable. The Court’s use of the word “exclusively” implies that as a minimum requirement, 100% of the on-reserve financial institution’s income generating activity would have to be from loans and investments to Indians on a reserve and that such loans and investments have to be “intimately connected” to a reserve. We would be prepared to accept that this requirement may be met if an “all or substantially all” (i.e., 90% or more) test is used in this determination but it would also be necessary to ensure that the on-reserve financial institution’s investments are actually “intimately connected” to the reserve, that is, the investments and loans from the on-reserve financial institution are actually used by Indians for development on a reserve and not, for example, loaned back to off-reserve Indians or non-Indian organizations or invested in securities off the reserve.
We would expect that it would be very difficult for an on-reserve financial institution to meet this “all or substantially all” test but even if the financial institution did meet this test, the investments and loans of the financial institution have to be examined to ensure that they are “intimately connected” to the reserve. In this regard, the Department would have to examine the factual circumstances connecting the financial institution to the reserve to ensure that there is no manipulation or misuse of section 87 of the Indian Act. For example, if an on-reserve financial institution would not otherwise meet the “all or substantially all” test because its income generating activities are not exclusively to Indians on a reserve, the financial institution may set up and loan money to an intermediary such as an on-reserve trust company. The on-reserve trust company would then loan money off the reserve. Because of this arrangement, the financial institution that lent the money to the on-reserve trust company would technically meet the “all or substantially all” test because it is making all or substantially all of its loans and investments to Indians on reserve; however, in our view, such an arrangement would be a manipulation and misuse of the Indian Act since, ultimately, the income generating activities of the financial institution are off-reserve and in the commercial mainstream. If such arrangements have been set up by financial institutions that would otherwise not meet the “all or substantially all” test, then the Department would have to examine the chain of companies involved and we would expect this to be an onerous task.
In a situation where an on-reserve financial institution has less than 90% of its loans and investments on reserve, in our view, any investment income earned by an Indian from investments in that financial institution would be taxable. For the Department to consider an Indian’s investment income to be tax exempt, as a minimum requirement, the Indian’s investment income would have to be from an on-reserve financial institution that generates its income exclusively from investment and loans to Indians on a reserve and it has to be established that the loans and investments are used by Indians for development on the reserve. In addition to the above-mentioned test for the financial institution, in our view, other connecting factors would still have to be present such as the Indian has to live and work on a reserve and the capital with which the Indian made the investments has to be from an exempt source.
With respect to the correspondence of April 23, 1999, you received from XXXXXXXXXX, it is a question of fact whether there are sufficient connecting factors to determine whether the investment income earned by the taxpayer in question from XXXXXXXXXX is exempt. However, in our view, if XXXXXXXXXX makes investments off reserve, then the Department would not consider that its income is exclusively generated from a reserve and any investment income earned by Indians from that financial institution would be taxable. In our view, the Court placed greater weight on this connecting factor than any other and if this factor is not present, we believe that the presence of other connecting factors would likely be insufficient to establish that the investment income of an Indian would be exempt from tax.
We are of the view that proration of an Indian’s investment income based on the ratio of an on-reserve financial institution’s income generating activity on reserve to its off-reserve income generating activities is not a viable or feasible alternative given the Court’s comments on exclusivity. In conclusion, since we would expect that in the vast majority of situations, it would be extremely difficult for all of the above-mentioned connecting factors to be present, generally, the investment income of an Indian would be taxable. In particular, in the case of an Indian living and working off reserve who has investment income from an on-reserve financial institution, in our view, there would likely not be sufficient connecting factors present because the Indian would be viewed, based on the Court’s comments, as having chosen to enter the main economic mainstream of normal business conducted off a reserve and consequently, such investment income would be taxable.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department’s mainframe computer. 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 your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at 819 - 994-2898. The severed copy will be sent to you for delivery to the client.
R. Albert, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
- 5 -
