26 May 2000 Internal T.I. 2000-0025790 - ALLOCATION TRANSFER PROGRAM-STATUS INDIAN

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.

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.

Department of Fisheries & Oceans
Allocation Transfer Program
Questions and Answers
For Canada Customs and Revenue Agency Client Services

The Department of Fisheries and Oceans ("DFO") is responsible for issuing fishing licences which include commercial fishing licences to the public. An Allocation Transfer Program is in place whereby DFO encourages the holders of commercial fishing licences to retire or relinquish their licence in order that DFO might transfer the fish allocation in respect to that licence to First Nations fishing communities. If a holder of a commercial fishing licence relinquishes the licence to DFO, the holder will be compensated by a voluntary payment under the Licence Retirement Program ("Program") which will reflect the fair market value of the licence. DFO will then re-issue the commercial fishing licence to an Indian Band as a communal fishing licence and some or all of the fishing quota associated with that communal fishing licence will then be provided to the First Nation. The First Nation will then generally assign the fishing licence to individual Indian Fishers within its community for their use.

Q1

Is the fishing income of Indian Fishers subject to taxation?

A1

Paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act provide a tax exemption for an Indian's personal property situated on a reserve. The courts have previously determined that, for purposes of section 87 of the Indian Act, the reference to personal property includes income. In Williams (92 DTC 6320), the Supreme Court of Canada reconsidered the approach to use in determining whether income is situated on a reserve. The proper approach in determining the situs of personal property is to evaluate the various connecting factors which tie the property to one location or another.

Henry Southwind (98 DTC 6084) is the leading case dealing with the business income of an Indian proprietor. The case concerns income earned from logging, where a Status Indian lived on reserve and said that he had an office on reserve. However, all his income earning activities were carried out off reserve and his sole customer was off reserve. The Tax Court decided that his income from his logging activity was taxable and the taxpayer appealed this decision. The Federal Court of Appeal confirmed the Tax Court's decision.

In our view, one significant factor that serves to connect business income to a location on reserve or off reserve is the location where the activities are carried out. Another factor would be the location of the customers of the business. While there may be some activities carried on in an office located on reserve, in our view, the actual revenue-generating activities would be more significant in determining whether the business income is connected to a reserve. Thus, for example, if a bookkeeper were employed by a self-employed Indian to maintain the books and records in an on-reserve office, but the actual revenue-generating activities of the business were off reserve, the business income would be more connected to a location off reserve than it would to a location on reserve.

In our view, in the case of a fishing business, the location where the fishing is done is a connecting factor of major importance. Generally, fishing is done off reserve. Therefore, if all of the fishing is done off reserve, the fishing business income earned by a status Indian would be more connected to a location off reserve than to a location on reserve and, consequently, it would not be exempt from taxation.

Q2

If the Indian Fishers leave from harbours located on reserves, will their fishing income be exempt from taxation?

A2

The fact that Indian Fishers leave from harbours located on reserve would not be sufficient to connect the business income to a reserve. Consequently, as discussed in question 1, the business income would not be exempt from taxation.

Q3

If the customers of a fishing business are located on reserve, would the fishing income be exempt from taxation?

A3

In a situation where the fishing is done off reserve but the customers are located on reserve, we would take the view that the off reserve location of the actual revenue-generating activities, the more significant factor, would situate the business income off reserve and, thus, be taxable.

In addition, the limited weight that an on reserve customer would otherwise carry as a connecting factor will not be recognized if it can reasonably be considered that one of the main purposes for the location of the customer on reserve is to serve as a connection between an Indian Fisher's business and a reserve, by acting as an intermediary between an Indian Fisher and the actual fish buyers who are located off reserve.

Q4

If a portion of the revenue generating activities such as preparation, dressing, packing and repairs are carried on on reserve, can a portion of the business income be exempt from taxation?

A4

Yes, if a portion of the revenue generating fishing activities are carried on on a reserve, a portion of the business income would generally be considered exempt from taxation. However, it is the Agency's view that the main activity of a fishing business is the fishing itself. Accordingly, the revenue generating activities involved in preparing the fish for market may exempt a small portion of the business income. Each taxpayer must be willing to demonstrate a reasonable method by which income is allocated between taxable and exempt.

It should also be noted that where a portion of income from a business is exempt and the remaining portion is not exempt, the expenses which pertain to the exempt portion are not deductible. Normally, expenses should be allocated in the same proportion as revenue unless another allocation could be shown to be more reasonable in the circumstances.

Q5

Is a river that runs through a reserve, part of the reserve?

A5

Officials of the Department of Indian Affairs and Northern Development ("DIAND") advise us that there is no general rule according to which a body of water, that runs through a reserve, is part of the reserve. Such a determination is usually made at the time of establishment of each particular reserve. Thus, details would be required as to which particular body of water is involved in each situation, in order to determine whether it is part of a reserve. For confirmation of whether a particular body of water is part of a reserve, you may contact officials with the Land Research and Title Clarification Division of DIAND.

Q6

If an Indian Fisher incorporates his fishing business and becomes an employee of the corporation, would the employment income received by the Indian Fisher be exempt from taxation?

A6

Based on comments made by the Supreme Court in Williams, 92 DTC 6320, and after receiving representations from interested Indian groups and individuals, the Canada Customs and Revenue Agency ("CCRA") developed the Indian Act Exemption for Employment Income Guidelines (the "Guidelines"). The Guidelines incorporate the various connecting factors, that describe employment situations covered by section 87 of the Indian Act. A copy of the Guidelines is attached to this package.

The following summarizes the Guidelines:

Guideline 1 will apply to exempt all of the income of an Indian if at least 90% of the employment duties are performed on a reserve regardless of where the employer is resident. When less than 90% of the duties are performed on a reserve, and none of the other guidelines apply, only the portion that is performed on a reserve is exempt (the proration rule).

Guideline 2 will apply to exempt all of the employment income of employees who live on reserve provided that the employer is in fact resident on a reserve. The condition that the "employer is resident on a reserve" 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 an organization is usually considered to be exercised by the group that performs the function of a board of directors of the organization.

Guideline 3 would apply to exempt all of the income of an Indian if more than 50% of the employment duties are performed on a reserve and the employer is resident on a reserve or the Indian lives on reserve.

Guideline 4 requires a) that the employer is resident on a reserve; b) that 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) that the duties of the 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. These elements must all be satisfied in order for Guideline 4 to apply.

Thus, in a situation where the Indian Fisher lives on reserve and the corporation is in fact resident on reserve, Guideline 2 would apply to exempt the employment income from taxation.

Q7

What are the tax implications of payments made to fishermen to retire their fishing licences?

A7

A fishing licence held in connection with a fishing business is an eligible capital property in respect of the fishing business and, therefore, the rules in subsection 14(1) of the Act apply. Proceeds received on the relinquishment or sale of a fishing licence would be included as income from his fishing business under subparagraph 14(1)(a)(v), to the extent that such proceeds results in an "excess" amount as defined in subsection 14(1).

Prior to the repeal in 1994 of the $100,000 capital gains exemption found in subsection 110.6(3), an individual taxpayer could have claimed a capital gains exemption in respect of such excess amount as subparagraph 14(1)(a)(v), as it then read, deemed the excess amount in subsection 14(1) to be a taxable capital gain. As the $100,000 capital gains exemption is no longer available, such "excess" amount arising on the direct relinquishment or sale of a fishing licence will be taxable as income from the individual's fishing business under subparagraph 14(1)(a)(v) of the Act.

Individual's who filed form T664 for eligible capital property created an exempt gains balance for the fishing business. This exempt gains balance reduces the business income from the disposition of eligible capital property (other than recapture of annual allowances deducted in previous years).

Q8

Would a disposition of shares of a corporation carrying on the business of fishing qualify for the $500,000 lifetime capital gains exemption?

A8

The $500,000 lifetime capital gains exemption applies where the shares are qualified small business corporation shares. A qualified small business corporation share of an individual means a share of the capital stock of a corporation that:

a) at the determination time, is a share of the capital stock of a small business corporation owned by the individual, the individual's spouse or a partnership related to the individual;

b) throughout the 24 months immediately preceding the determination time, was not owned by anyone other than the individual or a person or partnership related to the individual; and

c) throughout that part of the 24 months immediately preceding the determination time while it was owned by the individual, or person or partnership related to the individual, was a share of the capital stock of a Canadian-controlled private corporation more than 50% of the fair market value of the assets of which was attributable to (i) assets used principally in an active business carried on primarily in Canada by the corporation or a corporation related to it... .

It is a question of fact, to be determined after a review of all relevant circumstances, whether an asset is used principally in an active business. The term "principally" is not a defined term in the Act. Generally, the Agency considers that an asset is used principally in an active business if its primary or main use is in respect of that business. The used principally test is applied on a property by property basis. The actual use to which an asset is put in the course of the business, the nature of the business involved and the practice in the particular industry are relevant in the determination of whether assets are used principally in an active business.

Q9

What are the income tax implication of an Indian Band purchasing shares of a corporation carrying on the business of fishing?

A9

Paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act provide a tax exemption for the personal property of an Indian or band situated on a reserve. Since a corporation is not an "Indian" or "band", as defined in the Indian Act, it does not qualify for this exemption. Therefore, a corporation will be taxable on its income unless otherwise exempt from taxation under another provision of the Act.

The taxation of income of the corporation depends on whether the Band itself is subject to income tax. An Indian band may be exempt from tax by virtue of paragraph 149(1)(c) of the Act. Paragraph 149(1)(c) of the Act provides an exemption from income taxes for municipalities in Canada or public bodies performing a function of government in Canada. In situations where the Indian band is considered a municipality for purposes of paragraph 149(1)(c), corporations owned by the Indian band may be exempt from taxation by virtue of paragraph 149(1)(d.5). The exemption in paragraph 149(1)(d.5) would not apply to a corporation owned by an Indian band if the Indian band is considered a public body performing a function of government.

For taxation years and fiscal periods that begin after 1998, a corporation may be exempt from Part I tax on its taxable income for a particular period under paragraph 149(1)(d.5) of the Act if not less than 90% of its capital is owned by one or more municipalities in Canada and the income of the corporation from activities carried on outside the geographical boundaries of the municipalities does not exceed 10% of its income for the period. Given that a large part of the income earning activities of a fishing business take place off reserve, it is unlikely that the 10% income test will be met.

We note that paragraph 149(1)(d.5) of the Act is subject to subsections 149(1.2) and (1.3) of the Act. Subsection 149(1.2) of the Act excludes certain income from the determination of whether more than 10% of the income of a corporation is derived from activities carried on outside the geographical boundaries of the municipality or municipalities that own the corporation. Specifically, income derived from activities carried on pursuant to an agreement in writing with Canada, a province, or a municipality, within its respective geographical boundary, is not included in the determination. Subsection 149(1.3) of the Act provides that 90% of the capital of a corporation that has issued share capital is to be considered to be owned by one or more municipalities only if the municipalities are entitled to at least 90% of the votes associated with the shares of the corporation.

When a corporation's tax status changes from non-exempt to exempt (or vice versa), the corporation is treated as if it had begun a new existence. A year-end is deemed to occur at the time of the change. At that time, the corporation is deemed to have disposed of all its property at fair market value and immediately reacquired it at that fair market value.

As indicated above, in order for a corporation owned by an Indian band to qualify for the exemption under paragraph 149(1)(d.5) of the Act, the Indian band would have to qualify as a municipality in Canada. In our view, having passed bylaws under sections 81 and 83 of the Indian Act would not be sufficient to have the Indian band considered to be a municipality for purposes of paragraph 149(1)(d.5) of the Act. In the 1994 case of Otineka Development Corporation Limited and 72902 Manitoba Limited v. Her Majesty the Queen (94 DTC 1234), the Tax Court of Canada concluded that, since there is no definition of a "Canadian municipality" in the Act, the term must be given its ordinary meaning and is not to be solely determined by the provincial legislation governing municipalities. In the Court's views, the powers conferred under the Indian Act and their exercise by The Pas Indian Band created a form of self-government that is an essential attribute of a municipality. In that case, the band had passed by-laws to regulate water, garbage disposal, weed control, domestic animal control, law and order, the provision of housing and other by-laws. It also provided services to band members in areas such as education, health care, social services, employment and training services, counselling and economic development.

In the end, the Court concluded that the band was a municipality for the purposes of former paragraph149(1)(d) of the Act (the relevant section prior to the enactment of paragraph 149(1)(d.5) of the Act) and that corporations owned by the band were exempt from taxation as municipally-owned corporations. In our view, for an Indian band to be considered a municipality in Canada, it would have to demonstrate that it fits within the facts of the Otineka case.

- 8 -