17 October 2000 Internal T.I. 2000-0049487 - INDIAN ACT EXEMPTION

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.

Principal Issues: 1. Whether we will look through the main purpose of establishing a connecting factor or whether we accept situations where the legal documentation is effected to establish an employer on a reserve. 2. Whether the 50% rule in Guideline 3 should be applied to business income in a similar manner, that is, once 50% of business income is on a reserve, all the business income should be exempt.

Position: 1. Our approach depends on the type of income. Employment income may not be connected to a reserve in cases where a placement agency is involved. 2. No.

Reasons: 1. The Guidelines apply to employment income. Our positions with respect to business income is based on the criteria established by the Court in Southwind. An employer would be considered to be resident on a reserve if the central management and control of the corporation was exercised from the reserve. 2. Guideline 3 applies only to employment income and the criteria laid out in Southwind apply to business income.

		October 17, 2000

	Audit Directorate	HEADQUARTERS
	Small & Medium Enterprise	David Shugar
	   Division	957-2134

	Attention: Diane Favel
		2000-004948

Indian Exemption - Employment Income Guidelines

This is in response to your correspondence of September 25, 2000, enquiring about Canada Customs and Revenue Agency's (the CCRA) position regarding the evaluation of factors connecting personal property to a reserve. Your correspondence refers to an example in the Indian Act Exemption for Employment Income Guidelines (the "Guidelines"), comments in a paper Rulings presented at the First Nations Workshop - Indian Taxation Act, and a reply to a question posed by the Department of Fisheries.

Our Comments

By virtue of paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act, personal property owned by an Indian and situated on a reserve is exempt from tax. Since the Courts have determined that employment income is personal property, the taxability of employment income earned by an Indian depends on whether such income is situated on a reserve. The Courts have directed that connecting factors must be considered when making this determination. In this regard, CCRA developed the Guidelines, which are based on comments made by the Supreme Court in Glenn Williams v. The Queen, 92 DTC 6320, and on comments made by interested Indian groups and individuals. The Guidelines incorporate the various connecting factors that describe employment situations covered by section 87 of the Indian Act.

The Guidelines only apply to employment and employment-related income. Our positions with respect to other sources of income are based on the criteria established by the Courts. For example, our position with respect to the factors connecting business income to a reserve, and the weight given to each factor, is based on the Federal Court of Appeal case of Southwind v. The Queen (98 DTC 6084) which is the leading case dealing with the business income of an Indian. With respect to the factors connecting investment income to a reserve, our position is based on the decision of the Federal Court of Appeal in the Recalma case (98 DTC 6238) which states that the connecting factors pointing to the location of shares are not to be given as much weight as other more significant factors, such as the location of the revenue-generating activities of the corporation that enables the corporation to earn income and pay dividends. In the case of rental income, the location where the rental property is used is the determining factor.

In Williams, the Court said that 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. The 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. The Court, in Williams, stated that "an overly rigid test which identified one or two factors as having controlling force has its own potential pitfalls. Such a test would be open to manipulation and abuse, and in focusing on too few factors could miss the purposes of the exemption in the Indian Act as easily as a test which indiscriminately focuses on too many." The Guidelines address the concern about overly rigid testing by including the following statement in the introduction:

However, there may be unusual or exceptional circumstances where:

(i) the income may not be taxable even though it does not fall within one of the guidelines; or

(ii) the income may be taxable even though it appears to fall within one of these guidelines.

Your correspondence includes one of the examples in the Guidelines, the example of Mr. K, a construction worker employed by an employment agency situated on a reserve, that makes employees available to work for other employers that are not situated on a reserve. In our view, the term "look through" does not properly describe the process involved in examining the connecting factors. There is no intention to "look through" the placement agency in determining whether an Indian's employment income is exempt from taxation. In fact, the role of the employment agency should be taken into consideration in determining to what extent it is relevant in connecting employment income to a reserve. The intention in the examples of Guideline 2 is just to ensure that the employment income has enough connection to a reserve. The last example of Guideline 2, the Mr. K example, merely illustrates the situation that if one of main purposes of the use of the employment agency is to establish a connecting factor between the employment income and a reserve, CCRA would not consider the fact that the placement agency is resident in a reserve to be a main factor for the determination of whether the employment income is connected to a reserve. Pending a decision in the Rachel Shilling case, which involves an employee of an employment-leasing agency located on a reserve, CCRA will continue to apply the Guidelines in its current format. If the Shilling decision is upheld, the impact that it will have on the CCRA's position on the taxation of employment income can only be determined at that time, based on the comments of the court.

Our comments in the First Nations Workshop paper which you referred to in your letter are as follows:

"Finally, the employment guidelines are not intended to apply when it can reasonably be considered that one of the main purposes for the existence of an employment relationship is to establish a connecting factor between the income in question and a reserve. And the Guidelines also note that there may be circumstances where income may be taxable even though it appears to fall within one of the guidelines."

The above comments appear in the section of the Workshop paper discussing employment income and are in the context of, for example, creating an employment relationship through the use of an intermediary, the purpose being to provide a connection to a reserve. The comments do not necessarily apply to other types of income.

In your correspondence you referred to the following answer given to a question from the Department of Fisheries & Oceans:

Question 6: 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?

Answer: [Summary of the guidelines given] 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.

A sole proprietorship can incorporate for many legitimate business reasons, including tax considerations. In our view, the situation of a reserve resident who incorporates their proprietorship and satisfies the requirement of employer resident on a reserve is very different from the situation of an employment-leasing agency, resident on reserve, that deals with businesses and/or employees that are situated off reserve.

In your correspondence you asked whether we accept situations where the legal documentation is effected to establish an employer on a reserve. Legal documentation such as annual returns or incorporating documents that indicate that the corporate headquarters' address is on a reserve is not sufficient to establish the location of the central management and control of the corporation. Numerous court cases have established that the residence of a corporate employer is the place where the employer exercises control and management. The most notable of these cases is De Beers Consolidated Mines Ltd. v. Howe (1906) A.C. 455. The CCRA considers an employer resident on a reserve if 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. The fact that an annual meeting of an organization is held on a reserve does not necessarily mean that the organization is controlled from a reserve. There must be sufficient control exercised from a reserve in order for the organization to be considered to be resident there. It is a question of fact where the central management and control is exercised. In our view, it would, generally, not be an abuse of the Act where an employer establishes or moves its office onto a reserve, at which the central management and control over the corporation is actually located, in order to gain a tax advantage for its employees.

In your correspondence you asked for clarification regarding why the 50% rule for activities on reserve applies for employment income (Guideline 3) but not for self-employed income. Specifically, you asked why a self-employed fisher who lives on a reserve and carries on more than 50% of his business activities on the reserve would only be exempt on a prorated amount of income.

As stated above, the Guidelines apply only to employment income, while the criteria laid down in the Southwind case apply to business income. The difference in the taxation of the business income and the employment income is due to the different weight given to the factors connecting the income to a reserve. The location where a self-employed Indian lives is not a determining factor in connecting the business income to the reserve. While it may carry some weight, the most important considerations in determining the situs of business income are the location of the revenue-generating activities, and the location of the customers of the business. In situations where a portion of the revenue-generating activities of the business are performed on the reserve, then a similar portion may be exempt from tax. This position was upheld in the Southwind case. While certain activities may be carried on in an on reserve office (i.e. maintaining of books and records), the actual revenue generating activities would be more significant in determining whether business income is connected to a reserve.

Your letter asked whether we are consistent in our application of the Guidelines and whether we have changed our policy. In our view, since being introduced in June 1994, our application of the Guidelines has been consistent in determining whether employment income is situated on a reserve.

Roberta Albert
for Director
Business and Publications Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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