9 February 2001 External T.I. 2000-0059605 - INDIANS

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: Taxation of business income, investment income and employment income of a status Indian

Position: Provided only general comments on CCRA position

Reasons: CCRA position

XXXXXXXXXX 2000-005960

February 9, 2001

Dear XXXXXXXXXX

Re : Taxation of Income of a Status Indian

We are replying to your letter of November 10, 2000, which was forwarded to us for reply by the Saskatoon Tax Services Office, concerning the taxation of income earned by a status Indian.

You have described five scenarios, each involving a status Indian resident in Canada and on a reserve who makes artwork on the reserve for sale to off-reserve customers who are not Indians. The scenarios differ in the manner in which the artwork is sold to and reaches the customers. Under the different scenarios, the Indian sells the artwork to the customers through direct negotiations, through negotiations by a non-Indian salesperson, or indirectly through different organizations, which include a "business" owned by the salesperson, a joint-venture and a partnership between the Indian and the salesperson, and a corporation equally owned by the Indian and the salesperson. Prior to being sold to the final customers, the artwork may be on consignment or transferred to the mentioned organizations and stored off reserve.

In respect of the different scenarios, you asked whether the income derived by the Indian from the artwork, whether by way of business profits, a bonus or commission based on the sales price of the artwork, or dividends, would be exempt from income tax by virtue of section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act (the "Act"). Furthermore, you requested that we explain the criteria we use in arriving at the answer in respect to each different scenario.

Our comments

The particular circumstances in your letter on which you have asked for our views appear to be a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R4, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. In addition, as noted in paragraph 15(d) of the circular, we do not rule where the request contains alternative courses of action. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. However, we are prepared to offer the following general comments which may be of assistance.

The type of scenarios you presented and the questions you posed elicit comments concerning the criteria used by the Canada Customs and Revenue Agency (the "CCRA") in determining whether business income, employment income and investment income of a status Indian are exempt from income tax. Accordingly, the comments below describe the general criteria used by the CCRA in making such determinations.

Business income

Paragraph 81(1)(a) of the Act provides that an amount declared exempt from income tax by another act of Parliament shall not be included in computing the income of a taxpayer. Section 87 of the Indian Act exempts from taxation the personal property of an Indian situated on a reserve. The courts have concluded that the term "personal property" includes income.

In determining whether income (personal property) is situated on a reserve, the approach taken by the Supreme Court of Canada in the case of Williams (92 DTC 6320) must be followed. The proper approach to determining the situs of personal property is to evaluate the connecting factors that tie the property to one location or another.

Henry Southwind (98 DTC 6084) is the leading case dealing with the taxation of business income of an Indian. At issue in this case was the taxation of income earned from logging by a status Indian who lived on reserve and had an office on reserve. However, all the income earning activities were carried out off reserve and the sole customer was off reserve. The Federal Court of Appeal upheld the Tax Court's decision that the income from the logging activity was taxable. In reaching its decision, the Federal Court of Appeal used two main connecting factors, namely the location where the services are performed and the location of the sole customer of the Indian. Speaking on behalf of the unanimous bench, Linden J.A. stated that:

"(15) Although Morell Logging is not the appellant's employer, the significance of its off-reserve location lies in that Morell Logging was the appellant's only customer and debtor in the taxation year. The nature of the appellant's business income must be determined, in part, by reference to the source from which that business income is received. In this respect, the appellant's situation is distinguishable from Nowegijick, where the debtor employer was located on a Reserve. Moreover, all of the services performed by the appellant were done off the Reserve, a very significant feature of this case. I agree with Mr. Nadjiwan that the method of payment by cheque drawn on an off-reserve bank, though relevant, is not as important as it was thought to be by the Tax Court Judge."

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. If a portion of revenue-generating activities were carried out on a reserve, a similar portion of business income may generally be exempt.

Investment income

In the case of Recalma (96 DTC 1520, 98 DTC 6238), the Tax Court of Canada, as confirmed by the Federal Court of Appeal, considered the taxation of income earned by an Indian living on reserve from investments (interest from banker's acceptances and income from mutual fund units) purchased from an on reserve branch of a bank. In determining if the investment income was situated on a reserve, the court reviewed the connecting factors and the weight to be given to each factor. The following factors were considered:

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; and

III) the location of the issuer's property in the event of a default that could be subject to potential seizure.

The courts placed considerable weight on (g)(II) - the location of the income generating activity of the issuer of the securities. Basically, the court concluded that the income from the investments started with companies off reserve and was passed to the taxpayers through the bank on reserve. The court held that the investment income was not personal property situated on a reserve as the court concluded that in making the investments the taxpayers chose to invest in the economic mainstream of normal business conducted off reserve.

In our view, the court decision in Recalma supports the position that investment income earned in the economic mainstream is so strongly connected to a location off reserve that it will generally outweigh other factors that may indicate the income is connected to a location on reserve. Based on the Recalma decision, unless the income can be identified as exclusively generated on the reserve, in our view, the income is not exempt.

Employment income

Based on the comments made by the Supreme Court of Canada in Williams and after receiving representations from various interested Indian groups and individuals, the CCRA developed the Indian Act Exemption for Employment Income Guidelines. The Guidelines describe the various connecting factors and employment situations covered by section 87 of the Indian Act. A copy of the Guidelines is enclosed for your consideration.

We trust that the foregoing comments are of assistance.

Yours truly,

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

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