20 March 2001 External T.I. 2001-0068055 - INDIANS-SUBCONTRACTING 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.

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:

Is the subcontracting income earned by a status Indian, who does not reside on reserve but maintains a proprietorship business office on reserve, from plumbing services rendered on homes located on reserve in respect of subcontracts with a general contractor corporation, which is owned by non-Indians and is not resident on reserve, exempt from income tax?

Position: Yes

Reasons: The major connecting factor is the location of the revenue generating activities, which in this case are the plumbing services rendered on homes located on reserve.

XXXXXXXXXX 2001-006805
S. Parnanzone, MBA, CMA
March 20, 2001

Dear XXXXXXXXXX:

Re : Taxation of Income of a Status Indian

This is in reply to your letter of January 24, 2001, and is further to your telephone conversation with Mr. S. Parnanzone of this office, concerning the taxation of business income earned by a status Indian.

You described the situation of a status Indian residing off the reserve who is self-employed as a plumbing contractor and derives about 90% of his income from plumbing work done on homes located on reserve and about 10% from work on homes located off reserve. About 60% of his income is from subcontracting plumbing work for a general contractor and relates exclusively to work done at new homes built on reserve or renovations on homes on reserve. The balance 40% of his income is from billings to home-owners customers. The Indian maintains a business office on reserve. The general contractor is a corporation owned by non-Indians and its residence is off reserve.

In your view, the Indian's income from work done on homes located off reserve is not exempt from income tax, while his income from work done on homes located on reserve under contracts directly with the home owners is exempt from income tax. You are concerned, however, with respect to the tax treatment of the Indian's subcontracting income derived from work on homes located on reserve. Your question is, therefore, whether the fact that the Indian bills the general contractor for the work done on homes located on reserve somehow makes the subcontracting income subject to income tax.

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. Since your situation appears to involve a specific taxpayer and completed transactions, 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.

Paragraph 81(1)(a) of the Income Tax 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. 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.

Based on the facts you described, in our view, the most important connecting factor of the Indian's income from the plumbing business is the location of the homes where the plumbing services are rendered. Accordingly, if the services are rendered at homes located on reserve, in our view the related business income (including the subcontracting income described above) is exempt from tax. Based on the facts described, while the location of the customer, which in the case of the subcontracting income is the general contractor, is a connecting factor, it has little significance in the determination of the taxability of the Indian's subcontracting income. The location where the self-employed Indian lives is not a determining factor in connecting the business income to the reserve.

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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