18 January 2002 External T.I. 2001-0118105 - BUS. INCOME - 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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Taxation of business income received by status Indians.

Position: Consulting business income should be allocated between exempt and non-exempt portions based primarily on the location of where the services are provided, whether on reserve or off-reserve and the location of the customers.

Reasons: The location where services are rendered is the major connecting factor because services are the revenue generating activities. The customers' location, as a factor, is reflected in the income allocation between exempt and non-exempt portions because of its influence over the location where the services are rendered.

						2001-011810
XXXXXXXXXX 					Karen Power, CA
(613) 957-8953
January 18, 2002

Dear XXXXXXXXXX:

Re: Taxation of a Status Indian's Business Income

This is in reply to your letter of January 11, 2002, wherein you requested our views regarding the taxation of consulting income earned by a self-employed status Indian that does not live on a reserve where part of the consulting income relates to services provided on a reserve. You also ask whether expenses incurred off reserve but which relate to consulting services performed on reserve should be prorated.

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 a consulting business, we would consider both the location of the revenue-generating activities and the location of the customers as being significant factors that serve to connect the business income to a location that is either on or off reserve. Where some of the revenue-generating activities take place on reserve and some off reserve, and some of the customers live on reserve while others live off reserve, it is our view that a portion of the business income will be taxable and the remaining portion will be exempt. We would also point out that where a portion of income from a business is exempt and the remaining portion is not exempt, the expenses pertaining to the exempt portion are not deductible in computing income. Normally, expenses should be allocated in the same proportion as revenue unless another allocation could be shown to be more reasonable in the circumstances. In a specific situation, it could be that some expenses pertain entirely to the exempt portion or to the taxable portion, and in that case, a specific allocation of the entire expense to its respective portion would be most appropriate.

Generally, the revenues earned from each on-reserve client should be pro-rata exempt based on the number of hours of revenue generating activities performed on reserve. The reviewing of reports, transcribing minutes of meetings, drafting correspondence, researching, making telephone calls and other similar work related to an on-reserve client that is performed in an off reserve office would, in our view, be considered revenue generating activities performed off reserve. Expenses that can be attributed to a specific client should be allocated on the same proportion as the revenues for that particular client. General expenses that do not relate to a particular client should be allocated in the same proportion as the business' overall revenues.

We trust our comments will be of assistance to you. These comments are provided in accordance with the practice outlined in paragraph 22 of Information Circular 70-6R4 titled Advanced Income Tax Rulings, dated January 29, 2001 and may be obtained on the Internet at http://www.ccra-adrc.gc.ca/menu/EmenuKKB.html.

Yours truly,

Mickey Sarazin, CA
Manager, Aboriginal Affairs Section
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch