25 July 2002 Internal T.I. 2002-0148697 - STATUS INDIAN-SHAREHOLDER BENEFIT

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: Is a subsection 15(1) benefit taxable when received by a status Indian?

Position: It depends on connecting factors.

Reasons: Where the corporation's income is situated on reserve, the 15(1) benefit would be exempt from tax.

            July 25, 2002

      Saskatoon TSO     HEADQUARTERS
      Verification  & Enforcement Division  Karen Power, CA
      Rhonda Burfitt    (613) 957-8953

            2002-014869

Shareholder Benefit - Status Indian

This is in reply to your facsimile of June 21, 2002, wherein you requested our views on whether a subsection 15(1) benefit conferred on a status Indian would be exempt from taxation under the Income Tax Act (the "Act").

Our Comments

Where at any time in a taxation year a benefit is conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by one of the transactions described in paragraphs 15(1) (a) to (d), the amount or value of such benefit shall be included in computing the income of the shareholder for the year under subsection 15(1) of the Act. A benefit under subsection 15(1), while not specifically defined in the Act, would include just about any payment, appropriation of property or advantage conferred on the shareholder by the corporation.

Paragraph 81(1)(a) of the Income Tax Act and section 87 of the Indian Act establish the Indian exemption from taxation. Section 87 of the Indian Act exempts from taxation the personal property of an Indian situated on a reserve. In determining whether the income earned by an Indian is situated on a reserve and thus exempt from taxation, the approach taken by the Supreme Court of Canada in the 1992 case of Glen Williams v. Her Majesty the Queen, 92 DTC 6320, [1992] 1 C.T.C. 225, must be followed. The proper approach to determining the situs of intangible personal property is to evaluate the various connecting factors which tie the property to one location or another. The Court also stated that the ultimate question is to what extent each factor is relevant in determining whether the taxation of the particular kind of property in a particular manner would erode the entitlement of an Indian qua Indian to personal property situated on a reserve.

An amount brought into income pursuant to subsection 15(1) of the Act is treated as income from property and such income will be exempt from tax pursuant to section 87 of the Indian Act if the income can be situated on reserve.

In Recalma v. The Queen, (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 purchased from an on reserve branch of a bank. It should be noted that the nature of the property in question was the income from the investments and not the investments themselves. The courts placed considerable emphasis on the location of the bank's income generating activity. The investments in this case were bankers acceptances and mutual funds units and the income generated from these was earned in the economic mainstream and was not connected to a reserve. Basically, the Court concluded that income from these investments started with companies off the reserve and passed through a bank on reserve to the taxpayers. It was held that the investment income of the taxpayer was not personal property situated on a reserve. The Court concluded that in making these investments, the taxpayer chose to invest in the economic mainstream of normal business conducted off the reserve. Consequently, the Canada Customs and Revenue Agency's ("CCRA") position is that income earned in the economic mainstream is so strongly connected to a location off reserve that it generally outweighs other factors that connect it to a reserve.

Based on the decision in Recalma v. The Queen, it is necessary to determine the location of the income generating activities of a corporation that enable the corporation to earn income and provide subsection 15(1) benefits. The location of the corporation's clients is another significant factor to be considered. Where, both the majority of the income generating activities and the customers of a corporation are located off reserve, it is our view that a subsection 15(1) income received by a status Indian shareholder would be subject to tax since the corporation's income has been earned off reserve in the commercial mainstream.

As discussed during our recent telephone conversation, the specific issues you raise concerning the application of subsection 15(1) of the Act are likely issues that arise frequently during audits, and should be addressed by the Technical Applications & Valuations Division, Audit Directorate, Compliance Programs Branch.

Should you determine that subsection 15(1) of the Act does not apply to your particular situation, you may wish to consider the reasonableness of the principal shareholder's salary. The CCRA has had a long-standing practice of not challenging the reasonableness of salaries or bonuses paid to a principal shareholder who is active in the corporation's business where the corporation has established either a practice of distributing profits to such shareholder/employee in this manner or a policy of declaring bonuses to shareholders to remunerate them for the profits the corporation has earned that, in fact, are attributable to special know-how or skills of the shareholder/employee. However, as stated at the 1991 Canadian Tax Conference Round Table, that practice does not extend to various scenarios that could result in inappropriate tax consequences. For instance, the practice does not apply to remuneration paid to spouses of the shareholder who are not active shareholders/managers nor to shareholders who are non-residents. Where a shareholder/employee lives on reserve and is, by virtue of paragraph 87(1)(b) of the Indian Act, exempt from tax on employment income from a corporation based on reserve, it would be a question of fact as to whether section 67 of the Act would apply to limit the amount which the corporation could deduct as salaries/management fees in computing its income. Section 67 denies the deduction in respect of an expense that is otherwise deductible, except to the extent that the expense was reasonable in the circumstances.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

We trust our comments will be of assistance.

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

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