30 December 2003 External T.I. 2003-0053135 - INDIAN EMPLOYMENT ADJACENT TO RESERVE

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: Will employment income paid to status Indians working for an electrician business in XXXXXXXXXX be tax-exempt? Will the owner/operator be taxable on his business income?

Position: The employees might be tax-exempt under Guideline 1, Guideline 3 or the Proration Rule - a question of fact. The business income may be tax exempt depending upon where the electrical services are performed.

Reasons: Application of the Guidelines - employment income may be exempt in this situation. However, unlike the XXXXXXXXXX situation, extenuating circumstances do not create additional connecting factors that would be significant enough to merit an exemption. With respect to the business income - Southwind will apply.

2003-005313
XXXXXXXXXX Renée Shields
(613) 948-5273
December 30, 2003

Dear XXXXXXXXXX:

Re: Employment income of status Indian employees

This is in response to your letter of October 22, 2003, addressed to the XXXXXXXXXX Taxation Centre, which was forwarded to the Income Tax Rulings Directorate for reply. You ask whether you are taxable on business income earned by your sole proprietorship, XXXXXXXXXX. You may also be asking whether employment income earned by status Indian employees of XXXXXXXXXX would be tax-exempt.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. The following comments are, therefore, of a general nature only and are not binding on the Canada Revenue Agency ("CRA"). All publications referred to herein can be accessed on the CRA website. In particular, we have recently established a link specifically for issues related to taxation of status Indians, which can be accessed at the following address: http://www.ccra-adrc.gc.ca/aboriginals/menu-e.html.

Paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act provide a tax exemption for a status Indian's personal property situated on reserve. In a case called Williams v. the Queen ("Williams"), the Supreme Court of Canada reconsidered the approach to use in determining whether income is situated on a reserve. The proper approach in determining the situs of personal property is to evaluate the various connecting factors that tie the property to one location or another.

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). In reaching its decision, the Federal Court of Appeal used the location where the services were performed as the primary connecting factor and the location of the sole customer of the status Indian was also an important connecting factor.

Accordingly, we would consider both the location of a sole proprietorship's revenue-generating activities and the location of its 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. 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.

With respect to the income of employees of a sole proprietorship, based on the guidance provided by the decision in Williams and after receiving representations from interested Indian groups and individuals, the CRA identified a number of connecting factors that can be used to determine whether employment income is situated on a reserve. With a view to assisting the Indian community, the CRA developed the Indian Act Exemption for Employment Income Guidelines (the "Guidelines"), incorporating the various connecting factors that describe the employment situations covered by the Indian Act. The Guidelines are also available on the CRA's website. Although a definitive determination of the tax status of an individual's employment income can only be made following a thorough review of all applicable facts, we can provide the following general comments.

Guideline 1 would apply to exempt all of the income of a status Indian if at least 90% of the employment duties are performed on a reserve. Subsection 2(1) of the Indian Act defines "reserve" to be "a tract of land, the legal title to which is vested in Her Majesty, that has been set apart by Her Majesty for the use and benefit of a band". For purposes of section 87 of the Indian Act, reserve includes "designated lands", which is in turn defined at subsection 2(1) to be "a tract of land or any interest therein, the legal title to which remains vested in Her Majesty and in which the band for whose use and benefit it was set apart as a reserve has, otherwise than absolutely, released or surrendered its rights or interests".

When less than 90% of the duties are performed on a reserve and none of the other Guidelines apply, only the portion that is performed on a reserve is exempt from tax (the proration rule). The proration rule to Guideline 1 may apply to exempt the portion of the employment income that relates to the employment duties performed on a reserve. A portion of the employment income may only be exempt by virtue of the Guideline 1 proration rule provided that such portion is significant enough to constitute a meaningful connecting factor and that the employee's presence on a reserve by virtue of employment is not merely occasional. The closer the amount of time spent on reserve is to nil, the greater the likelihood that the time spent on reserve will be considered incidental. When the time spent on reserve is considered incidental, the employment income will not qualify for the exemption.

Guideline 2 would apply to exempt the employment income of status Indian employees who live on a reserve provided that the employer is also resident on a reserve. As stated in the Guidelines, an employer is 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. Generally, management and control is exercised at the principal place of business but it is recognized that this function may be legitimately exercised at a place other than the principal administrative office of the organization. There must be sufficient control exercised from a reserve in order for the organization to be considered to be resident there. The fact that annual meetings are held on a reserve does not, in and by itself, mean that the organization is controlled from a reserve as it is a question of fact as to whether central management and control is exercised during those meetings which are held on reserve.

Guideline 3 would apply to exempt all of the income of a status Indian if two conditions are met. Firstly, more than 50% of the employment duties must be performed on a reserve. Secondly, either the employer must be resident on a reserve or the status Indian must live on a reserve.

Guideline 4 requires that the employer be resident on a reserve. It also requires that the employer is an Indian band which has a reserve, or a tribal council representing one or more Indian bands which have reserves, or an Indian organization controlled by one or more such bands or tribal councils, if the organization is dedicated exclusively to the social, cultural, educational, or economic development of Indians who for the most part live on reserves, and that the duties of the employment are in connection with the employer's non-commercial activities carried on exclusively for the benefit of Indians who for the most part live on reserve. These elements must all be satisfied in order for Guideline 4 to apply. The determination of whether Guideline 4 would apply is question of fact.

Because the Guidelines were developed as an administrative tool to assist in the determination of whether employment income of a status Indian is taxable, they do not constitute a definitive test. It is acknowledged that occasionally there may be unique situations in which additional connecting factors are relevant and may be given significant emphasis. As an example, in situations where a business is established in an extremely remote location, is completely surrounded by or adjacent to reserve land and is historically connected to the reserve, the employment income of a status Indian may be connected to the reserve where the business is generally the primary source of supplies and necessities of life for status Indians resident on the reserve, and at least 90% of its business is with such Indians. Where a particular situation involves proposed transactions, this determination will only be made in the context of a request for an advance income tax ruling. Where a particular situation involves completed transactions, the relevant tax services office will make this determination.

Because XXXXXXXXXX is a business located off-reserve in the XXXXXXXXXX and, in our view, does not satisfy most of the conditions described in the previous paragraph, the income of status Indian employees of XXXXXXXXXX would not be tax-exempt by virtue of any connecting factors resulting from unique extenuating circumstances. However, if status Indian employees of XXXXXXXXXX perform employment duties on reserve, Guideline 1 and/or the Proration Rule may apply to exempt all or part of their employment income. If the status Indian employee resides on a reserve, and at least 50% of the employment duties are performed on-reserve, then Guideline 3 may apply to exempt the employment income from tax. In any case, this determination is a question of fact.

We trust that these comments will be of assistance.

Yours truly,

Roxane Brazeau-Leblond, C.A.

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch