6 July 2004 External T.I. 2004-0067371E5 - Proration of status Indian pension 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.

Principal Issues: Can a portion of pension income be tax-exempt if the status Indian individual worked on a reserve during a part of their employment?

Position: Yes, provided the period of employment with on-reserve service is not merely incidental to the calculation of the pension benefit.

Reasons: In determining whether a portion of pension income will be exempt, reference must be made to the taxability of employment income in each year of employment during which pension contributions were made or pension benefits accrued. Having completed such a calculation, generally anything less than 10% will not be considered to be a meaningful connecting factor to locate the pension income on a reserve and proration would not be appropriate.

XXXXXXXXXX 2004-006737
Renée Shields
(613) 948-5273
July 6, 2004

Dear XXXXXXXXXX:

Re: Taxation of Pension Income

This is in response to your undated facsimile received March 17, 2004 inquiring whether, as a status Indian, there is a possibility of a tax exemption on a portion of your registered pension plan payments.

The particular situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, Advanced Income Tax Rulings, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advanced Income Tax Ruling. Where a situation involves a specific taxpayer and a completed transaction, all relevant facts and documentation should be submitted to the appropriate Tax Services Office for their views. However, the following general comments, which are not binding on the Canada Revenue Agency ("CRA"), may be of assistance. All publications referred to herein can be accessed on the CRA website at the following address: http://www.cra-arc.gc.ca/formspubs.

Paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act provide a tax exemption for an Indian's personal property situated on reserve. The courts have previously determined that, for purposes of section 87 of the Indian Act, the reference to personal property includes income. Because income is intangible property, as opposed to a physical object, it can be difficult to determine whether it is situated on a reserve. The Supreme Court of Canada addressed this problem in a case called Williams v. the Queen (92 DTC 6320). The decision in Williams requires that we first identify the various connecting factors that are relevant to the particular property. These factors should then be analyzed to determine what weight they should be given in identifying the location of the property. If the most significant factors connect the property to a location on a reserve, the income will be tax-exempt.

Based on the guidance provided by the decision in Williams and after receiving representations from interested government departments, as well as Indian groups and individuals, the CRA dentified a number of connecting factors that can be used to determine whether employment income is situated on a reserve. Generally, the most common connecting factors in the employment income context are: the place where employment duties are performed, the residence of the employee and the residence of the employer.

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 a useful administrative tool for taxpayers and for CRA employees to be able to work with the very broadly worded tax exemption provided by the Indian Act and the Act. The following is a very general summary of the Guidelines:

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. When less than 90%, but more than an incidental proportion 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").

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.

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 CRA's position concerning the taxation of pension income of a status Indian is reflected in the Guidelines. In short, income that is ancillary to employment income, such as pension income and Canada Pension Plan benefits, is treated the same as the employment income itself. In other words, if the employment income earned by a status Indian was tax exempt under paragraph 81(1)(a) of the Act and section 87 of the Indian Act, any pension benefits relating to that exempt employment income that are received by the status Indian will also be exempt from tax.

If a portion of the employment income was exempted by the Proration Rule, it is appropriate that the exemption be factored into the determination of the tax treatment of the related pension benefits. In determining what portion of the pension income should be tax exempt, reference must be made to the taxability of employment income in each year of employment during which pension contributions were made or pension benefits accrued. As with the proration of employment income, the proportion of exempt pension income must be more than incidental to the pension itself in order to constitute a meaningful connecting factor. Generally anything below 10% would be considered incidental and would not receive proration treatment.

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 Planning Branch