23 July 2004 External T.I. 2004-0077351E5 - Indian limited partnership 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: Would a status Indian limited partner be taxable on partnership income derived exclusively from mortgages held by the limited partnership on property located on an Indian reserve?

Position: Question of fact.

Reasons: Although the existence of a partnership is a question of fact outside of the scope of this reply, the existence of a partnership requires the carrying on of business. As held in R. v. Robinson, a limited partner in a limited partnership is considered to be carrying on business. Southwind v. the Queen stands for the principle that the 2 most significant connecting factors to situate business income on a reserve are: the location where the income-generating business activities take place and the location of the customers. In this fact situation, the business is arguably one of investment, so we should also consider Recalma v. the Queen. In Recalma, the courts determined that in the case of investment income, the connecting factor of the most significance is the location of the income generating activity of the investment. Other factors would be relevant, but their weight would depend on the facts of any particular situation. We generally take the position that in addition to generating income/earnings on a reserve, other factors would have to be present, such as: the investment is used to benefit Indians on reserve, the residency of the status Indian investor and the capital invested came from an exempt source.

2004-007735
XXXXXXXXXX Renée Shields
(613) 948-5273
July 23, 2004

Dear XXXXXXXXXX:

Re: Status Indian Income from Limited Partnership

This is in response to your letter of May 18, 2004 inquiring about the taxation of income received by a status Indian from a limited partnership that derives its income exclusively from mortgages on real property located on Indian reserves.

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. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation 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. Any publications referred to in this letter can be accessed on the CRA website at the following Internet address: http://www.cra-arc.gc.ca

The CRA's general views on what constitutes a partnership are contained in Interpretation Bulletin IT-90 "What is a Partnership." In general, a partnership is the relation that subsists between persons carrying on business in common with a view to profit. Moreover, it is our view that a partner would be regarded as carrying on the business of the partnership. In this regard, our comments herein are based upon the assumption that a partnership exists in the situation described in your letter.

The fact that a particular income earning activity is carried by what is, or purports to be, a partnership does not, in and of itself, justify that the activity must be a business or that the partnership is carrying on a business. The determination of whether an activity carried out by a partnership constitutes carrying on business is also a question of fact.

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.

Southwind v. the Queen (98 DTC 6084) is the leading case in determining the taxation of business income of a status Indian. Based on Southwind, the CRA generally takes the position that the two most significant factors connecting business income to a location on reserve or off reserve are the location where the activities are carried out and the location of the customers of the business.

However, where the business of a limited partnership may be considered to be investment, it is also arguable that the connecting factors identified by the Tax Court of Canada in Recalma v. the Queen (96 DTC 1520), as confirmed by the Federal Court of Appeal (98 DTC 6238), would be relevant. Although the decision in Recalma placed significant emphasis on the location of the income generating activity that gave rise to investment income, the court identified several other factors including:

? the residence of the taxpayer;
? the origin or location of the capital used to buy the investment;
? the location of the bank branch where the investments were bought;
? the location where the investment income is used;
? the location of the investment instruments;
? the location where the investment income payment is made, and
? the nature of the investments and in particular:

o the residence of the issuer, and
o the location of the issuer's property in the event of a default that could be subject to potential seizure.

The CRA has also indicated that it will consider whether the loans and investments are used for the benefit of Indians on reserves, whether the status Indian investor lives and works on a reserve and whether the capital which the status Indian invests came from an exempt source.

It is possible that income received by a status Indian from a limited partnership that derives its income exclusively from mortgages on real property located on Indian reserves would be tax-exempt based on a connecting factors analysis. However, whether these factors exist in any particular situation would be a question of fact to be determined following a review of all details relevant to the circumstances.

You have also asked about the taxation of monies paid by a reserve-resident general partner of a limited partnership to a reserve-resident status Indian for services rendered to the limited partnership.

If the payment is made to the individual pursuant to an employer-employee relationship (the existence of which would be a question of fact), the situs of the resulting employment income must be ascertained in order to know if it is 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 identified 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. Although not hard and fast rules, 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. Although the Guidelines can be read in their entirety on-line at http://www.cra-arc.gc.ca/aboriginals/guidelines-e.html, the following is a very general summary:

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.

In any particular situation, it would be a question of fact whether the employment income fits within one of the Guidelines.

If no employer/employee relationship exists, the status Indian individual would likely be considered an independent contractor or sole proprietor providing services to a client. The income to the individual would be business income, the taxation of which would be based on the analysis in Southwind, described above. Accordingly, the taxation of such income would depend primarily on whether the income generating activities take place on a reserve and whether the client or customer is located on a reserve. This determination would be 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 Planning Branch