21 November 2005 External T.I. 2005-0122181E5 - Employment income earned by a 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.

Principal Issues: Will employment income earned by status Indians employed by a First Nation band be tax exempt where the status Indian employees are then subcontracted to various industries both on and off reserve?

Position: Question of fact

Reasons: Consistent with previous positions and based on the connecting factors test

2005-012218
XXXXXXXXXX Kimberly Duval
(613) 599-6054
November 21, 2005

Dear XXXXXXXXXX:

Re: Employment Income Earned by a Status Indian

This is in response to your letter of March 2, 2005 and subsequent telephone conversations (Duval/XXXXXXXXXX) inquiring as to whether employment income earned by reserve-resident status Indian employees of a First Nation band would be exempt from tax where the services of these employees were then leased to various other industries located both on and off reserve. We apologize for the delay in our response.

The situation outlined in your letter appears to relate to a factual one, involving several individual taxpayers. 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. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.

A status Indian's personal property is exempt from tax pursuant to paragraph 81(1)(a) of the Income Tax Act and section 87 of the Indian Act if that property is situated on a reserve. Although income is personal property, its intangible nature makes it difficult to determine its location. In the case of Williams v. the Queen, the Supreme Court of Canada created the connecting factors test to assist in this determination. The test requires identification of various connecting factors that tie the property to a location either on or off a reserve and a weighing of the significance of each such factor. To simplify applying the connecting factors test to a status Indian's employment income, the CRA developed the Indian Act Exemption for Employment Income Guidelines (the "Guidelines").

The Guidelines can be read in their entirety on-line on our website at http://www.cra-arc.gc.ca/aboriginals/guidelines-e.html, but the following is a very general summary:

Guideline 1 exempts all of the employment 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.

Guideline 2 exempts employment income of status Indian employees who live on reserve provided that the employer is also resident on a reserve. 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 a corporation is usually considered to be exercised by the group that performs the function of a board of directors of the corporation. 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.

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 be an Indian band that has a reserve, or a tribal council representing one or more Indian bands that 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 status 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.

It is important to note that the Guidelines were developed as an administrative tool to assist taxpayers and CRA employees in working with the very broadly worded tax exemption provided by the Indian Act and the Act. As such, they do not necessarily constitute a definitive test as they were designed with the more common employment situations in mind. There may be situations in which income may be taxable even though it appears to fall within one of the Guidelines. Certain unusual or unique situations may have to be examined individually to consider additional connecting factors or the impact of court decisions on the taxation of the employment income in question. This would appear to be the case in the situation you have presented and therefore, it is unlikely that the Guidelines will apply in this situation.

One such recent court decision relevant to your question is the case of Her Majesty the Queen v. Rachel Shilling (2001 DTC 5420), which dealt with an employee leasing arrangement, whereby an individual who lived and worked off reserve was employed by an on-reserve employment agency. In this case, the Federal Court of Appeal concluded that the employment income at issue was not exempt from tax under section 87 of the Indian Act, as significant connecting factors pointed to an off-reserve location for the income. The court held that although Indians are entitled to tax-planning arrangements, similar to any other Canadian taxpayer, contracting with an on-reserve employer will only be given limited weight as a connecting factor in the absence of evidence or other connecting factors that would support giving this factor significant weight.

As a result, in doing a connecting factors analysis, it is our view that a leasing arrangement with an on-reserve employer will generally not be sufficient by itself to render the employment income exempt from tax under section 87 of the Indian Act. However, a connecting factors analysis of each individual situation would be required in order to definitely determine the tax treatment of any employment income earned.

Finally, in the event the status Indian individual is found to be an independent contractor as opposed to an employee of the First Nation band, the Guidelines would be irrelevant in the circumstances and the connecting factors test would be applied. Please refer to the CRA's policy with respect to this determination in our publication entitled "RC4110 - Employee or Self-Employed".

We trust that these comments will be of assistance.

Yours truly,

John Oulton, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Planning Branch