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: 1. How to calculate the Indian Act income tax exemption when the pension becomes payable?
2. How to calculate the Indian Act income tax exemption when the public service career includes a period of pensionable leave without pay (LWOP)?
Position: 1. If a portion of the individual’s employment income was exempt, then a similar portion of the related registered pension plan benefits will be exempt from income tax.
2. Where there is no related employment income earned during a period of pensionable LWOP, it is reasonable to consider the tax treatment of the employment income received immediately prior to commencement of the pensionable LWOP to determine the tax-exempt percentage that should be applied to the deemed employment income.
Reasons: 1. According to our general position, income that is ancillary to employment income, such as pension plan benefits, is treated in the same way as the employment income itself.
2. Prior interpretative position.
XXXXXXXXXX
2021-088912
A. Mahendran
April 26, 2022
Dear XXXXXXXXXX:
Re: Pension benefits and the exemption from income tax under the Indian Act
This is in response to your request for our comments on the appropriate method of calculating the amount of pension income that is exempt from income tax under section 87 of the Indian Act. Specifically, you have asked for our comments in situations where the employment income that gave rise to the pension benefit was not fully exempt under section 87 of the Indian Act or where the individual’s years of service includes a period(s) of leave without pay (LWOP).
You stated that under the Federal Public Service Superannuation Act, LWOP automatically counts as pensionable service. An individual does not have to buy back the service, but they are required to pay the contributions they would have paid had they not been on LWOP. Those contributions are based on deemed earnings, that is, earnings they would have earned had they not been on LWOP.
Our comments
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.
The employment income of an individual who is registered or entitled to be registered under the Indian Act, is exempt from income tax under paragraph 81(1)(a) of the Income Tax Act and section 87 of the Indian Act, only if the income is situated on a reserve. The courts have established that determining whether income is situated on a reserve, and thus exempt from tax, requires identifying the various factors connecting the income to a reserve and weighing the significance of each factor. This is referred to as the “connecting factors test”.
To simplify the application of this connecting factors test with respect to common employment situations, the Canada Revenue Agency (CRA) together with interested First Nations organizations, developed the Indian Act Employment Income Guidelines (footnote 1) (the “Guidelines”).
Both the Guidelines and the CRA webpage entitled “Information on the tax exemption under section 87 of the Indian Act” (footnote 2) confirm that the Indian Act tax exemption applies to pension benefits in the same manner as the employment income that gave rise to the benefits.
It is the CRA’s long-standing position that in determining the amount of pension benefits that is exempt from income tax under section 87 of the Indian Act, it is reasonable to consider the tax treatment of the employment income received during the period in which pension contributions were made or pension benefits accrued (pensionable years of service). In other words, if the individual’s employment income during that period was 100% exempt from income tax under the Indian Act, then 100% of the pension benefits will also be exempt. If part of the employment income was exempt, any pension benefits arising from that exempt employment income will also be exempt from income tax. For example, if the individual’s employment income was 50% exempt, then only 50% of the pension benefits will be exempt.
Where an individual has had different percentages of exempt employment income either in a year or during their pensionable years of service, it is the CRA’s long-standing position that reference must be made to the taxability of employment income in each year of employment during the individual’s pensionable years of service to determine the amount of pension benefits that is exempt from income tax.
Where there is no actual employment income earned during a year that is included in the individual’s pensionable years of service (e.g., pensionable LWOP), it is reasonable to consider the tax treatment of the employment income received immediately prior to commencement of the LWOP to determine the exempt portion of the deemed employment income during the pensionable LWOP. For example, if an individual’s actual employment income was 20% tax-exempt immediately before they commenced their pensionable LWOP, then this percentage would also apply to the deemed employment income during the pensionable LWOP.
The CRA recognizes that these calculations can be complex, and generally accepts any reasonable method of calculation that is based on CRA’s position outlined in the Guidelines and on its webpage referenced above. Based on our review of your examples, your calculations appear reasonable and appropriate in calculating the amount of pension benefits exempt from income tax under the Indian Act. Should you require further assistance, please contact Stephen O’Kane, Manager, Individuals Compliance Directorate, Collections and Verification Branch at Stephen.O’Kane@cra-arc.gc.ca.
We trust these comments will be of assistance.
Yours truly,
Ms. Nerill Thomas-Wilkinson, CPA, CA
Manager
Non-Profit Organizations and Indigenous Issues Section
Business and Employment Income Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 https://www.canada.ca/en/revenue-agency/services/indigenous-peoples/indian-act-exemption-employment-income-guidelines.html
2 https://www.canada.ca/en/revenue-agency/services/indigenous-peoples/information-indians.html
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