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 apply the Indian Act tax exemption to the income received by a First Nations employee who is on paid sick leave or paid suspension leave?
2. How are the Indian Act Exemption for Employment Income Guidelines applied where a First Nations employee’s circumstances changes during a taxation year and the employee’s suspension leave straddles two taxation years?
Position: 1. Income replacement benefits received while on paid sick leave (i.e., wage-loss replacement plan benefits) are benefits received from employment (i.e., employment-related income) and are treated in the same way as the employment income (i.e., wages and salary) that gave rise to the particular benefits. Income received while on paid suspension leave will be exempt from income tax under the Indian Act on the basis of whether the income is situated on a reserve (that is, whether Guidelines apply during the period of suspension).
2.Where there is a change in an employee’s circumstances, the percentage of days worked on a reserve will be calculated separately based on the number of days worked in each period before and after the change.
Reasons: 1. Both the CRA webpage entitled “Information on the tax exemption under section 87 of the Indian Act” and the Indian Act Exemption for Employment Income Guidelines confirm that wage-loss replacement plan benefits (i.e., paid sick leave) are treated in the same way as the employment income that gave rise to the particular benefits. Consistent with prior interpretations, income received while on paid suspension leave will be exempt from income tax under the Indian Act on the basis of whether the income is situated on a reserve (that is, whether Guidelines apply during the period of suspension).
2. Prior interpretations - E2016-065965 XXXXXXXXXX.
Assistant Research Officer Business and Employment Division
Indigenous Affairs Section Income Tax Rulings Directorate
Federal, Indigenous and Quebec Affairs Division Ananthy Mahendran
Service, Innovation, and Integration Branch
Attention: Wynn Coates 2021-090148
SUBJECT: Tax treatment of income received by a First Nations employee while on paid sick leave or paid suspension leave
This is in response to your enquiry dated March 9, 2021, regarding the tax treatment of pay received by First Nations employees who are on long-term paid absences from work. Specifically, you have asked how to apply the Indian Act tax exemption to a First Nations employee who is on paid sick leave or paid suspension leave for an extended period. Further, the First Nations employees are registered under the Indian Act, and both the employees and their employer reside off-reserve.
Unless otherwise stated, all statutory references herein are to the Income Tax Act (Canada).
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) 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”).
Tax treatment of paid sick leave
Paragraph 6(1)(f) includes in employment income benefits received from an employer-funded group sickness or accident insurance plan that provides periodic payments as compensation for the loss of employment income. These plans are often referred to as wage-loss replacement plans. The amounts are included in the employee's income net of any contributions made by the employee. Accordingly, paid sick leave received by an employee is included in employment income under paragraph 6(1)(f) and is taxable unless it is exempt from tax under another provision of the Act.
Both the CRA webpage entitled “Information on the tax exemption under section 87 of the Indian Act” (footnote 2) and the Guidelines confirm that the Indian Act tax exemption applies to wage-loss replacement plan benefits (e.g., paid sick leave such as disability, maternity, etc.) in the same manner as the employment income (i.e., wages and salary) that gave rise to the particular benefit. It is our long-standing position (footnote 3) that where there is a service period relevant to the determination of the benefit received, it is reasonable to consider the tax treatment of the employment income received during that service period to determine the portion of benefits received that is exempt from income tax under the Indian Act. In other words, if the individual’s employment income during that period was 100% exempt from income tax under section 87 of the Indian Act, then 100% of the benefits will also be exempt. If part of the employment income was exempt, any benefits received 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 benefits will be exempt.
On the other hand, where there is no service period particularly relevant to the determination of the benefit received, it is reasonable to consider the tax treatment of the employment income received immediately prior to commencement of benefits being received to determine the exempt portion of the benefits received.
Tax treatment of paid suspension leave
Section 5 includes in employment income salary, wages, and other remuneration received in the year. Accordingly, pay received by an employee while suspended is included in income under section 5 unless it is exempt from tax under another provision of the Act.
The wages or salary received by an employee who is registered or entitled to be registered under the Indian Act is exempt from tax under section 87 of the Indian Act if the wages or salary is situated on a reserve. Generally, if one of the Guidelines apply to the wages or salary received during the period of suspension, then it will be exempt from tax. This is consistent with our previously published positions (see 2005-0149181E5 and 9705315(E)).
In the situation you described, a First Nations employee was suspended with pay from their duties of employment with the XXXXXXXXXX (the “Employer”). The Employer does not reside on a reserve. Since the employee did not perform any employment duties on a reserve during the period of suspension, Guideline 1 and Guideline 3 will not apply to exempt all or part of the pay they received during that period. Furthermore, Guideline 2 and Guideline 4 will not apply to exempt the pay during the period of suspension leave, since the Employer is not resident on a reserve. Accordingly, pay received by a First Nations employee during a period of suspension from an employer that is not resident on a reserve, is not exempt from tax under section 87 of the Indian Act.
The tax treatment of paid suspension leave is different than the tax treatment of paid sick leave situations (discussed above) even though no employment duties are performed in all situations. In the latter situations, the nature of the absence is such that the paid leave is generally tied to prior employment and the related employment income received during that prior employment. As a result, the tax treatment of the related employment income will determine the tax treatment of the paid sick leave received. As such, it is not necessary to apply the Guidelines at the time the paid sick leave is received to determine if it is exempt under the Indian Act. Paid suspension leave received during a period of suspension has no such nexus. Therefore, it is our view that the Guidelines must be applied at the time the paid suspension leave is received in order to determine if it is exempt from tax under the Indian Act. In particular, unless both the employee and the employer reside on a reserve, there is no significant connecting factor that would situate the paid suspension leave on a reserve.
Application of Indian Act exemption where there is a change in an employee’s circumstances
Form TD1-IN, Determination of Exemption of an Indian’s Employment Income, reflects the Guidelines and it is used to help determine whether the employment income of a First Nations employee is exempt from income tax under the Indian Act. The instructions for completing Form TD1-IN state that where an employee’s employment or personal circumstances change, the employee is required to complete a new Form TD1-IN. Whether there has been a change in an employee’s circumstances that requires completion of a new Form TD1-IN is a question of fact. Generally, a change in an employee’s circumstances is considered to take place when there is a change that impacts the application of the Guidelines.
It is our position that where a change in an employee’s circumstances warrants a new Form TD1-IN to be completed, the calculation of the number of days worked on a reserve throughout the year for purposes of applying the Guidelines (for example, the proration rule), is based on the number of days during the period that the relevant Form TD1-IN is applicable. In other words, the periods before and after the change should be treated as different periods for the purposes of applying the Guidelines. Therefore, the percentage of days worked on a reserve will be calculated separately based on the number of days worked in each period before and after the change.
EXAMPLE
Employee A is registered under the Indian Act and lives off-reserve. She works for ABC Ltd. that is not resident on a reserve.
January 1, 2019 – August 31, 2019
Employee A performed all of her employment duties on a reserve.
September 1, 2019 – August 31, 2020
Employee A was suspended with pay until August 31, 2020. She continued to receive her salary and benefits from ABC Ltd.
January 1, 2020
Employee A became resident on a reserve effective January 1, 2020.
September 1, 2020 – December 31, 2020
Employee A’s suspension ended and she started to perform all of her employment duties on a reserve from September 1, 2020.
Application of the Guidelines to each period
The regular salary received from January 1, 2019 to August 31, 2019, would be exempt from tax under Guideline 1 since 100% of Employee A’s employment duties were performed on a reserve.
The paid suspension leave received from September 1, 2019 to December 31, 2019, would be taxable since none of the Guidelines applied during this period as Employee A did not perform any employment duties on a reserve.
Although Employee A resided on a reserve starting January 1, 2020, she did not perform any employment duties on a reserve and her employer was not resident on a reserve. Therefore, the paid suspension leave received from January 1, 2020 to August 31, 2020, would also be taxable.
The regular pay received from September 1, 2020 to December 31, 2020, would be exempt from tax under Guideline 1 because Employee A performed a 100% of her employment duties on a reserve.
Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure.
We trust these comments will be of assistance to you.
Yours truly,
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
3 2004-0065811E5
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