3 December 2024 CTF Roundtable Q. 16, 2024-1038281C6 - Indian Act Tax Exemption for Employment Income and Employees of a Limited Partnership

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 CRA comment regarding both scenarios whether the employment income earned off-reserve by LP’s employees, who are registered under the Indian Act and who live on a reserve, is exempt from tax under section 87 of the Indian Act?

Position: No.

Reasons: Based on our understanding of the connecting factors presented in the two hypothetical scenarios and absent the identification of any other connecting factors, the employment income earned off-reserve by the First Nations employees is not situated on a reserve, regardless of where the employees live and where the employer is resident.

2024 CTF Annual Conference

CRA Round Table

Question 16: Indian Act Tax Exemption for Employment Income and Employees of a Limited Partnership

Consider the two variations of limited partnership arrangements, scenario 1 and scenario 2:

Scenario 1

A limited partnership (FNP) is created by a First Nation band (99.9% interest) and a general partner (a corporation indirectly owned by the First Nation band) (0.1% interest). The FNP is located on a reserve and holds 50.5% of the voting partnership interest in another limited partnership (LP) of which a non-First Nations corporation resident off-reserve (NFNC) holds 48.5% of the voting partnership interest. The general partner of LP is a corporation (GPC) that holds 1% of the voting partnership interest. The common shareholders of the GPC are the FNP (51%) and the NFNC (49%).

The GPC is resident off-reserve and is authorized with full power and authority to administer, manage, control, and operate LP’s business. The NFNC has an operating agreement with the GPC under which the NFNC makes day-to-day operating decisions of LP. However, any decisions about financing, management changes, management compensation, project proposal, and acceptance etc. must be reviewed and approved by the board of the GPC. More than 50% of LP’s business activities are carried on off-reserve. All LP’s offices are located off-reserve except for its registered office which is located on-reserve. Some of the LP’s employees live on-reserve and some live off-reserve. All LP’s employees consider LP’s registered on-reserve office as their reporting office even though less than 50% of their employment duties are performed on-reserve.

Scenario 2

Scenario 2 is essentially the same as scenario 1 except for the following: (1) all the offices of the LP are located off-reserve, and (2) all the employees consider the off-reserve office as their reporting office.

Can CRA comment regarding both scenarios whether the employment income earned off-reserve by LP’s employees, who are registered under the Indian Act and who live on a reserve, is exempt from tax under section 87 of the Indian Act?

CRA Response

Employment income earned by an individual who is registered or entitled to be registered under the Indian Act (a First Nations employee), is exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax 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 income tax, requires identifying the various factors connecting the income to a reserve and weighing the significance of each factor. The weight assigned to each connecting factor is determined by considering the purpose of the exemption, which is to ensure the protection of reserve lands and property on those lands from erosion by the government through taxation; it is not to confer a general economic benefit to First Nations individuals. The type of property in question and the nature of the taxation of the property must also be considered. This is referred to as the “connecting factors test”.

Connecting factors that have been considered and given weight by the courts in employment income situations include:

• the location where the work is performed,
• the residence of the employee,
• the residence of the employer,
• the nature of the services performed, and
• the special circumstances in which they were performed.

Generally, where employment duties are performed on a reserve, the income from that employment is tax-exempt. Conversely, where employment duties are performed off-reserve, the income from that employment is not tax-exempt unless there are other factors connecting the income to a reserve. However, it should be noted that an employee’s on-reserve residence generally will not be given much weight, in and of itself, in connecting their employment income to a reserve.

In the two hypothetical scenarios presented, LP’s business activities are primarily carried on off-reserve, with some activities carried on on-reserve.

Whether LP is the employer and resident on a reserve is a question of fact. However, even if it is determined that LP is the employer and resident on a reserve, the courts (footnote 1) have concluded that such a connecting factor will have minimal weight if the residence of the employer has no tangible significance to the reserve. The courts (footnote 2) have also stated that connections that are artificial should not be given weight in determining if income is situated on a reserve for purposes of the exemption. Generally, the courts (footnote 3) have indicated that weight should be given to an employer’s residence on a reserve only where the scope of the employer's activities on the reserve, or the direct benefits flowing to the reserve, indicate a clear nexus between the employer and the reserve.

Based on our understanding of the two hypothetical scenarios presented, the following factors indicate that there is no clear nexus between LP and the reserve:

• LP’s business activities are primarily carried on off-reserve.
• The day-to-day business decisions of LP are made off-reserve by senior management of a corporation that is not owned by the First Nation and that is resident off-reserve.
• The First Nations employees perform 50% or more of their employment duties off-reserve.
• At least 48.5% of LP’s profits are flowing to a corporation that is not owned by the First Nation and that is resident off-reserve. Further, this corporation will receive a fee for managing the day-to-day operations of the LP and this fee will not benefit the reserve.
• In Scenario 1, LP has its registered office on-reserve, but (as is in Scenario 2) it will conduct its board meetings virtually. All the board of directors except one, will attend the meetings virtually from off-reserve locations.

Consistent with jurisprudence, it is our view that even if LP is determined to be the employer and is resident on a reserve, that factor will likely be given minimal weight in a connecting factors test as there does not appear to be any direct and significant benefits flowing to the reserve from LP’s business activities. Based on our understanding of the connecting factors presented in the two hypothetical scenarios and absent the identification of any other connecting factors, it is our view that the employment income earned off-reserve by the First Nations employees is not situated on a reserve, regardless of where the employees live and where the employer is resident. As a result, section 87 of the Indian Act will not apply to exempt from income tax the employment income earned off-reserve.

Ananthy Mahendran
2024-103828
December 3, 2024

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Shilling v. The Queen, 2001 FCA 178

2 Bastien Estate v. Canada, 2011 SCC 38, and The Queen v. Ronald Robertson and Roger Saunders, 2012 FCA 94

3 Ibid.