6 August 1997 External T.I. 9426255 - INDIAN EXEMPTION SELF-EMPLOYED BUSINESS CONSULTANT

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Taxation of business income earned by a self-employed status Indian.

Position:

General comments provided.

Reasons:

With respect to business income of a consultant, two significant factors to consider are:

1. The place where the revenue-generating consulting services are provided, and

2. the location of the residence of the customers. The residence of the self-employed Indian and presumably the location of the office on reserve carry little weight .

R. Albert
XXXXXXXXXX 942625

August 6, 1997

Dear Sir:

Self-employed Income Earned by a Status Indian

We are writing in response to your request of June 28, 1994, for our comments regarding the taxation of income earned by a self-employed status Indian. You have provided the following scenario: the Indian lives on reserve and is self-employed as a consultant for the oil industry. We understand that all revenue-generating activities are conducted off reserve and that the customers are located off reserve. We also understand that you consider that the office of the business is on reserve. You have asked whether the status Indian's self-employment income will be exempt under the Indian Act and whether our response would be different if the activity was undertaken via a corporation.

Our comments

We apologize for the unavoidable delay that has been encountered in replying to your request. In light of the decision of the Supreme Court of Canada in Williams v. Her Majesty the Queen (92 DTC 6320), the Department has had to review its interpretation of the scope of the exemption from income taxation provided under the Indian Act. In addition, the scenario which you set out is quite specific and if it relates to an actual situation it should be addressed to your local tax service office. As explained in Information Circular 70-6R3 dated December 30, 1996, assurance as to the tax consequences of proposed transactions is provided by the Rulings Directorate but only on an advance income tax rulings basis and only with respect to the taxpayers identified in such rulings. However, we are able to provide the following comments.

Section 87 of the Indian Act, along with paragraph 81(1)(a) of the Income Tax Act (the "Act"), establish the Indian exemption from taxation. Section 87 of the Indian Act exempts from taxation the personal property of an Indian situated on a reserve, and the courts have previously concluded that the reference to personal property in section 87 includes income. In determining whether income is situated on a reserve, the approach taken by the Supreme Court in the case of Williams must be followed. The proper approach to determining the situs of personal property is to evaluate the various connecting factors that tie the property to one location or another. The Supreme Court indicated that the ultimate question is to determine to what extent each connecting factor is relevant in determining whether taxing the particular kind of property in a particular manner would erode the entitlement of an Indian to personal property situated on a reserve.

One significant factor that serves to connect business income to a location on or off reserve is the location where the revenue-generating activities of the business are undertaken. Another significant factor is the location of the business customers. In a situation where all of an Indian's business income is derived from activities carried on off reserve for customers located off reserve, such as that described in the scenario above, the business income would generally not be exempt from taxation. If a portion of the business activities are carried out on reserve, a similar portion of the business income would generally be exempt. While there may be some administrative activities carried out on reserve, it is our view that the actual revenue generating activities would be more significant in determining whether business income is connected to a reserve. For example, if a bookkeeper were employed to maintain the books and records in an on reserve office of a self-employed Indian who performed all of the actual revenue-generating activities off reserve, the business income would be more connected to a location off reserve than it would be to a location on reserve.

Since a corporation is not an Indian, section 87 of the Indian Act does not provide an exemption and income earned by a corporation wholly-owned by a status Indian would be taxable. If a corporation is resident on a reserve and a status Indian employee is resident on a reserve, in normal circumstances, Guideline 2 of the Indian Act Exemption for Employment Income Guidelines (the "Guidelines") would exempt any employment income earned by the employee. A copy of the Guidelines are attached. As to the payment of bonuses by corporations, the Department has had a long-standing practice of not challenging the reasonableness of salaries or bonuses paid to a principal shareholder who is active in the corporation's business where the corporation has established either a practice of distributing profits to such shareholder/employee in this manner or a policy of declaring bonuses to shareholders to remunerate them for the profits the corporation has earned that, in fact, are attributable to special know-how or skills of the shareholder/employee. This position was adopted largely for administrative ease and because the overall tax effect did not vary significantly whether the corporate profits were drawn out as salaries or as dividends. However, as stated at the 1991 Canadian Tax Conference Round Table, that practice does not extend to various scenarios that could result in inappropriate tax consequences. For instance, the practice does not apply to remuneration paid to spouses of the shareholder nor to shareholders who are non-residents. Where a shareholder/employee lives on reserve and is exempt from tax on employment income from a corporation based on reserve, it would be a question of fact as to whether section 67 of the Act would apply to limit the amount which the corporation could deduct for bonuses in computing its income. Section 67 denies the deduction in respect of an expense that is otherwise deductible, except to the extent that the expense was reasonable in the circumstances.

In addition, as noted in the Guidelines, "the Guidelines are not intended to apply when it can reasonably be considered that one of the main purposes for the existence of an employment relationship is to establish a connecting factor between the income in question and a reserve." Although there are many reasons for incorporating a business, we would need to consider the application of this clause to a situation where a long-standing self-employment arrangement is incorporated.

We trust that these comments will be of assistance.

R. Albert
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch