31 March 1995 Internal T.I. 9503330 - INDIANS -- CONNECTION OF INCOME TO RESERVE

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.

The Connection of Income to a Reserve

Presented by E.M. Wheeler at

the inSIGHT Aboriginal Conference:

Tax & Finance 1995
Toronto, Ont., March 31, 1995

Introduction

The decision of the Supreme Court of Canada in the Glenn Williams case, 92 DTC 6320, (1992) 1 CTC 225, has required the Department to review its interpretation of the scope of the exemption from income taxation provided under the Indian Act. This review does not involve a change in law or in departmental policy, but rather a re-examination of the existing law in light of new jurisprudence. Such an exercise is necessary after every significant court case.

Background - Taxation of Indians

By virtue of section 87 of the Indian Act the following property is exempt from taxation, namely:

a)the interest of an Indian or a band in a reserve or surrendered lands; and

b)the personal property of an Indian or band situated on a reserve.

No Indian or band is subject to taxation in respect of ownership, occupation, possession or use of such property.Williams - Identifying The Approach to Determining Whether Property Is On a Reserve.

The Supreme Court's decision in the Glenn Williams case (92 DTC 6320, (1992) 1 CTC 225) rejected the situs of the debtor test (derived from the Nowegijick case, 83 DTC 5041, (1983) CTC 20) as the sole test for determining whether or not a particular property was on a reserve, saying that "any overly rigid test which identified one or two factors as having controlling force ... would be open to manipulation and abuse."

Instead of relying on any single test, the Court recommended the following approach:

• analyze the matter in terms of categories of property and types of taxation;
• identify the various connecting factors (i.e. factors connecting the property to a location on or off a reserve) which are potentially relevant;
• determine the weight to be given the connecting factors in the light of the three considerations:

1. the purpose of the exemption under the Indian Act,
2. the type of property in issue, and
3. the nature of taxation of the property.

Mitchell v. Peguis Indian Band - Clarifying the Purpose of the Indian Act

In Mitchell v. Peguis Indian Band ((1990) 2 SCR 85), the Supreme Court described the purpose of the Indian Act as being the preservation of the entitlements of Indians to their reserve lands and the prevention of their erosion through taxation, but not the conferring of a general economic benefit upon Indians.

La Forest, J. stated that

"... one must guard against ascribing an overly broad purpose to ss. 87 and 89. These provisions are not intended to confer privileges on Indians in respect of any property they may acquire and possess, wherever situated. Rather, their purpose is simply to insulate the property interests of Indians in their reserve lands from the intrusions and interference of the larger society so as to ensure that Indians are not dispossessed of their entitlements."

"Indians have a plenary entitlement to their treaty property; it is owed to them qua Indians. Personal property acquired by Indians in normal business dealings is clearly different; it is simply property anyone else might have acquired, and I can see no reason why in those circumstances Indians should not be treated the same as other people." "Property of that nature will only be protected once it can be established that it is situated on a reserve."

LaForest, J. concluded that

"... Indians, when engaging in the cut and thrust of business dealings in the commercial mainstream are under no illusions that they can expect to compete from a position of privilege with respect to their fellow Canadians."

The Issue

The challenge we face is to determine how to apply the "connecting factors" approach to various types of income. The identification of the various connecting factors is probably the easiest step in the process. The difficulty is in determining the weight to be given the connecting factors in light of the purpose of the exemption under the Indian Act.

A number of cases involving business and investment income of Indians are presently before the Courts. It is expected that these cases will provide assistance in applying the "connecting factors" approach.

CURRENT CASES

BUSINESS INCOME

There have been two relatively recent cases in the Tax Court of Canada on the issue of the application of the exemption from taxation under the Indian Act to business income.

Jacob Pete

The case of Pete (91 DTC 204, (1991) 1 CTC 2001) was heard prior to the decision of the Supreme Court of Canada in Williams. The taxpayer was a consultant who lived off reserve. He kept a small office in his house, but he met with clients at their places of business, which in many cases was on a reserve. He was paid under contracts with Indian bands and other Indian organizations, some of which were located on reserves, and under contracts with the Department of Indian Affairs and Northern Development.

Mr. Pete was assessed by the Department on the basis that his business income was allocable to his "permanent establishment", that is to say, to the off-reserve office, and accordingly the business income was not property situated on a reserve. This approach was based on a long-standing Departmental position set out in Interpretation Bulletin IT-62, dated August 18, 1972.

The Tax Court of Canada rejected this approach and substituted for it the "situs of the debtor" test, relying specifically on the F.C.A. judgement in Williams (90 DTC 6320, (1992) 1 CTC 225). The Department has appealed the T.C.C. decision in Pete to the F.C.A.

Constant Charleson

In the Charleson case (91 DTC 844, (1991) 2 CTC 2236), also decided by the T.C.C. before the Supreme Court of Canada decision in Williams, the taxpayer was an Indian engaged in a commercial fishing business, fishing for salmon, cod and herring. He chartered a boat from an off-reserve corporation, which also provided the requisite fishing licence. He would take the fishing boat to a reserve at the start of the fishing season in order to prepare the fishing nets. His fishing catch was sold to an off-reserve buyer while he was at sea. He and his crew were members of a native fisherman's union. He resided off-reserve, although he lived at his brother's house on a reserve for part of the fishing season. Most of the books and records of his business were kept at his off-reserve residence.

Mr. Charleson was also assessed by the Department in accordance with the "permanent establishment" approach. The Tax Court of Canada noted the rejection of this theory in the Pete case. The Court nevertheless agreed with the Department that the taxpayer was taxable on the income from his fishing business, primarily because the "situs of the debtor" test in this case would site the business income off-reserve, but also because the taxpayer's rights of ownership with respect to the business would not be situated on a reserve. To determine where a business is situated, the Court said that one must consider, amongst other things, where it is carried on, where decisions affecting the business are made and where its books and records are kept.

The taxpayer had appealed this decision to the Federal Court of Appeal, although I understand the appeal has been discontinued.

*****

The Tax Court of Canada has, in two cases, rejected the traditional view of the Department on the scope of the Indian Act exemption from taxation with respect to business income, as set out in Interpretation Bulletin IT-62. Both of these decisions came out prior to the decision of the Supreme Court of Canada in Williams, although perhaps Judge Rip, with his remarks in Charleson on determining where a business is situated, anticipated Williams to some extent.

There is a third case on business income before the Tax Court which will give the Court an opportunity to pronounce on business income in light of the Williams case.

Henry Southwind

In the Southwind case, the taxpayer was an Indian engaged in the logging business as a self-employed, one man operation. He cut logs off reserve under contract to a non-Indian corporation, which was neither located on nor operated on a reserve. The non-Indian corporation took delivery of any logs cut at a road near to the work site, and paid based on weigh scale slips issued by the mill that took delivery of the logs. The taxpayer was paid by a cheque drawn on an off-reserve bank account. Logs were never stored on a reserve. The taxpayer resided on a reserve, except that when he was cutting logs, he would live in a trailer at the work site. The books and records of the taxpayer's business were kept on the reserve and any related paper work, other than the preparation of financial statements, was done by the taxpayer on the reserve. Financial statements were prepared by an off-reserve bookkeeper.

The Department assessed the taxpayer on the basis that his logging income was not exempt under the Indian Act. As the "debtor" in this case is off-reserve, the assessment is consistent with the Tax Court decisions in Pete and Charleson, and given the number and significance of the factors pointing to an off-reserve situs for the logging income, it is also consistent with the Supreme Court's decision in Williams.

The taxpayer has appealed to the Tax Court of Canada. I understand that he is receiving assistance with his appeal from counsel working for the Assembly of First Nations, so the various arguments will be well aired before the Court. The case is expected to be heard this fall.

INVESTMENT INCOME

With respect to investment income, there are two cases on the Tax Court of Canada list which will provide post-Williams guidance from the Court.

James and Helen Minde

Helen and James Minde derived interest income from Ontario Hydro Bonds, Alberta Capital Savings Bonds and Government of Canada Strip Coupons and Treasury Bills. The Mindes state that the monies invested were derived from per capita payments made to them by their band. They have each filed a Notice of Appeal with the Tax Court of Canada.

Arnold Recalma

Arnold Recalma is a registered Indian who derived investment income from Bankers Acceptances. Mr. Recalma earned business income on reserve land and he states that he lives on a reserve. The Bankers Acceptances were issued by the head offices of four chartered banks and were purchased at a branch of a chartered bank located on land leased from an Indian band. The Bankers Acceptances were held in the head office of the bank that sold them. Mr. Recalma has filed a Notice of Appeal with the Tax Court of Canada.

QUESTIONS AND ANSWERS

Re: Proprietorships or Band-operated Businesses

Will the location of the permanent establishment of a business be the sole determining factor in determining if a proprietorship or Band-operated business resides on reserve?

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In the Charleson case (91 DTC 844, (1991) 2 CTC 2236), Rip T.C.J. stated that

"To determine where a business is situated one must consider, amongst other things, where it is carried on, where decisions affecting the business are made and where its books and records are kept."

Thus the location where business activities are carried on is relevant. Consideration was also given in the case to the location where sales were made and the location where money passed between the purchaser and the vendor. The location from where the vendor's products were obtained was also noted.

Charleson stated that a room in a house on a reserve was set aside for him for use as an office; however, it was determined that any books and records of the business on the reserve were there only incidentally.

As stated in the Williams case, which was decided by the Supreme Court after Charleson, it is important to consider all the factors which may "connect" income to a location on or off reserve. It is expected that the Courts will soon provide guidance on this question.

Re: Proration of Business Income

On what basis will Revenue Canada allocate income to an on-reserve permanent establishment where there is more than one permanent establishment? Will Revenue Canada apply different factors on a case-by-case basis OR will the traditional formula used for corporations under Regulation 402(3) be applied? Alternatively, might Revenue Canada use rules that are more in line with those contained in Article VII of the Canada-U.S. Income Tax Convention?

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There is no deeming provision which determines for purposes of the Indian Act exemption how income should be allocated among various locations. In our view, allocations should be determined on a case-by-case basis and should be reasonable in the circumstances.

Normally, expenses should be allocated in the same proportion as revenue unless another allocation could be shown to be more reasonable in the circumstances. Where a portion of income from a business is exempt and the remaining portion is not exempt, the expenses which pertain to the exempt portion are not deductible. In a specific situation, it could be that some expenses pertain entirely to the exempt portion or to the taxable portion, and in that case, a specific allocation of the entire expense to its respective portion would be appropriate.

If an Indian carries on a business and substantially all of the business would be considered exempt but an incidental part of that business could otherwise be considered taxable, the entire income from that business will be exempt. Otherwise, it would be appropriate to prorate the exemption.

Re: Partnerships

What are the (connecting) factors that Revenue Canada will consider in determining whether a Status Indian’s or Band’s income from a partnership resides on-reserve?

One should look at each partner individually to determine whether that partner is exempt with respect to any particular income source. The factors to consider would depend on the facts of a particular situation; the partner's degree of involvement in the partnership's activities would be a factor to consider. Other factors to consider would be similar to those that are relevant to proprietorships.

Re: Allocation of Partnership Income

How would the exemption be allocated in a situation where the partnership has two (or more) permanent establishments - one of which is on-reserve, and the other off-reserve? If the on-reserve permanent establishment is significantly larger than the off-reserve permanent establishment, could it be successfully argued that - because the majority of all profits are derived from on-reserve - that the entire partnership resides on-reserve and, consequently, that all of the income allocated to an Indian partner would be exempt?

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A non-exempt source cannot become an exempt source by simply aggregating the incomes of a business from various locations. An exception to this would be where the income earned off reserve was merely incidental to the income earned on reserve, provided that the different locations were part of the same operation.

Since partners share in all of the income/loss of the partnership, it would generally not be appropriate to allocate exempt income to one partner and taxable income to another partner. Having first determined each partner's share of income, one would then need to consider each partner individually to determine the extent to which their income is connected to a reserve or is not so connected, just as in the case of a sole proprietor.

Re: Employment Income Proration rule

What will Revenue Canada consider as sufficient evidence of on-reserve duties? Will a time sheet or diary suffice (along with addresses of clients/customers)?

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Sufficient records should be maintained so that the total time for duties performed may be properly apportioned between duties performed on reserve and duties performed off reserve. Generally, time sheets or diaries/travel logs which account for an employee's total time and record the names and addresses of clients/customers will be sufficient for the Department.

These remarks are consistent with paragraph 5(b) of Information Circular 78-10R2, which is the Department's general position with respect to books and records. Paragraphs 10 through 12 of Information Circular 73-21R7 and paragraph 5 of Interpretation Bulletin IT-63R4 provide comments on other situations involving record keeping by individuals.

Re: Terminology in Guideline 4

What is meant by the word “exclusively”?

What is meant by the term “for the most part”?

What is meant by the term “commercial activity”?

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These terms are not terms of art with specialized technical meanings. They are intended to carry their ordinary dictionary meanings.

“exclusively” --

The intention of the word "exclusively" is to restrict Guideline 4 to those organizations which are dedicated only to the social, cultural, educational or economic development of Indians living on reserve. It would not be sufficient to have these being only part of an organization's objectives. Guideline 4 is a generous interpretation of the direction provided by the Courts in Williams so it is appropriate to restrict its application to situations that fit squarely within it.

“for the most part” --

One of the requirements of Guideline 4 is that an organization must be dedicated to the development of Indians "who for the most part live on reserves". That is, almost all of the Indians in the population served by the organization must live on reserve.

Guideline 4 recognizes that there will be situations where an Indian works for an organization which is dedicated to the development of Indians on reserves, and the work may require the Indian to live away from the reserve. Although the employee's residence would not be a factor which connects the Indian's employment income to the reserve, it is appropriate under the circumstances laid out in Guideline 4 to recognize a connection since the employee is working for the benefit of Indians on reserve. However, if the population served by the organization was not comprised almost entirely of Indians who live on reserve, this latter connection would not exist.

“commercial activity” --

Even though an organization is operated without a profit motive, it may still be carrying on a commercial operation. The guidance provided by Williams is that the Indian Act was not intended to provide Indians with an economic advantage when dealing in the commercial mainstream. It is recognized that an organization may be dedicated to the economic development of Indians and thereby enable some or all of its employees to be tax-exempt on their employment income. The extent to which an exemption would be available to the employees would depend on the facts of the situation. A commercial activity would generally entail the provision of services or the creation of a product to be provided to others for compensation. On the other hand, an example of a non-commercial activity would be a governmental or quasi-governmental activity.

Re: Indian Living On The Reserve

Has Revenue Canada considered the issue of temporary residences in this regard? In many cases, individuals who are seasonally employed may stay in a camp away from their normal residence. In these cases, will the Indian still be considered to live on-reserve? Conversely, it may be that an Indian living off-reserve goes to work on a seasonal basis and, during that period of time, he/she lives in an on-reserve camp. In this case, will he/she be considered to live on-reserve?

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The term "Indian lives on a reserve" as used in the Guidelines means the Indian lives on the reserve in a domestic establishment that is his or her principal place of residence and that is the centre of his or her daily routine. The fact that an Indian is absent from a reserve for short periods of time because of either the type of employment duties being performed, the distance between the reserve and the location of those duties, or both, does not necessarily mean that the Indian has taken up residence off reserve. It is a question of fact whether, in those circumstances, the Indian continues to live on a reserve. However, the longer the period of absence from the reserve, the more likely it is that the domestic establishment maintained on the reserve is not part of the daily routine of the employee.

Re: Anti-avoidance test

What is the intent of the anti-avoidance comment in the Guidelines? Is it intended to catch situations that might otherwise be normal employment relationships? For example, an individual incorporates a company to carry on a business. The head office and administrative offices are on-reserve and the corporation clearly resides on-reserve. This person’s spouse, who is Status Indian, is the office manager/bookkeeper/secretary, reports to work at the on-reserve office, and performs all employment duties at that location. Because the spouse would most likely have been an employee whether or not the business was incorporated, it would seem that the anti-avoidance test should not apply in this case. Does Revenue Canada agree with this conclusion?

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The anti-avoidance clause is clear. It states that:

"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."

On the basis of the brief facts presented in the example, it appears that the spouse would be exempt on the basis of working on reserve.

Re: Investment Income

In what circumstances will a Status Indian or Band be exempt from income tax in respect of investments, for example:

		Dividends from common or preferred shares
	Income from GICs, term deposits, ordinary bank deposits, or bonds
	Capital gains from the sale of investments or other property
		Income from mutual funds
e. Income from a trust

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There are presently a couple of cases (Minde and Recalma) dealing with investment income which it is hoped will be heard by the Courts in the near future. These cases should clarify what factors are relevant to connect investment income to a location either on or off a reserve, and the weights to be assigned the factors. In addition to the location of the investment property, the residence of the investor may prove to be a relevant factor, as may be the source of funds used to make the investment.

The Courts have noted that "the purposes of the conflict of laws have little or nothing in common with the purposes underlying the Indian Act." "The test for situs under the Indian Act must be constructed according to its purposes, not the purposes of the conflict of laws",1 and so it is not appropriate to simply adopt general conflict of law principles when determining whether investment income is connected to a reserve.

Re: Interpretation

Regarding Revenue Canada’s interpretation of Williams, will this change in light of The Supreme Court of Canada’s decision in Corporation Notre Dame de Bon Secours?

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No.

The case of Corporation Notre-Dame de Bon-Secours v. CUQ et al, 95 DTC 5017, concerned the scope of an exemption under the Quebec Act Respecting Municipal Taxation. The Supreme Court makes comments in the case regarding the rules of interpretation of taxing statutes.

The case applies the modern rule for the construction of taxing statutes which has been developing since Stubart Investments Ltd. v. Her Majesty The Queen, 84 DTC 6305, (1984) CTC 294. The case sets out a useful summary of the present state of the jurisprudence. It describes a purposive (teleological) approach to the interpretation of taxing statutes.

The purpose of the exemptions from taxation and seizure under the Indian Act was established by the Supreme Court of Canada in Mitchell v. Peguis Indian Band ((1990) 2 SCR 85) to be the preservation of the entitlements of Indians to their reserve lands and the prevention of their erosion through taxation, but not the conferring of a general economic benefit upon Indians. In Williams (92 DTC 6320, (1992) 1 CTC 225), the Supreme Court described the analytic approach to be taken to the application of these exemptions.

The Department has followed the guidance provided by the Supreme Court of Canada. The Indian Act Exemption for Employment Income Guidelines apply the Williams decision in a fair and liberal manner consistent with the Supreme Court's decision.

Re: Not-for-Profit Organizations

The Federal Court Trial Division in Gull Bay Development Corp. v. The Queen considered that the earning of profits by a corporation would not cause it to lose its non-profit status where those profits were used for certain specified purposes. What purposes, in Revenue Canada’s view, would satisfy this test? Would promoting the welfare, or economic development, of the Band be a sufficient purpose?

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Paragraph 149(1)(l) of the Act contemplates that an organization may carry on income generating activities and earn income and still qualify for exempt status where there is a causal relationship between the profit making activity and the exempt purpose of the organization. It is a question of fact whether such a relationship exists.

To be tax-exempt, an organization must be both organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit. Explanations of these purposes can be found in Interpretation Bulletin IT-496 (Non-Profit Organizations), paragraph 5.

Re: Operating Not-for-Profit Organizations

The test imposed by paragraph 149(1)(l) of the Income Tax Act requires that a non-profit organization be operated exclusively for any purpose except profit. This language would seem to suggest that the operation for profit for even one day would cause the organization to lose its non-profit status. What is Revenue Canada’s position on meeting the non-profit test on an ongoing basis?

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Paragraph 149(1)(l) of the Act contemplates that an organization may carry on income generating activities and earn income and still qualify for exempt status where there is a causal relationship between the profit making activity and the exempt purpose of the organization. It is a question of fact whether such a relationship exists.

Paragraph 149(1)(l) is a test that applies to an organization throughout each year. It may pass one year and fail another year. Although an organization may be organized as a non-profit organization, it might not operate as such in a particular taxation year. This information, however, can only be obtained by reviewing all of its activities for that year. Such a determination cannot be made in advance of or during a particular year but only after the end of the year.

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¹ Glenn Williams v. Her Majesty the Queen, 92 DTC 6320, [1992] 1 CTC 225.