17 April 1998 Internal T.I. 9713737 - INDIAN ACT EXEMPTION - G2 - SHAREHOLDER LOAN

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:

(1) Whether employment income from wholly owned corporation is taxable in the hands of a status Indian working off reserve but living on reserve? Corporation's head office is on reserve; its XXXXXXXXXX operation is carried on off reserve.

(2) Whether, in the same set up as (1), loans will be taxable in the Indian's hands?

Position:

(1) Guideline 2 will exempt income from taxation provided the usual conditions for its application are met.

(2) The loans can be exempt if they were granted to the Indian as an employee, since his employment income could be exempt by virtue of Guideline 2. However, if they were granted to him in his capacity as a shareholder, then the tax treatment is the same as interest income and connecting factors similar as those used in Recalma must be used. Since the services rendered by the corporation in view of earning its income were performed off reserve, the loans granted from these profits to the shareholders would be taxable. It is a question of fact as to whether a loan is granted to a person in his capacity as an employee or a shareholder.

Reasons:

(1) Guideline 2 applies to Indians who live on reserve and work for an employer which also resides on reserve.

(2) Loans can be treated as employment income if granted to an employee or as investment income if granted to a shareholder. Based on Recalma, when they are assimilated to investment income, a connecting factor such as the location where the services are rendered by the corporation in view of earning the income from which it made the loans becomes relevant.

		April 17, 1998

	Brian Watkins	HEADQUARTERS
	Halifax T.S.O.	P.-A. Sarrazin
(613) 957-8984
		7-971373

Indian Act Exemption for Employment Income

This is in reply to your correspondence of May 22, 1997, concerning the application of the above-mentioned tax exemption. We are replying directly to you so that you can make the necessary determinations of fact required to answer the client's queries.

In his letter, the client's representative mentions that his clients, XXXXXXXXXX status Indian XXXXXXXXXX, own a corporation which operates a XXXXXXXXXX concession off reserve. All XXXXXXXXXX are employees and shareholders of the corporation and live on the XXXXXXXXXX Reserve. The head office of the company is also located on reserve.

We were asked to determine whether the corporation is taxable, whether it is required to file T2 returns, whether the remuneration from the corporation is taxable in the status Indians' hands and if not, whether this remuneration is deductible to the corporation, whether shareholder loans are taxable in these circumstances and whether the corporation is required to charge and pay HST on its sales or purchases.

Our Comments

Paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act provide a tax exemption for the personal property of an Indian or band situated on a reserve. Since a corporation is not an "Indian" or "band", as defined in the Indian Act, it does not qualify for this exemption. Therefore, a corporation will be taxable on its income unless otherwise exempt from taxation under another provision of the Act.

Since the corporation is a separate entity, it must also pay the Goods and Services Tax (GST) or the Harmonised Sales Tax (HST) on its purchases of taxable goods and services. If the corporation is registered for GST/HST, it will be eligible to claim input tax credits for the GST/HST paid or payable on purchases to the extent that the goods or services were acquired for commercial activity.

As the corporation is a GST/HST registrant involved in commercial activity, it will charge GST/HST on its sales and rentals. If these supplies take place outside the participating provinces of Nova Scotia, New Brunswick and Newfoundland, the supplies will be subject to tax at 7%. If the supplies take place in Nova Scotia or another participating province, these supplies will be subject to tax at 15%.

However, as referred to above, purchases made by individual Indians from businesses located on a reserve are relieved of tax. As well, goods purchased off reserve by an Indian individual and delivered to a reserve by the vendor or vendor's agent are also relieved of tax. Vendors must retain proof that the sale was made to an Indian or an Indian band or a band empowered entity. In addition, vendors who are situated off reserve must also maintain proof that property acquired by Indian customers is delivered to a reserve.

The Courts have determined that employment income is personal property. Therefore, what must be determined is whether the employment income is situated on a reserve. The approach adopted by the Supreme Court of Canada in the case of Williams v. The Queen, 92 DTC 6320, requires the examination of all factors connecting income to a reserve to determine if the income is situated on the reserve.

Based on the guidance provided in Williams and after receiving representations from interested Indian groups and individuals, the Department identified a number of connecting factors that can be used to determine whether employment income is situated on a reserve. With a view to assisting the Indian community, the Department developed the Indian Act Exemption for Employment Income Guidelines (the "Guidelines"), incorporating the various connecting factors that describe the employment situations covered by the Indian Act. We have enclosed a copy of the Guidelines for your information.

Based on the information provided in the client's letter, it appears that Guideline 2 may be applicable to the above situation. Please note that Guideline 2 requires a) that the employer is resident on a reserve; and b) that the Indian is resident on a reserve. Both these elements must be satisfied in order for Guideline 2 to apply.

The term "employer is resident on a reserve" means that the reserve is the place where the central management and control over the employer organization is actually located. The central management and control of an organization is usually considered to be exercised by the group that performs the function of a board of directors of the organization. However, it may be that the real management and control of an organization is exercised by some other person or group. Generally, management and control is exercised at the principal place of business, but it is recognized that this function may be legitimately exercised in a place other than the principal administrative office of the organization. Where an organization, which would otherwise not be considered to be resident on reserve, is asserting that it satisfies the definition because it holds its board of directors meetings on reserve, it should generally be considered to satisfy the definition where management and control over the organization is legitimately exercised during those meetings. As regards Guideline 2, the Tax Services Office is in a better position to determine whether an employer is resident on a reserve and whether an Indian employee lives on a reserve.

Provided the remuneration paid out by the corporation would otherwise be deductible, the fact that this remuneration would be tax exempt for the Indian employee does not impact on the deductibility of the corporation's expense.

With respect to the loans, it must be determined whether they were granted to the Indian shareholders/employees in their capacity as shareholders or employees. It is a question of fact whether shareholder loans to shareholders/employees are granted by virtue of employment or by virtue of shareholding. These questions of fact are better resolved by the Tax Services Offices.

If it can be determined that the loans were granted by virtue of employment, then the tax treatment of any income inclusion relating to the loans should be similar to that accorded to employment income.

If it can be determined that the loans were granted by virtue of shareholding, then the tax treatment of any income inclusion relating to the loans should be similar to that accorded to investment income. The leading case on investment income earned by a status Indian is that of Arnold, Laura and R. Mark Recalma v. Her Majesty the Queen, 96 DTC 1520. In Recalma, the court considered the taxability of income earned by an Indian living on reserve, from investments purchased from an on reserve branch of a bank. It should be noted that the nature of the property in question was the income from the investments and not the investments themselves. The court had to determine if the investment income was situated on the reserve. This determination required a review of all relevant connecting factors and consideration as to how much weight should be given to each factor. The following were considered in determining the situs of the investment income:

a) the residence of the taxpayer;

b) the origin or location of the capital used to buy the securities;

c) the location of the bank branch where the securities were bought;

d) the location where the investment income is used;

e) the location of the investment instruments;

f) the location where the investment income payment is made; and

g) the nature of the securities and in particular:

(i) the residence of the issuer;

(ii) the location of the issuer's income generating activity from which the investment is made, and

(iii) the location of the issuer's property in the event of a default that could be subject to potential seizure.

While the court considered all of these factors it placed considerable weight on (g)(ii), the location of the income generating activity of the issuer of the securities. In Recalma, the income in question was interest from banker's acceptances and income from mutual fund units. Basically the court concluded that income from these investments started with companies off the reserve and was passed through a bank on reserve to the taxpayers. It was held that the investment income of the taxpayer was not personal property situated on a reserve. The court concluded that in making these investments the taxpayers chose to invest in the economic mainstream of normal business conducted off the reserve. The Federal Court of Appeal confirmed this decision in March 1998.

Applying Recalma to this case, in our view, since the income generating activity which allowed the corporation to be in a position to make shareholder loans was performed off reserve, i.e., in the economic mainstream, then any income of the shareholders due to shareholder loans is taxable in the Indians' hands.

It is a question of fact whether the requirements of any particular Guideline are satisfied and the Tax Services Offices are better able to resolve these questions of fact.

Roberta Albert, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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