25 October 1999 Income Tax Severed Letter 9917666 - STATUS INDIANS - EXEMPTION

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. Is the income earned in the estate of a status Indian exempt from tax?

2. Once the estate's income has been distributed to a status Indian beneficiary, is this income and future income taxable in her hands?

3. If the rental income received by the estate is from a source located on reserve lands, is it exempt from tax in the estate's hands? In a status Indian beneficiary's hands?

Position:
1. No.
2. Generally, taxable.
3. The estate's rental income is taxable.  Rental income from a source on reserve 	earned 	by the status Indian would be exempt from tax.

Reasons:

1. A trust is not an Indian and, consequently, is not itself exempt from taxation pursuant to section 87 of the Indian.

2. Interest income is generated off reserve and is considered to be earned in the economic mainstream and therefore not tax exempt. The rental income earned on lands located off reserve cannot be situated on reserve for purposes of section 87 of the Indian Act.

3. A trust is not an Indian and, consequently, is not itself exempt from taxation pursuant to section 87 of the Indian. Rental income earned from the rental of lands located on reserve, would be exempt from taxation if paid or payable to a status Indian beneficiary who lived on reserve.

		October 25, 1999

Individual returns and Payments HEADQUARTERS
Processing Directorate Karen Power, CA
Assessment and Collections Branch
Vanier, Tower C

	Attention:  Brian Watkins
		1999-000220

Status Indians

We are writing in reply to your correspondence of June 22, 1999, concerning the taxation of income received by a status Indian in the following situation.

Our understanding of the facts is as follows:

a) An individual taxpayer, "Mrs. A", is the executrix of the estate of XXXXXXXXXX. Mrs. A is a status Indian living on reserve and is also a beneficiary of the estate. The administration of the estate takes place on reserve.

b) XXXXXXXXXX was a status Indian, however, his income was not exempt from income tax.

c) The income the estate receives is from Canadian sources (interest and rental) and is generated off reserve.

d) All of the income the estate received has been transferred directly to the beneficiaries.

You have asked the following questions relating to the above situation:

1. Is the income earned in the estate exempt from tax?

2. Once the income has been distributed to Mrs. A, is this income and future income taxable in her hands?

3. If the rental income received by the estate is from a source located on reserve lands, is it exempt from tax in the estate's hands? In Mrs. A's hands?

Our Comments

Question #1:

Paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act establish the Indian exemption from taxation. Section 87 of the Indian Act exempts from taxation the personal property of an Indian situated on reserve. A trust is not an Indian and, consequently, is not itself exempt from taxation pursuant to section 87 of the Indian Act.

Generally, when an individual dies an estate is created on the day the person dies. Under the Act, an estate whether testate or intestate, is considered to be a trust and is subject to all the taxation rules which apply to trusts. An estate arising as a consequence of the death of an individual is taxed as a testamentary trust for income tax purposes. The terms of the trust are established by the will, by law where there is no will, or by court order.

As the estate is taxed as a trust for income tax purposes and a trust is not an Indian, any income earned in the trust is subject to income tax. However, paragraph 104(6)(b) of the Act provides that a trust (other than an employee trust or a trust governed by an employee benefit plan) may deduct in computing its income for a taxation year an amount not exceeding the amount which would be its income for the year as became payable in the year to a beneficiary. Paragraph 104(13)(a) of the Act requires the beneficiary to include in income the amount that would be the trust's income, but for subsection 104(6), that became payable to the beneficiary. Finally, subsection 104(24) deems an amount to be payable for these purposes if it was paid or the beneficiary was entitled to enforce payment in the year. Thus, if all of the estate's income becomes payable to beneficiaries in the year, the estate will pay no income taxes as it will not have any income.

Question #2:

As discussed in question #1, if the estate's income is made payable to the beneficiaries, paragraph 104(13)(a) of the Act requires the beneficiary to include in income the amount that would be the trust's income. Therefore, the interest and rental income which is made payable to the beneficiaries will be taxed in their hands.

Interest Income

In determining whether the income earned by an Indian is situated on reserve, and thus exempt from taxation, the approach taken by the Supreme Court of Canada in the 1992 case of Glenn Williams v. Her Majesty the Queen (92 DTC 6320) is followed. This approach requires the examination of all factors connecting income to a reserve to determine if the income is located on the reserve. The Supreme Court also 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 general direction provided in Williams was that "an overly rigid test which identified one or two factors as having controlling force ... would be open to manipulation and abuse". The Supreme Court rejected the situs of the debtor test as the sole test for determining whether the personal property of an Indian or band was situated on a reserve.

Based on Williams, in our view, the location of a savings account on reserve would not, in itself, be sufficient to exempt the interest income earned thereon. Where a bank account is considered to be situated at a location on reserve, this is one factor to weigh in determining whether interest earned on deposits in that account is exempt from taxation. There could be other factors that would connect the income to a location off reserve.

In Recalma (98 DTC 6238), the Federal Court of Appeal confirmed the decision of the Tax Court (96 DTC 1520). 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 reserve.

Based on the Recalma decision, it is necessary to determine the location of the issuer's income generating activity of the investment instrument. In our view, the income stream from most term deposits and savings accounts acquired from a financial institution located on reserve cannot be related to a reserve with certainty. As such income may be generated off the reserve or by non-Indians, it would be considered to be earned in the normal economic mainstream and, accordingly, not considered personal property situated on a reserve. In our view, unless the income can be identified as exclusively generated on the reserve, the income is not exempt from tax.

In our view, the interest received by a status Indian beneficiary in the above situation, would not be exempt from taxation. Any future income generated from savings accounts located on reserve would also be subject to taxation.

Property Income

As discussed above, in determining whether income is situated on reserve, the approach taken by the Supreme Court of Canada in the Williams case must be followed. This approach requires the examination of all factors connecting income to a reserve to determine if the income is located on the reserve. In our view, the rental income earned on lands located off reserve cannot be situated on reserve and, thus, would be subject to taxation in the hands of a status Indian beneficiary.

Question #3:

As discussed in question #1, a trust is not an Indian and, consequently, is not itself exempt from taxation pursuant to section 87 of the Indian. In our view, rental income received by the estate from a source located on reserve lands will be taxable to the estate.

However, if this rental income is made payable in the year to a status Indian beneficiary resident on a reserve, in our view, that rental income earned from the rental of lands located on reserve, would be exempt from taxation.

We have not been provided with many details of this situation. Accordingly, we have provided comments based on our understanding of the general situation. Should you require further comments regarding other trust issues, please do not hesitate to contact our office.

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