26 March 1998 External T.I. E9705955 - INTEREST FROM RESERVE BASED TRUST CO

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:

Interest income from a term deposit issued by a reserve based trust company.

Position:

Insufficient information, but not exempt unless it can be shown that it was generated on the reserve.

Reasons:

The investment income is the property in question and if it was not generated on reserve it is considered to be earned in the economic mainstream and is not exempt.

XXXXXXXXXX 	D Duff
 		5-970595
March 26, 1998

Dear XXXXXXXXXX:

Re: Interest on Term Deposits issued by reserve based trust company

This is in reply to your letter dated February 28, 1997 requesting our opinion on the tax status of interest earned on certain term deposits you were acquiring.

You indicated that you are a status Native living on a reserve. You are employed as a teacher at XXXXXXXXXX. Your investment funds came from your employment income and from removing your name from the XXXXXXXXXX list.

The term deposits in question are from the XXXXXXXXXX. You wanted to know if interest on these term deposits would be exempt from tax and generally what were the criteria to be met in order for investment income to be exempt.

Our Comments

In general terms, it is section 87 of the Indian Act, along with paragraph 81(1)(a) of the Income Tax Act, that establish the exemption from taxation for status Indians. 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 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 purchase of term deposits from an institution on reserve would not, in itself, be sufficient to exempt the interest income earned thereon. While this is one factor to weigh in determining whether interest earned on term deposits is exempt from taxation there could be other factors that would connect the income to a location off reserve.

In the recent case of Arnold Recalma v. Her Majesty the Queen (96 DTC 1520), the Tax Court of Canada considered the taxability of income earned by an Indian living on reserve, from investments purchased from an on reserve branch of a bank. In the present case, whether the issuing company has its head office on reserve is not sufficient to establish that the interest earned on the funds is exempt. This determination would require a review of all relevant connecting factors and consideration as to how much weight should be given to each factor.

In Recalma 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 some of these factors will support an argument in your case for exemption, we would like to point out that the court placed very much weight on (g)(ii), which would be the location of the income generating activity of the issuer of the term deposits. 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.

Since the issuer of the term deposits can use the funds received to make loans to Indians off the reserve or to non-Indians or to invest in off reserve activities, it may not be possible to trace the interest earned on these funds directly to the reserve. Based on this, unless the interest income on your term deposits can be identified as being generated exclusively on the reserve, in our view the income is not exempt from tax.

We trust our comments will be of assistance to you.

Roberta Albert, C.A.

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

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