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.
Principal Issues: Is the business income earned by a self-employed Indian XXXXXXXXXX exempt from tax?
Position: The Indian may be able to claim a partial exemption.
Reasons: The CRA will allow a claim for a partial exemption on business income if the Indian can clearly identify the income earned from work completed on a reserve. Expenses to earn income must be allocated on a reasonable basis.
June 9, 2010
London Tax Services Office HEADQUARTERS
Income Tax Rulings
Attention: Marie McKeown Directorate
L. Zannese
(613) 957-2747
2010-036759
Indian-Business Income-Application of Tax Exemption
This is in response to your memorandum of May 17, 2010, requesting our views on whether the business income earned by an Indian was situated on a reserve and therefore exempt from tax.
You provided us with the following information:
- The taxpayer, XXXXXXXXXX advised that he is an Indian, as that term is defined in section 2 of the Indian Act.
- XXXXXXXXXX is a XXXXXXXXXX and he stated that he operated a XXXXXXXXXX practice from an office located on the XXXXXXXXXX Indian Reserve during the years XXXXXXXXXX to XXXXXXXXXX . He claimed a full exemption from tax on income earned from that XXXXXXXXXX practice.
- He advised that he performed most of his duties on behalf of his clients from his office on a reserve. Some of his duties were conducted off-reserve, for example, XXXXXXXXXX.
- For the taxation years XXXXXXXXXX to XXXXXXXXXX , XXXXXXXXXX 's accountant advised that XXXXXXXXXX paid $XXXXXXXXXX rent for the office on the XXXXXXXXXX Indian Reserve.
- Most of XXXXXXXXXX 's clients qualified for XXXXXXXXXX and thus a majority of his business income comes from XXXXXXXXXX .
- Your investigation revealed various personal addresses for XXXXXXXXXX . Some of these locations were on a reserve; some were off-reserve. In XXXXXXXXXX , XXXXXXXXXX advised that he was in the process of moving to a personal residence on the XXXXXXXXXX Indian Reserve.
An Indian's personal property is exempt from tax pursuant to paragraph 81(1) (a) of the Income Tax Act and section 87 of the Indian Act if that property is situated on a reserve. Although income is personal property, its intangible nature makes it difficult to determine its location. In the case Williams v. The Queen, the Supreme Court of Canada set out the connecting factors test to assist in this determination. The test requires identifying the various connecting factors that tie the particular income to a location either on or off a reserve and weighing the significance of each such factor.
The leading court case with respect to the taxation of business income earned by an Indian is Southwind v. The Queen. In the Southwind case, the Federal Court of Appeal endorsed consideration of a series of factors that would be relevant, but not necessarily of equal significance. These factors were: the location of the business activities, the location of the customers, the location where decisions affecting the business are made, the type of business and nature of work, the place where payment is made, the degree to which the business is in the commercial mainstream, the location of a fixed place of business and the location of books and records and, finally, the residence of the business owner. In addition to the factors set out in Southwind, the courts have also considered the location of a business' suppliers.
The key factor in determining whether an Indian's business income is tax-exempt is the location of the income-earning activities of the business. Generally, we consider income earned from work completed on a reserve to be situated on a reserve. Therefore, self-employed individuals who complete all their income-earning activities from a location on a reserve will usual qualify for the tax exemption with respect to all of their self-employment income.
Normally, we will conclude that income from an Indian's business is either situated on a reserve and therefore tax-exempt or situated off-reserve and therefore taxable. However, where an Indian individual earns business income through the completion of specific tasks, to which specific income can be allocated, we will allow the individual to claim the tax exemption on the portion of the income that is situated on a reserve. This type of proration only applies as long as the services performed on a reserve are a meaningful part of earning the business income. If only a very small portion of the income-earning activities take place on the reserve, then these activities may be incidental to the business, which is therefore considered to be operated off-reserve. In situations where on-reserve activities are incidental, we do not pro-rate the tax exemption. Similarly, where the activities completed off-reserve are incidental, we will consider all the business income earned to qualify for the exemption.
In the situation you describe, it appears that XXXXXXXXXX 's business is located wherever XXXXXXXXXX performs his services; this is due to the nature of his business as a XXXXXXXXXX . Therefore, XXXXXXXXXX may have income that can be pro-rated (i.e. that is partially tax-exempt). However, he has failed to provide any evidence supporting his claim that he earned income from an office on a reserve for the years XXXXXXXXXX to XXXXXXXXXX , for which he claimed a full tax-exemption. Although his accountant indicated that XXXXXXXXXX paid rent for an office on a reserve during that time period, this is not evidence that XXXXXXXXXX actually completed any work from that office. As you indicated, he had several addresses recorded with CRA during those years, and many of them were for locations in the City of XXXXXXXXXX , which is not reserve land. In particular, his registration with the XXXXXXXXXX provided a mailing address located in XXXXXXXXXX .
In addition to the lack of evidence provided by XXXXXXXXXX , it seems unlikely to us that he would qualify for the tax exemption for all of the income earned by him from XXXXXXXXXX to XXXXXXXXXX . He acknowledged that some of his services were performed off-reserve, although he stated that this only occurred because of a lack of facilities on a reserve. For example, he was required to XXXXXXXXXX at a location off reserve, as there were no XXXXXXXXXX located on the reserve. However, the fact that facilities are not available on a reserve does not mean that the income earned by an Indian who was "forced" to work off-reserve is tax-exempt. Both the courts and the CRA have rejected this argument on several occasions. Thus, services performed off-reserve by XXXXXXXXXX resulted in his earning income that would be taxable, unless there are other factors connecting that income to a reserve.
Other factors that might connect XXXXXXXXXX 's business income earned off-reserve to a reserve include the location of his clients, the location where the payments are made, his residence and the location of books and records. In our view, the information provided suggests that none of these additional factors would be of sufficient weight, either separately or together, to connect income earned by XXXXXXXXXX from off-reserve activities to a reserve, such that the income would be situated on a reserve. There is no evidence as to who XXXXXXXXXX 's clients were, other than that a majority of them were XXXXXXXXXX . As for the payments, these were not made by Indians resident on a reserve, but were from XXXXXXXXXX , which is likely situated in XXXXXXXXXX . These payments did not have any connection to a reserve, except to the extent that the client was an Indian residing on a reserve. Even in this latter situation, the weight to be given to a payment by XXXXXXXXXX on behalf of an Indian resident on a reserve would be minimal. However, we do note that location of clients is a factor to consider. It is not clear where the books and records were located or where XXXXXXXXXX resided during this period.
Assuming that the services XXXXXXXXXX performed were compensated at an hourly rate and that the services performed on a reserve were not incidental, then part of his income may be exempt from tax. In this case, any business expenses incurred must be allocated reasonably between the income that is tax-exempt and the income that is taxable, to the extent that these expenses have not been otherwise reimbursed by XXXXXXXXXX or from another source. When calculating the amount of time spent on the reserve, it is our view that general book-keeping and other administrative duties completed by the business owner are not considered to be income-earning activities related to specific business income located on or off a reserve and should not be taken into consideration in establishing the amount of income earned on a reserve.
In conclusion, there is insufficient evidence to support XXXXXXXXXX 's claim for either a full or partial tax exemption for the business income he earned from the XXXXXXXXXX practice during the years XXXXXXXXXX to XXXXXXXXXX . In fact, based on the information that you have given us, and that XXXXXXXXXX has given you, we expect that little of XXXXXXXXXX 's business income was tax-exempt. It is XXXXXXXXXX 's responsibility to provide satisfactory evidence to support his claim for a tax exemption. XXXXXXXXXX must be able to support the number of hours for which he earned income from work completed on a reserve. This may be evidenced by his billing records for XXXXXXXXXX . Further, should XXXXXXXXXX have expenses that he would like to claim with respect to off-reserve (taxable) income, he must provide documentation to support these amounts and their connection to that income and indicate that these expenses were not reimbursed.
We trust that these comments will be of assistance.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.
Yours truly,
Eliza Erskine
Manager
Non-Profit Organizations and Aboriginal Issues
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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