15 August 2002 External T.I. 2002-0148995 - TAXATION OF PENSION INCOME-STATUS INDIAN

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Taxation of Registered Pension Plan income paid to status Indians.

Position: General Comments given.

Reasons: General Comments given.

XXXXXXXXXX 	2002-014899
		Cornelis Rystenbil, CGA
August 15, 2002

Dear XXXXXXXXXX:

Re: Taxation of Pension Income Received by Status Indians

We are writing in reply to your letter of June 25, 2002, in which you requested our comments regarding the taxation of pension income received by status Indians.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. The following comments are, therefore, of a general nature only and are not binding on the Canada Customs and Revenue Agency ("CCRA").

Paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act provide a tax exemption for an Indian's personal property situated on reserve. The courts have previously determined that, for purposes of section 87 of the Indian Act, the reference to personal property includes employment income. In Williams (92 DTC 6320), the Supreme Court of Canada reconsidered the approach to use in determining whether income is situated on a reserve. The proper approach in determining the situs of personal property is to evaluate the various connecting factors that tie the property to one location or another.

Based on the guidance provided by the decision in Williams and after receiving representations from interested Indian groups and individuals, the CCRA 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 CCRA 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.

The CCRA's position concerning the taxation of pension income of a status Indian is reflected in the Guidelines. In short, income that is ancillary to employment income, such as pension income and Canada Pension Plan benefits, is treated the same as the employment income itself. In other words, if the employment income earned by a status Indian was exempt from taxation under paragraph 81(1)(a) of the Act and section 87 of the Indian Act, any pension benefits relating to that exempt employment income that are received by the status Indian will also be exempt from tax. Any pension benefits paid to a status Indian beneficiary of the particular status Indian subsequent to his or her death would also be exempt from tax. You may refer to the enclosed copy of the Guidelines to determine whether the employment income of a status Indian related to a particular pension was exempt.

A non-status Indian individual does not qualify for exemption from taxation under the Indian Act. Consequently, pension benefits paid to a beneficiary of the deceased status Indian that is a non-status Indian surviving spouse or a non-status Indian child will be taxable even though the benefits relate to a status Indian's employment income that was tax exempt.

An estate arising as a consequence of the death of an individual is taxed as a testamentary trust for income tax purposes. Where pension benefits arising as a result of a deceased status Indian's tax-exempt employment income are paid to the deceased status Indian's estate, the pension benefits will be included in the income of the estate under subparagraph 56(1)(a)(i) of the Act. Since a trust is not a status Indian, the trust would have to pay tax in respect of the pension benefits. However, the estate would be entitled to deduct the amount that became payable to a beneficiary in the year under paragraph 104(6)(b) of the Act. This deduction is limited to the amount that would be its income for the year. We note that subsection 104(24) of the Act deems an amount to be payable for these purposes where it was paid or the beneficiary was entitled to enforce payment in the year. Paragraph 104(13)(a) of the Act requires the beneficiary to include in his or her income for the year the amount by which the estate reduces its income under paragraph 104(6)(b) of the Act. Where the beneficiary of the estate is a status Indian and the pension benefits included in the estate's income related to employment income earned by a status Indian that was exempt from taxation under paragraph 81(1)(a) of the Act and section 87 of the Indian Act, the amount required to be included in the beneficiary's income under paragraph 104(13)(a) of the Act will be treated by CCRA as exempt income.

With reference to investment income, in Recalma v. The Queen, (96 DTC 1520, 98 DTC 6238), the Tax Court of Canada, as confirmed by the Federal Court of Appeal, considered the taxation 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 courts placed considerable emphasis on the location of the bank's income generating activity. The investments in this case were bankers acceptances and mutual funds units and the income generated from these was earned in the economic mainstream and was not connected to a reserve. Basically, the Court concluded that income from these investments started with companies off the reserve and 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 taxpayer chose to invest in the economic mainstream of normal business conducted off the reserve. Consequently, the CCRA's position is that income earned in the economic mainstream is so strongly connected to a location off reserve that it generally outweighs other factors that connect it to a reserve.

Based on the decision in Recalma v. The Queen, it is necessary to determine the location of the issuer's income generating activity in respect of the investment instrument. Unless the interest income can be identified as exclusively generated on a reserve, it is the CCRA's position that the interest income is not tax exempt. For the CCRA to consider an Indian's investment income to be tax exempt, the Indian's investment income would have to be from an on-reserve financial institution that generates its income exclusively from investments and loans to Indians on a reserve and it has to be established that the loans and investments are used by Indians for development on the reserve. In addition to the above-mentioned test for the financial institution, in our view, other connecting factors would still have to be present such as the Indian having to live and work on a reserve. We would also consider whether the capital with which the Indian made the investments resulted from an exempt source.

With reference to your question whether a non-redeemable term deposit can be liquidated upon the death of the taxpayer upon the request of the spouse or beneficiary, this is a question of contract law and depends on the terms of the contract entered into when the non-redeemable term deposit was purchased. This question should be addressed to your client's legal advisor.

We trust our comments will be of assistance to you. These comments are provided in accordance with the practice outlined in paragraph 22 of Information Circular 70-6R5.

Yours truly,

Mickey Sarazin, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate