By Rob Picton, CA CPA, Partner, Kingston Ross Pasnak LLP
(Edmonton) – Canada’s Income Tax Act (ITA) is a very complex document totaling over 3,000 pages. Our tax system becomes even more complex when it intersects with Section 87 of the Indian Act, which provides that “personal property of an Indian or band situated on a reserve” shall be exempt from taxation. This legislation predates the Income Tax Act.
We recognize that generally First Nations People in Canada do not describe themselves as Indians. However, this article uses the term “Indian” in reference to its legal meaning in the Indian Act.
In qualifying for tax exemption, the location of the income is key, and simply living on-reserve does not guarantee all of an Indian employee’s income is exempt. Similarly, an Indian employee living off-reserve can still earn income on-reserve and be exempt from tax. All the factors must be reviewed in determining location of income. These factors can lead to different interpretations, and recent court decisions indicate that law in this area evolves from year to year. As such, this article can only provide basic information, and specific analysis would be required for any given set of facts.
Income from Employment
There is considerable jurisprudence surrounding the exemption of employment income. Canada Revenue Agency (CRA) has indicated that the following four guidelines will generally result in tax exemption for employment income:
- The work is performed on-reserve.
- The employer is resident on-reserve AND the Indian employee lives on-reserve.
- Either the employer is on-reserve or the Indian employee lives on-reserve, AND more than half the work is performed on-reserve.
- The employer is either an Indian band which has a reserve, a Tribal Council representing one or more such bands, or an organization controlled by such entities, is resident on-reserve and is dedicated exclusively to the social, cultural, educational or economic development of Indians who for the most part live on-reserve. This is the most limited and complex guideline.
As these are simplifying interpretations of case law, in some cases, the above may not apply.
Employment Insurance (EI)
When an Indian employee receives EI, the CRA will look at the nature of the employment income which generated the EI rights. If that income was exempt, the EI will also be exempt.
Only a status Indian can benefit from tax exemption, so these rules apply only to unincorporated businesses. The most significant factor here is the location where the business carries on its revenue-generating activities. In addition, CRA may look at location of customers, the residence of the business owner, the business office address, and the location of books and records. Generally, CRA accepts that when revenue-generating activities take place in part on-reserve, and in part off-reserve, the portion of the business income generated on a reserve can be exempted.
CRA will consider interest income tax-exempt if:
- The interest income was earned on a bank account or guaranteed income certificate (GIC) at a financial institution located on-reserve;
- The financial institution is required to pay the interest to the Indian at a location of the financial institution on-reserve; and
- For a GIC, the interest rate is fixed or can be determined when the investment is acquired.
Dividend income is exempt only if the corporation operates exclusively on-reserve, which would require head office, management, and principal revenue-generating activities all be situated on-reserve, which is a rather stringent test. Rental and royalty income would be exempt where the rental property, or the resource generating the royalties, is located on-reserve.
Exempt income does not give risk to Registered Retirement Savings Plan (RRSP) contribution room, and as such, no exemption is normally available for funds withdrawn from an RRSP, or Registered Retirement Income Fund (RRIF). However, a pension arising from exempt employment can be exempt. Where such a pension is transferred to an RRSP, the result can be exempt income from the RRSP, or a RRIF to which it is later transferred. Tracing the history of such funds can be challenging.
Canada Pension Plan (CPP) premiums generally are not required on exempt employment or self-employment income but can be paid by election. Old Age Security (OAS) and Guaranteed Income Supplement (GIS) are not connected to a reserve, so these amounts are taxable.
Director fees generally follow the same guidelines as employment income in determining exemption. Even if the fees meet exemption criterion, they are still technically required to be reported to CRA on a T4 slip.
Conclusion and Acknowledgment
It is clear that tax exemption is very valuable; however, the eligibility is complex. Even if an Indian employee has tax-exempt income, he should file a tax return to be eligible to receive carbon tax rebates, GST rebates, and other possible rebates, which are generally tax-free.
This article was written with significant insight from Hugh Neilson, FCPA, FCA, TEP, an independent contractor to Kingston Ross Pasnak LLP, where he is our Director of Taxation Services.