The Indian Act – Exemption from Taxation

Photo of Canadian bills and coinsThe Canada Revenue Agency notes on its website that “We recognize that many First Nations people in Canada prefer not to describe themselves as Indians. However, we use the term Indian because it has a legal meaning in the Indian Act.”  For the same reason, the author uses the term in this article.

Aboriginal persons are subject to the same income tax laws as any other Canadian, however Section 87 of the Indian Act , which provides that “the personal property of an Indian or a band situated on a reserve” shall be exempt from taxation.  This legislation predates the Income Tax Act, and considerable case law has developed over the years addressing the exemption’s application to income tax matters. It is important to note that it is the location of the income which is determinative – simply living on a reserve does not guarantee all of an Indian’s income is exempt.  Similarly, an Indian living off-reserve can still earn income which is situated on a reserve and thus exempt from tax. The courts have concluded that income can be “personal property”, and that the determination of whether such property is “situated on a reserve” is a question of fact requiring a review of all factors connecting the income to a reserve.

Over the years, a considerable body of interpretations and court decisions has accumulated, and the law in this area continues to evolve regularly.  As such, this article can only provide basic information on the  state of the law at this time, and specific advice will be required for any given set of facts.  It is important to note that it is the location of the income which is determinative – simply living on a reserve does not guarantee all of an Indian’s income is exempt.  Similarly, an Indian living off-reserve can still earn income which is situated on a reserve and thus exempt from tax.

Some First Nations have entered self-governing agreements with the federal government, commonly giving up the rights to this exemption for their members.

Income from Employment

As employment income is common, considerable law has developed.  Furthermore, the Canada Revenue Agency (CRA) has developed the following guidelines to determine when employment income will usually be exempt:

(a) The work is performed on a reserve – where at least 90% of the work is performed on a reserve, the employment income will all be exempt.  Where less than 90% of duties are performed on the reserve, that portion of the income which is earned on the reserve will be exempt (for example, if the employee works on a reserve two out of five days, 40% of the income would be exempt).

(b) The employer is resident on a reserve AND the Indian employee lives on a reserve.  Where an Indian receives EI benefits, CRA looks to the nature of the employment income which generated the EI rights.  To the extent that income was exempt, the EI will also be exempt. However, where an employment agency is created on a reserve to engage the services of Indians for off-reserve employment, CRA looks to the residence of the off-reserve employer and will not apply this Guideline.

(c) Either the employer is resident on a reserve or the Indian employee lives on a reserve, AND more than half the work is performed on a reserve – in this case, all of the income will usually be exempt.

(d) The most limited, and most complex guideline applies where 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 a reserve and is dedicated exclusively to social, cultural, educational or economic development of Indians who for the most part live on reserves.  If the duties of employment are in connection with non-commercial activities carried out exclusively for the benefit of Indians who for the most part live on reserves, that employment income will usually be exempt.

It must be noted that these are guidelines, and the  CRA has identified situations where the income is not connected to a reserve, despite technically falling within one of the above guidelines.

Employment Insurance (EI)

Where an Indian receives EI benefits, the CRA looks to the nature of the employment income which generated the EI rights.  To the extent that income was exempt, the EI will also be exempt.  For example, if Jake had two jobs, one which was exempt and accounted for 1/3 of his benefits while the other was  not exempt, CRA would consider 1/3 of his EI benefits tax-exempt.

Income from Business/Self-Employment

Only a status Indian can benefit from the exemption, so it only applies to an unincorporated business. The shareholders of a private corporation are typically employees of their corporation – employment earnings would be subject to the guidelines discussed above. Most child support is non-taxable under current law.   Where payments are received by an Indian living on a reserve, such receipts, whether for spousal or child support, will qualify for the exemption.  If dividends are received, these would be considered investment income as discussed below.

The most significant connecting factor for self-employment income is the location where the business carries on its revenue-generating activities.  The location of customers is also an important factor.  Less important factors include whether the following are on a reserve:

  • the residence of business owner;
  • the business office;
  • the books and records;
  • administrative, clerical or accounting activities.

Here again,the  CRA accepts that, where revenue-generating activities take place in part on a reserve, and in part off-reserve, the portion of the business income generated on a reserve can be exempted. The  CRA has more detailed guidance for farming and fishing businesses specifically on its web site.

Investment Income

Based on a Supreme Court decision in 2011, the CRA considers interest income exempt where all of the following conditions are met:

  • the interest arises from a chequing or savings account, term deposit or guaranteed income certificate (GIC) at a financial institution (eg a credit union or bank branch) located on a reserve;
  • the financial institution is required to pay the interest to the Indian at a location of the financial institution on a reserve; and
  • for a term deposit or GIC, the interest rate is fixed or can be determined when the investment is acquired.

The CRA considers dividend income will be exempt if the corporation operates only on a reserve,  CRA considers dividend income will be exempt if the corporation operates only on a reserve, which requires the head office, management and principal income-generating activities of the corporation all be situated on a reserve.which requires the head office, management and principal income-generating activities of the corporation all be situated on a reserve.  This is a more stringent test than that applied to business income, as discussed above.

Similarly, income from a Trust would be exempt if the income itself is connected to a reserve.

Rental and royalty income would be exempt where the rental property, or the resource generating the royalties, is located on a reserve.  Rental of moveable property requires a more detailed review of the connecting factors, much like business income.

The location of the underlying property would determine whether capital gains are exempt.  For assets used in a business,the  CRA takes the position that the exemption would be pro-rated on the same basis as the business income.

Pension Income

Exempt income does not give rise to Registered Retirement Savings Plan (RRSP) contribution room, and as such no exemption would be available for funds withdrawn from an RRSP, or from a Registered Retirement Income Fund (RRIF).

Canada Pension Plan (CPP) premiums generally are not required on exempt employment or self-employment income. Old Age Security, including the Guaranteed Income Supplement, is considered unrelated to any other source of income.  As OAS has no connection to a reserve, these amounts are not exempt.  However, the individual can elect to pay premiums on such income.  In such cases, a portion of the CPP benefits would be exempt, proportionate to the exempt income the benefits are based on.  This is similar to the rule for EI discussed above.   Similarly, pension income, retiring allowances and other amounts related to employment would be exempt in proportion to the employment income on which it is generated. As this could relate to income earned over a lengthy career, considerable analysis might be required to determine the exempt portion.

Old Age Security, including the Guaranteed Income Supplement, is considered unrelated to any other source of income.  As OAS has no connection to a reserve, these amounts are not exempt.

Foreign Income

The CRA takes the position that income arising from a foreign country, such as the United States, cannot be connected to a reserve in Canada, and as such the exemption will not apply to such income.

Scholarships and Training Allowances

Scholarships received as a student in respect of a program which entitles the student to claim the education amount are exempt from taxation for all Canadians.  Where a scholarship, bursary or fellowship does not qualify for this broad exception, but is paid by Indian and Northern Affairs Canada, the CRA presently accepts it is exempt. However, that policy is under review at the time this article was written (May, 2014).

The CRA takes the position that a training allowance will be exempt only if the training takes place on a reserve.

Spousal and Child Support

Most child support is non-taxable under current law.   Where payments are received by an Indian living on a reserve, such receipts, whether for spousal or child support, will qualify for the exemption.

Goods and Services Tax (GST/HST)

The applicability of the Indian Act exemption to income tax is, as seen above, quite complex.  In respect of the GST, as a general rule, goods bought on a reserve by Indians, Indian bands and unincorporated entities empowered by the band, are exempt from GST/HST.  Goods bought off-reserve do not enjoy this exemption – the exempt person must take possession of the goods on a reserve.  The vendor should maintain evidence of the transfer of possession, in order to demonstrate why they were not required to collect GST/HST.  Goods imported from outside Canada are still subject to GST/HST.

Similarly, services provided on a reserve are GST/HST exempt.  Services related to real estate on a reserve are exempt even where provided off-reserve.

Claiming the exemption requires the Indian to show proof of status (typically the Certificate of Indian Status), and the vendor should maintain evidence of the status of the purchaser and on-reserve delivery.  Where GST/HST is paid in error, the Indian can apply for a refund of the GST/HST paid on Form GST 189.

Conclusion

Exemption from tax is clearly very valuable.  However, eligibility for the exemption can be complex and uncertain.  This area of the law will doubtless continue to evolve, and cases are regularly heard by the Tax Court on its application.  It would be prudent, especially where eligibility may be uncertain, to maintain sufficient funds to pay the taxes in the event of a successful CRA challenge to the exemption.

 

Hugh Neilson, FCPA, FCA, TEP, is an independent contractor with Kingston Ross Pasnak LLP, and a member of the Video Tax News editorial board in Edmonton, Alberta.
About Hugh Neilson

Hugh Neilson, FCPA, FCA, TEP, is an independent contractor with Kingston Ross Pasnak LLP, and a member of the Video Tax News editorial board in Edmonton, Alberta.

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