Principal Issues: Two questions are posed:
1) if a status Indian incorporates a reserve-resident company and employs himself to perform duties off-reserve, is his employment income tax-exempt?
2) if a status Indian operates a farm on a reserve, can he deduct farm losses from other taxable business income earned off-reserve?
Position: 1) Income from the corporation to the individual might be tax exempt. It will be a question of fact
2) A farming loss is unlikely to arise, therefore would not be available to offset taxable business income
Reasons: 1) It will be a question of fact whether the individual receives amounts from a corporation in his capacity as shareholder or in his capacity as an employee. If the amount is determined to be employment income, then Guideline 2 will likely have application.
2) Business income from a farm operated on a reserve by a status Indian is likely tax-exempt. As such, paragraph 18(1)(c) provides that no deduction may be taken for expenses incurred to earn that income. It is therefore not likely that a loss could arise in this situation.
2005-016145 XXXXXXXXXX Renée Shields (613) 948-5273 February 13, 2006
Dear XXXXXXXXXX:
Re: Taxation of status Indian income from employment and business income
This is in response to your letter of November 21, 2005 inquiring about the taxation of employment income and business income earned by a status Indian in particular circumstances.
The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.
Paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act provide a tax exemption for a status Indian's personal property situated on reserve. Because income is not a physical object, determining its location can be difficult. The Supreme Court of Canada addressed this problem in the 1992 case of Williams v. the Queen. The decision in Williams requires the identification of various factors connecting the particular income to a location either on or off a reserve. These factors are then analyzed to determine what weight they should be given in identifying the location of the property. If the most significant factors connect the property to a location on a reserve, the income will be tax exempt.
Your first question concerns the taxation of a status Indian's employment income. In the circumstances you describe, a reserve-resident status Indian incorporates a company that is resident on a reserve. The corporation then employs the individual. It would be a question of fact whether amounts received by the individual from the corporation are received in his or her capacity as an employee or in his or her capacity as a shareholder. If it were determined that the amount qualifies as employment income, it will generally be taxed in accordance with the Indian Act Exemption for Employment Income Guidelines (the "Guidelines"). The CRA developed the Guidelines in consultation with interested Indian groups and other government stakeholders, in order to facilitate the complex connecting factors determination with respect to employment income. Although the Guidelines do not cover every employment situation, they are nonetheless a useful administrative tool.
The situation you describe appears to give rise to the application of Guideline 2, which exempts the employment income of status Indian employees who live on a reserve provided that the employer is also resident on a reserve. As stated in the Guidelines, an employer is resident on a reserve if the reserve is the place where the central management and control over the employer organization is actually located. It is important to keep in mind that there may be unusual or exceptional circumstances where the income may be taxable even though it appears to fall within one of these Guidelines.
Your second question is whether farm losses incurred by a status Indian operating a farm on a reserve can be applied to taxable business income earned off-reserve. Since the determination of whether the farm constitutes a source of income for an individual is beyond the scope of this letter, our comments assume that the on-reserve farm constitutes a source of business income to the status Indian. Using the connecting factors approach required by the above-noted Williams decision, such business income will be tax-exempt if sufficient factors exist to connect it to a reserve. Under the principles established by the Federal Court of Appeal in the Recalma case, the key connecting factors in the business income context are:
1) where the income generating activities take place and
2) where the customers of the business are located
Although always a question of fact to be determined by the specifics of a particular situation, it would likely be concluded that business income generated by a farm operated on a reserve by a status Indian is tax-exempt. That being the case, we draw your attention to paragraph 18(1)(c) of the Income Tax Act, which prohibits the deduction of expenses incurred to earn exempt business income. In light of this prohibition, it is unlikely that the farm business could incur a loss. Accordingly, the issue of application of the loss to other income would not arise.
We trust that these comments will be of assistance.
Yours truly,
John Oulton, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch