Principal Issues: Whether a salary paid by a corporation held by a sole shareholder and sole director with a head office situated on a reserve is tax exempt.
Position: Question of facts.
Reasons: In Bell v. the Queen (2018 FCA 91), the court commented that where an employee is receiving income from a company that the employee controls, it would be relevant to examine the business that the company is carrying on, to determine if the income received is situated on a reserve. In the case provided, determining whether the income received by the sole shareholder-employee is property situated on a reserve, requires a review of the relevant connecting factors applied at the corporation level to determine whether that income is situated on- or off-reserve.
XXXXXXXXXX 2023-099620
Y. Barrak, LL.B.,
LL. M. Fisc.April 4,, 2024
Dear Mr. XXXXXXXXXX,
Subject: Tax exemption for employment income earned by an Indian within the meaning of the Indian Act.
This is further to your email dated October 27, 2023 in which you requested our opinion as to whether paragraph 81(1)(a) of the Income Tax Act (the "Act") and section 87 of the Indian Act (the "IA") exempt from income tax the salary received by the sole shareholder and employee of a professional corporation (the "Corporation"). We apologize for the delay in responding to your request.
Our understanding of the hypothetical facts you have provided is as follows:
- The sole shareholder and employee of the Corporation is a physician who is registered as a status Indian under the IA (the "Physician").
- The Physician carries on his business through a corporation and pays himself a salary.
- The Corporation is managed and administered from its office which is located on a reserve within the meaning of the IA (the "Reserve").
- The Physician does not personally reside on a reserve within the meaning of the IA.
- The Physician spends 60% of his time caring for patients and 10% of his time managing his professional activities and carrying out administrative tasks from the health centre located on the Reserve.
- The Physician spends 30% of his time off the Reserve performing hospital duties in a hospital that is located off a reserve, as defined by the IA, as part of the regional medical manpower plan program.
Our Comments
This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC70-6R12, Advance Income Tax Rulings and Technical Interpretations ("IC 70-6R12"). However, we can offer the following general comments.
Paragraph 81(1)(a) of the Act and section 87 of the IA together provide for a tax exemption for the income of an "Indian", as defined in the IA, where that income is situated on a reserve. It is important to note that this exemption under the Indian Act does not extend to a corporation even if the corporation is owned or controlled by a band or individual who is registered or entitled to be registered as an "Indian" within the meaning of the IA.
The courts have established that to determine whether income is situated on a reserve and, therefore, exempt from tax, one must first identify the various connecting factors that are relevant to the income and then analyze those factors to determine the weight to be given to them in identifying the location of the income. If the most significant connecting factors link the location of the income to a reserve, the income will be exempt from income tax. This two-step test of identifying and analyzing the connecting factors of the intangible personal property (the income) to a particular location is often referred to as the "connecting factors method".
Bell v. Canada, 2018 FCA 91 ("Bell") involved bonuses paid by a corporation to its majority shareholder who was an Indian within the meaning of the Indian Act. The Federal Court of Appeal stated at paragraph 22 of the Bell decision that “in determining whether employment income that is paid by a corporation that is controlled by the employee is exempt under section 87 of the Indian Act, it would be appropriate to look at the particular business that is being carried on by that company to determine the relevant connecting factors.” In addition, paragraph 24 of the Bell decision states that “[t]he exemption under the Indian Act should not be dependent on the legal form or structure that the particular person chose to carry on his or her business, but rather on the substance of the activities and transactions that gives rise to the income in question. ”
Guidelines identifying a number of connecting factors that may be used to determine whether employment income is situated on a reserve for the purpose of exempting income under the IA (the "Guidelines") have been developed by the Canada Revenue Agency (the "CRA"), in consultation with interested aboriginal organizations, as an administrative tool to simplify the application of the "connecting factors method" to employment income. However, those Guidelines are designed to assist in dealing with the most common employment situations and therefore may not apply to unusual or exceptional cases. Employment income received by a single employee-shareholder is not considered a common employment situation.
Thus, in this situation, the question of whether there are sufficient connecting factors linking the income to a reserve can only be determined by taking into account all of the relevant facts and considering the connecting factors that relate to the Corporation's activities rather than those that relate to the employment income.
Based on jurisprudence, the most relevant connecting factors with respect to business income are as follows:
- the location where the income-generating activities of the business take place;
- the type of business and the nature of the commercial activities;
- the place where the management and decision-making activities of the business take place;
- the location of customers.
In addition, the following connecting factors are considered to be of lesser importance in the context of business income:
- whether or not you live on a reserve;
- the fact that you have an office on a reserve or that you take orders from a location on a reserve;
- the fact that you keep your accounting documents on a reserve;
- the fact that your administrative, secretarial and accounting activities take place on a reserve.
The above list of factors is not exhaustive, as other connecting factors may apply depending on the situation in question. In addition, the degree of relevance of a connecting factor or the weight given to it will vary depending on the facts of the case. Consequently, there is no standard test that can be used to determine whether business income is situated on a reserve (footnote 1). This can only be determined by a review of all the relevant facts at the end of each year, which is beyond the scope of a technical interpretation. However, we can offer the following general comments to help you make this determination.
Consistently with jurisprudence and based solely on the facts submitted, it appears to us that 60% of the Corporation's activities are revenue-generating activities that take place on a Reserve to serve patients located on the Reserve, that 10% of the Corporation's activities are management and decision-making activities that take place on the Reserve and that 30% of the Corporation's activities are revenue-generating activities that take place off a Reserve. The location of revenue-generating activities and the location of business management and decision-making activities are important factors used by the courts to link business income to a reserve. Consequently, it appears to us, subject to other connecting factors that may apply, that assuming that 70% of the Corporation's business income is located on a reserve, it is possible to consider that when the Corporation pays its business income in the form of salary to its sole shareholder-employee, the Physician, the salary will not be entirely tax-exempt. The proportion of 70% of the salary earned by the Physician could be considered to be situated on the Reserve and would therefore be exempt from tax pursuant to paragraph 81(1)(a) of the Act and section 87 of the IA. It is also important to note that despite the income tax exemption applicable pursuant to section 87 of the IA to all or part of the employment income paid by a corporation to its sole shareholder and employee who is an Indian within the meaning of the IA, the employment income paid must be reasonable in the circumstances in order to be deductible by the corporation for the purposes of section 67 of the Act. Whether or not an expense is reasonable is a question of fact that must be examined on a case-by-case basis.
We hope you find our comments of assistance.
Best regards,
Sophie Larochelle
Manager
Specialized Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 https://www.canada.ca/en/revenue-agency/services/indigenous-peoples/information-indians.html