12 June 2009 External T.I. 2009-0313071E5 - Taxation of Business Income - Indian Proprietor

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.

Principal Issues: Is the business income earned by an Indian, where part of the duties are carried on off the reserve, exempt from tax? If not could the proration rule apply?

Position: Possibly

Reasons: It depends on the facts. Proration of business income is possible if specific income-earning activities can be directly connected to a reserve. A record of activities should be maintained to support a claim for proration of business income.

		2009-031307
XXXXXXXXXX 		Lori Merrigan
(613) 957-8979
June 12, 2009

Dear XXXXXXXXXX :

Re: Taxation of Business Income - Indian Proprietor

This is in response to your letter of March 9, 2009, asking for documents relating to the taxation of business income earned by an Indian proprietor. It is our understanding that the taxpayer described in your letter is an Indian who earns income as a self-employed lawyer XXXXXXXXXX . The taxpayer operates from his or her home on a reserve and spends time XXXXXXXXXX on other reserves, but he or she also spends time off-reserve in federal courts and XXXXXXXXXX .

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 advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advanced 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.

Our Comments

Paragraph 81(1)(a) of the Income Tax Act (the "Act") provides that an amount declared exempt from income tax by another act of Parliament shall not be included in computing the income of a taxpayer. Section 87 of the Indian Act exempts from taxation the personal property of an Indian situated on a reserve. The courts have concluded that the term "personal property" includes income.

The Supreme Court of Canada, in Williams v. The Queen, 92 DTC 6320, concluded that the determination of whether income is situated on a reserve and thus exempt from tax under the Indian Act requires the evaluation of the various factors which connect the income to a location either on or off a reserve. In Southwind v. The Queen, 98 DTC 6084, the Federal Court of Appeal concluded that the most significant factors that serve to connect business income to a location on or off a reserve are:

1. the location where the revenue-generating activities are carried out; and

2. the location of the business' customers.

Other factors that were considered relevant, but not necessarily of equal significance, are:

• the place where decisions affecting the business are made;
• the type of business and the nature of the work;
• the place where the payment is made;
• the degree to which the business is in the commercial mainstream;
• the location of a fixed place of business and the location of the books and records; and
• the residence of the business' owner.

The CRA considers income earned from work completed on a reserve to have sufficient connecting factors to a reserve to conclude that the income is situated on a reserve. Therefore, self-employed individuals who complete all their income-earning activities from a location on a reserve will usually qualify for the tax exemption with respect to all of their self-employment income. However, in this situation, it appears that some of the taxpayer's business income will result from activities completed off-reserve.

Where an Indian individual earns business income through the completion of specific tasks, to which specific income can be allocated, the CRA will allow the individual to claim the tax exemption on the portion of the income that is situated on a reserve. This type of allocation only applies as long as the duties completed on a reserve are a meaningful part of earning the business income. If only a very small portion of the income-earning activities take place on the reserve, these activities may be incidental to the business, which is therefore considered to be operated off-reserve. In situations where activities performed on a reserve are incidental, none of the income is exempt.

Assuming that the specific duties performed on a reserve are not incidental, the self-employment income earned that is clearly attributable to those duties would be exempt from tax. For example, where a taxpayer earns business income based on an hourly rate, such income can be directly attributed to a particular activity performed for a specific length of time on or off a reserve. Business expenses incurred must be allocated reasonably between the income that is tax-exempt and the income that is taxable, to the extent that these expenses have not been otherwise reimbursed.

In order to support a claim for a partial exemption of business income under section 87 of the Indian Act, taxpayers should maintain documentation, for each taxation year, regarding the activities completed under their business contracts and the circumstances surrounding each of those activities. In particular, a taxpayer should maintain a record of whether each activity was performed on or off a reserve and how each activity was linked to generating revenue. At the end of each taxation year, a taxpayer should be able to compute the time spent on duties completed on a reserve, and the related self-employment income.

As requested, we have also included severed copies of Income Tax Rulings documents 2003-0052311, 2005-0143761 and 2008-0299381.

We trust that these comments will be of assistance.

Yours truly,

Eliza Erskine
A/Manager
Non-Profit Organizations and Aboriginal Issues
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch