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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
1. Is band a Canadian Municipality?
2. Are corporations owned by band exempt from tax?
3. If corporations exempt, which years are exempt and when does ss 149(10) apply?
4. Can the band retract Canadian municipality status?
5. Is the interest income from loans to these corporations exempt from tax in the hands of the Band?
6.What is the treatment for federal forgivable grants?
7. What are GST implications of municipality status of band?
8. Is employment income of status Indian employees of one corporation exempt from tax?
Position:
1. Band is municipality
2. No decision
3. Application of a possible exempt status applied prospectively from XXXXXXXXXX .
4. Band can not ‘revoke’ such status.
5. No decision
6. No decision
7. Referred to GST Rulings and Interpretation Directorate.
8. No decision
Reasons:
1 Band has met tests laid out in Otineka of being a public body exercising powers of self-government and providing services municipalities typically provide.
2. Not enough information on ownership or where revenues are derived--on or off reserve.
3. Prospective application of cases per Revenue Canada position, see index to IT’s.
4. Status as municipality is question of fact.
5. Not enough information to advise on treatment of interest income.
6. Not sufficient information to advise on treatment of grant income.
7. GST implications of municipal status referred to GST Rulings and Interpretation Directorate.
8. Not enough information to advise on tax status of employment income, referred to Indian Act Exemption Employment Guidelines
September 24, 1998
XXXXXXXXXX Tax Service Office HEADQUARTERS
Verification and Enforcement Division Nancy Graham
Section XXXXXXXXXX (613) 957-2136
Attention: XXXXXXXXXX
981559
XXXXXXXXXX Indian Band
We are writing in reply to your June 10, 1998 correspondence concerning the XXXXXXXXXX Indian Band. XXXXXXXXXX.
You have requested our opinion on the following issues.
1. Does the XXXXXXXXXX Indian Band qualify as a Canadian municipality for purposes of paragraphs 149(1)(c) and 149(1)(d) of the Income Tax Act (the “Act”)?
If the Band is considered a municipality, are the XXXXXXXXXX corporations owned by the Band exempt from tax under paragraph 149(1)(d) of the Act? They conduct their business off the reserve.
2. If the corporations are exempt, which taxation years are exempt? When does the deemed disposition of subsection 149(10) occur?
3. Can the Band retract its Canadian municipality status if it so wishes?
4. Is the interest income received by the Band on the loans made to two of the corporations it owns exempt?
5. If XXXXXXXXXX is not exempt from tax, how should the forgivable grants from the federal government be treated for tax purposes?
6. What are the GST implications to the Band if it is a municipality?
7. Is the employment income of a status Indian employee of XXXXXXXXXX, who does not live on a reserve, exempt from income tax?
We wish to point out the relevant section of the Act, paragraph 149(1)(d), has been amended recently. The relevant section under current law will be paragraph 149(1)(d.5). The amendments are effective for fiscal periods beginning after 1998. Our comments deal with the legislation in place for the time period you have audited, the fiscal period ending XXXXXXXXXX.
1. Does the Band qualify as a municipality?
The Tax Court of Canada determined in the case of Otineka Development Corporation Limited v. MNR, 94 DTC 1234, that the Band was a municipality. This decision was based on the fact that the community had and was exercising powers of self-government and was providing the types of services municipalities typically provide. You have advised that the XXXXXXXXXX Band has passed bylaws under section 81 and section 83 of the Indian Act. We have relied on your review of these by-laws in our comments that follow. Further, you advised the Band has commenced the assessment and taxation of the XXXXXXXXXX Indian Reserve Lands. The Band provides municipal services such as police and fire protection, sewer, water and infrastructure maintenance to ratepayers by way of contracts with the XXXXXXXXXX. The chief and council are democratically elected and meet regularly on Band matters. The Band has departments to deal with land claims, treaties, fisheries, land management, capital projects, community health and education. Recreational and social development services are also provided on a self-administered basis. Accordingly, in our view, the Band is a municipality for the purpose of paragraphs 149(1)(c) and 149(1)(d) of the Act.
2. Are the XXXXXXXXXX corporations owned by the Band exempt from tax under paragraph 149(1)(d) of the Income Tax Act?
You provided us with an organization chart showing that the Band owns XXXXXXXXXX.
XXXXXXXXXX head office is located on the reserve; the operations of the XXXXXXXXXX are conducted off reserve. XXXXXXXXXX head office is on the reserve; the XXXXXXXXXX, is located off reserve.
Former paragraph 149(1)(d) provided that no tax was payable under Part I on the taxable income of a person for a period when the person was “a corporation...not less than 90% of the shares or capital of which was owned by...a municipality, or a wholly-owned subsidiary to such a corporation...” This provision did not apply if there existed any right, contingent or absolute, for a person other than Her Majesty in right of Canada, a province or a Canadian municipality to acquire shares of the corporation. We cannot comment on the application of these provisions to this situation as you have not provided us information concerning any outstanding rights to acquire shares of these companies.
New paragraphs 149(1)(d.5) and 149(1)(d.6) clarify the scope of this exemption. For a municipal corporation to be exempt from Part I tax, the income of the corporation from activities carried on outside the geographical boundaries of the municipality cannot exceed 10% of its income for the period. In the case of an Indian Band, the geographical boundaries of the municipality are considered to be the boundaries of the reserve lands. Reserve lands are defined in the Indian Act as a tract of land, the legal title to which is vested in Her Majesty, that has been set apart by Her Majesty for the use and benefit of a Band, and for purposes of section 87 of the Indian Act includes ‘designated lands’. Designated lands is defined in section 87 of the Indian Act, as a ‘tract of land or any interest therein, the legal title to which remains vested in Her Majesty and in which the Band for whose use and benefit it was set apart as a reserve has, otherwise than absolutely, released or surrendered its rights or interest.’
In the case of XXXXXXXXXX, you have advised that these activities are carried on off the reserve. If these activities account for more than 10% of the company’s income in a given period of time, the corporation’s income would not be exempt. A similar analysis would have to be applied to the other companies.
3. For which taxation years are the corporations exempt?
If the analysis under #2 above, provides any of the corporations an exemption from tax, in our view, the corporations would have become exempt from Part I tax no sooner than the start of the taxation year that includes January 28, 1994, being the time of the decision in Otineka. Prior to that time, the corporations were considered to be taxable. If the 1994 corporate tax return was filed on time and is not under objection or appeal, the taxpayer would be constrained by the status claimed on filing, and the time of the change in status would therefore occur on the first day of the 1995 fiscal year.
Whenever a corporation’s status changes, subsection 149(10) applies. This section would apply on the first day of the fiscal year of the corporation. From your information, this would appear to be either XXXXXXXXXX, subject to the comments above.
4. Could the Band retract its Canadian municipality status if it found such a claim was not to its advantage?
Whether or not a Band is a municipality is a question of fact. If the XXXXXXXXXX Indian Band qualifies as a Canadian municipality, the Band could not ‘revoke’ its municipal status. However, if the facts regarding the Band’s situation changed, for instance, certain by-laws were canceled and the Band’s powers were reduced, the facts could indicate that the Band no longer qualifies as a Canadian municipality.
5. Is the interest income received by the Band from two of the corporations it owns tax exempt?
In your discussion of XXXXXXXXXX, you indicated that no interest has been paid on the $XXXXXXXXXX loan owed by XXXXXXXXXX to the lender, the XXXXXXXXXX Indian Band. Further, interest that accrued prior to 1993 was forgiven. Interest for 1993 and subsequent years has been added to the loan. While you raised the question about the treatment of interest income, we wish to raise some concerns we have concerning the interest expense.
Interest expense is deductible in the computation of a corporation’s income where the interest expense is reasonable in the circumstances and paid pursuant to a legal obligation. Depending on the terms of the loan documentation, such non-payment without steps taken by the Band to collect may be an indication that such interest does not result from a legal obligation, and therefore would not be deductible. Section 80 debt forgiveness rules may also have application in these circumstances. Further, we would refer you to subsection 78(1) of the Act and IT -109R2, Unpaid Amounts, for a discussion of the potential implications of the non-payment of a deductible amount owed between non-arm’s length parties.
If you find the interest to be deductible, and you find the Band has earned interest income, this investment income would be exempt from income tax under paragraph 149(1)(c) as the Band would be exempt from tax on its taxable income as a municipality.
6. If XXXXXXXXXX is not exempt from tax, how should the forgivable grants from the federal government be treated for tax purposes?
Subsection 149(1) of the Act provides that no tax is payable under Part I on the taxable income of a person for a period when that person was an entity described within the following paragraphs. Accordingly, if an entity is as described within section 149, the entity should still calculate its taxable income.
You advised that in XXXXXXXXXX a forgivable grant was received from the federal government of approximately $XXXXXXXXXX to provide XXXXXXXXXX the funds to develop the XXXXXXXXXX business. The majority of the funds were used to acquire the operating assets of the XXXXXXXXXX. Further, in XXXXXXXXXX, a $XXXXXXXXXX grant was received to assist in covering the operating expenses of XXXXXXXXXX. One half of this grant was forgiven.
Interpretation Bulletin IT-273R, Government Assistance, outlines the general principles followed by the Department for the taxation of government grants and forgivable loans. We do not have sufficient information to provide you with our views on how these grant monies should be treated for tax purposes. However, paragraph 2 of this IT states that if the grant is related to an income deficiency or to specific expenses of the taxpayer, the government assistance payments (in absence of legislation to the contrary) may be added to the income or deducted from the specific expenses of the recipient. Paragraph 8 discusses the treatment of government assistance to enable a taxpayer to acquire capital property. Such assistance would not increase income, but pursuant to subsection 13(7.1) or paragraph 53(2)(k) may result in an adjustment to the capital cost or adjusted cost base of the property. This could have particular relevance when subsection 149(10) has application.
7. What are the GST implications to the Band if it is a municipality?
We have referred your request to Paule Labbe, Acting Manager, Educational Services and Indians, Public Service Bodies and Government Division, GST Rulings and Interpretations Directorate. We have requested she respond to you directly. We have copied her on this memo. She can be reached at 613-957-7957.
8. Is the employment income of a status Indian employee of XXXXXXXXXX, who does not live on a reserve, exempt from income tax?
Paragraph 81(1)(a) of the Income Tax Act and section 87 of the Indian Act exempt from taxation the personal property of an Indian situated on a reserve. The Courts have determined that, for purposes of section 87 of the Indian Act, employment income is personal property. Consequently, in the case of employment income earned by an Indian, what must be determined is whether the employment income is situated on a reserve. The approach to determining whether income is situated on a reserve is based on the Supreme Court of Canada in Williams (92 DTC 6320). The Supreme Court has directed that all factors connecting income to a reserve must be examined to determine if the income is located on a reserve and, thus, is tax exempt.
Based on guidance provided in Williams and after receiving representations from interested Indian groups and individuals, the Department identified a number of connecting factors that describe the employment situations covered by the Indian Act. The Indian Act Exemption for Employment Guidelines (the “Guidelines”) have been developed as a result. Within these guidelines, there are four possible ways in which employment income could be exempted from income tax.
We do not have sufficient information to make a determination under the guidelines. However, we offer these general comments. You have indicated the Indian employee does not live on a reserve, so Guideline 2 does not have application. Given the information you provided it appears unlikely that Guideline 4 could be met, as the activities of XXXXXXXXXX would not meet the requirement that the duties of employment be in connection with the non-commercial activities of the employer.
It is possible that the proration rule under Guideline 1 may be helpful in determining if the employee’s income could be at least partially exempt. Under Guideline 1, the proration rule may exempt the portion of income related to the duties performed on the reserve. This would apply to those employees carrying out at least a portion of their employment duties on the reserve.
Alternatively, Guideline 3 would exempt the employee’s income if more than 50% of the duties of employment were performed on the reserve, and the employer was resident on a reserve. We are unable to assess where the employer is resident. Your letter indicates the corporation’s head office is located on the reserve, while the operations of the XXXXXXXXXX are conducted off reserve. It is a question of fact whether an employer is resident on a reserve. For an employer to be considered resident on a reserve, the reserve must be the place where the central management and control over the employer organization is actually located. The central management and control of an organization is usually considered to be exercised by the group that performs the function of a board of directors of the organization. However, it may be that the real management and control of an organization is exercised by some other person or group. Generally, management and control is exercised at the principal place of business, but it is recognized that this function may be legitimately exercised in a place other than the principal administrative office of the organization. Where an organization, which would otherwise not be considered to be resident on a reserve, is asserting that it satisfies the definition because it holds its board of directors meetings on a reserve, it should generally be considered to satisfy the definition where management and control over the organization is legitimately exercised during those meetings.
A review of all the facts surrounding a situation including a review of the minutes of the board of directors' meetings and resolutions or by-laws passed thereat would be required to conclusively resolve this question of fact.
In summary, it is possible, in certain limited circumstances, for employees of XXXXXXXXXX to have some tax exempt employment income.
Roberta Albert, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
cc. P. Labbe
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