29 March 2011 External T.I. 2011-0395841E5 - Indian Sole 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: 1. If a portion of business income earned by an Indian sole proprietor results from work completed on a reserve will this income be exempt from tax? 2. Can an Indian sole proprietor rely on the Guidelines?

Position: 1. Maybe 2. No

Reasons: 1. If the income is a result of specific tasks or contracts that are more than incidental to the business and can be readily identified then it is possible to claim a partial exemption from tax. 2. The Guidelines are for employment income only.

XXXXXXXXXX
				2011-039584
				L. Zannese
				(613) 957-2747
March 29, 2011

Dear XXXXXXXXXX :

Re: Indian Sole Proprietor

This is in response to your email dated February 11, 2011, in which you ask whether certain income earned by an Indian, as that term is defined in section 2 of the Indian Act, who operates a business as a sole proprietor is exempt from tax. In addition, you ask whether a sole proprietor can use the Indian Act Exemption for Employment Income Guidelines (the "Guidelines") to claim a partial tax exemption with respect to income earned from duties completed on a reserve.

The situation outlined in your email 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"), together with paragraph 87(1)(b) of the Indian Act, exempt from tax certain income of Indians. Paragraph 87(1)(b) of the Indian Act states that "the personal property of an Indian or a band situated on a reserve" is exempt from taxation. The courts have determined that income is personal property for purposes of section 87 of the Indian Act. 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, requires identifying the various factors connecting the income to a reserve and weighing the significance of each such factor (the "connecting factors test").

The leading court case with respect to the taxation of business income earned by an Indian is Southwind v. The Queen, 98 DTC 6084 (FCA) ("Southwind"). In Southwind, the Federal Court of Appeal endorsed consideration of a series of factors that would be relevant, but not necessarily of equal significance. These factors were: the location of the business activities, the location of the customers, the location where decisions affecting the business are made, the type of business and nature of work, the place where 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 books and records and finally, the residence of the business owner. In most cases, the factor with the greatest significance is the location of the income-earning activities of the business. In addition to the factors set out in Southwind, the courts have also considered the location of a business' suppliers.

In your email, you advise that you are completing the books for a construction company that is owned and operated by an Indian as a sole proprietorship. Further, you advise that the office of the business and its records are not situated on a reserve. The owner of the business does not reside on a reserve. However, some of the business' income is earned on a reserve. You ask whether this income is exempt from tax.

As mentioned above, the key factor in determining whether an Indian's business income is tax-exempt is the location of the income-earning activities of the business. Generally, we consider income earned from work completed on a reserve to be situated on a reserve. Therefore, an Indian operating a business as a sole proprietorship who completes all of his or her income-earning activities from a location on a reserve will usually qualify for the tax exemption with respect to all of the income derived from this business. However, in the situation described in your email, it appears that only some of the business income resulted from construction work completed on a reserve.

Generally, when determining whether business income earned by an Indian is situated on a reserve, we will consider the activities undertaken by the business as a whole. Consequently, the income of the business will be considered to be either situated on a reserve and thus tax-exempt, or situated off-reserve and thus taxable. This is consistent with the view that a business is a single source of income and the exemption should be applied accordingly.

However, where an Indian proprietor earns business income through the completion of specific tasks, to which specific income can be allocated, we will allow the Indian 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 work completed on a reserve is 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 on-reserve activities are incidental, none of the income is exempt.

For a construction business, it may be that certain income can be attributed to specific contracts for work completed on a reserve. Therefore, as long as the work completed on the reserve is not incidental having regard to the business as a whole, the Indian proprietor may be able to claim this income as tax-exempt. In determining the amount of income earned from work done on a reserve, any expenses must be allocated reasonably between the income that is tax-exempt and the income that is taxable.

With respect to your question regarding the application of the Guidelines to income earned by an Indian sole proprietor, we note that these Guidelines reflect the connecting factors that the courts have identified with respect to employment situations. Thus, the Guidelines only apply to employment income and cannot be relied on by a sole proprietor. Instead, a sole proprietor should determine whether his or her income is tax-exempt by reference to the considerations discussed above.

We trust that these comments will be of assistance.

Yours truly,

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