The s.87 Tax Exemption: Applying the "Connecting Factors" Test

Under section 87 of the Indian Act, status Indians and Indian Bands are exempt from paying tax on their real property (land and buildings) and personal property (including income and employment insurance) situated on a reserve.

When the property being considered is intangible, such as employment income or employment insurance benefits, it is not always simple to determine where it is situated. Should one decide the location of such property by examining where the income is earned, where it is spent or where it is paid?

"Connecting Factors" Test

In the 1992 Williams decision, the Supreme Court of Canada developed a test that helps to clarify the location of intangible property. The Court held that to determine where the property is located one must consider the factors that connect the property to the reserve. For example, in the case of employment income, the factors that may connect the income to the reserve include: the residence of the employee, the residence of the employer, where the work is performed, where the income is paid, and whether the employment benefits the reserve. The Courts have considered many other connecting factors as well.

Although the various factors are weighed differently in each case, the underlying question is whether or not granting the tax exemption furthers the purpose for which section 87 was enacted. The Courts have held that the aim of the tax exemption is not to confer a benefit to all aboriginal people, but rather to protect the property interests of aboriginal people in their reserve lands. There have been several Court cases applying the Williams "connecting factors" test.

Decisions Following the Williams Case

In 1997, the Federal Court of Appeal decided in the Folster case that the employment income of an aboriginal woman who worked as a hospital administrator was tax exempt. The Court rejected the trial judge's decision to focus only on the employer's residence and the location of the hospital, which were both off-reserve. Instead, the Court assigned more weight to the nature of the employment and the circumstances surrounding it. The employee lived on reserve and worked at a hospital near the reserve which was dedicated to meeting the health needs of the reserve community. Taking these and other factors into consideration, the Court held that the employee's income was tax exempt because it was intimately connected to the reserve.

In 1998, the Federal Court of Appeal considered in the Recalma case whether the investments made by an aboriginal family through a Bank of Montreal branch located on a reserve were tax exempt. The Court denied the tax exemption because it found that the corporations through which the investment had been made, the location of the assets and the sources of the income were not connected to the reserve. The Court suggested, however, that its conclusion might have been different if the investment had been used entirely or mainly for loans to aboriginal people on reserve.

In 2000, the Federal Court of Appeal rendered a decision in favour of Canada in Walkus. In that case, the taxpayer was an aboriginal person who owned a fishing company. Even though the company had an office on the reserve, the Court concluded that income of the company's First Nation employees was taxable.

In this case there was little activity carried out in the office. Further, no argument was made concerning a significant connecting factor: the fact that Coastal Indian reserves were set apart in small, low value locations based on the understanding that Coastal First Nations would continue to rely on the sea for their livelihood. Under this argument a tax on fishing is indeed a direct erosion of the value of the reserve base itself.

Finally, in 2001, the Federal Court of Appeal issued the Shilling decision. In that case, an aboriginal person was employed at a health agency off reserve but was hired through an employer located on reserve. The Court held that there was little evidence of the benefit the employment provided the reserve. It found, instead, that the location and nature of the employee's work were important factors in determining whether the employment income was situated on or off reserve, and found that the income was not tax exempt.

The cases following Williams provide some helpful guidance as to the nature and limits of the section 87 tax exemption. However, the scope of this exemption remains to be fully worked through on a case by case basis.

First Nations and First Nation members should consider discussing their business and employment arrangements with their lawyer or accountant so as to maximize the benefits available from this and other tax exemptions.