12 September 2025 External T.I. 2025-1058741E5 - Indian Act Tax Exemption - Owner and Employees

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) Whether the income of an owner-employee is situated on a reserve and exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act. 2) Whether the self-employment income of contract staff is situated on a reserve and exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act.

Position: 1) and 2) It depends.

Reasons: 1) and 2) A connecting factors analysis is required to determine whether the income is situated on a reserve. Where a portion of the income-earning activities takes place on reserve, the exemption may be prorated to reflect the portion of such activities located on a reserve.

XXXXXXXXXX									2025-105874
										Phyllis Chiu

September 12, 2025

Dear XXXXXXXXXX:

RE: Employment income and the tax exemption under section 87 of the Indian Act

This is in response to your enquiry asking whether the employment income of the First Nations employee-owner (Owner-Employee) of XXXXXXXXXX (Corp) and the income of some of its contract staff is exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Income Tax Act (Act).

Our understanding of the information provided is as follows:

• The Owner-Employee is the sole employee and owner of the Corp, is registered under the Indian Act, and lives on-reserve.
• Some of the Corp’s contract staff are registered or entitled to be registered under the Indian Act and live on-reserve (Contract Staff).
• The Corp’s head office is located on-reserve.
• The Corp provides protection services such as emergency placements, 24-hour high risk crisis protection, safe homes, and youth dwelling/group homes, for children and youth under 18 of XXXXXXXXXX under a service agreement with XXXXXXXXXX. Under the agreement, the Corp provides basic needs and essential care for children at risk of harm and ensures the environment promotes family and tribal continuity and integrity. Its services, including support for the children’s social and educational development for First Nations children and youth, are designed to strengthen their connection to the reserve community. The Corp also provides similar services to the children from XXXXXXXXXX First Nation.
• The Corp receives service fees under its agreement with XXXXXXXXXX. The Owner-Employee receives salary from the Corp exclusively for providing services to First Nations individuals.
• The Corp owns and rents multiple homes in XXXXXXXXXX, one on-reserve and three off-reserve, to provide the services. The off-reserve homes are located near reserves to support culturally appropriate teachings. In some cases, these off-reserve locations offer a safer, more structured environment that distances children from high-risk or unsafe situations on-reserve. The services are provided to First Nations children who would have lived on-reserve had they not been brought into the care of the Corp.

You are of the view that the Corp is resident on-reserve and that the Indian Act Exemption for Employment Income Guidelines (Guidelines) (footnote 1) could apply to the Owner-Employee’s and Contract Staff’s income-earning activities.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). 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 IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

Income earned by an individual who is registered or entitled to be registered under the Indian Act (First Nations individual) is exempt from income tax under section 87 of the Indian Act and paragraph 81(1)(a) of the Act only if the income is situated on a reserve. The courts have established that determining whether income is situated on a reserve, and thus exempt from income tax, requires identifying the various factors connecting the income to a reserve and weighing the significance of each factor. This is referred to as the connecting factors test. The connecting factors test is a two-step analysis. First, all potentially relevant factors that connect the property to a location are identified and then each factor is given weight in light of three considerations: the purpose of the income tax exemption, the type of property, and the taxation of that property.

To simplify the application of the connecting factors test with respect to common employment situations, the Canada Revenue Agency together with interested First Nations organizations, developed the Guidelines. You asked whether the Guidelines apply to the situations of the Owner-Employee and the Contract Staff. Whether the Guidelines apply depends on whether the income received by the individuals is employment income. The Contract Staff’s income appears to arise from self-employment (that is, business income) rather than employment and it is a question of fact whether the income received by the Owner-Employee is received qua employee or qua shareholder.

Even if the income received by the Owner-Employee is considered to be employment income, their situation is not considered a common employment situation for which the Guidelines were created to address. Accordingly, the Guidelines do not apply to the situations of either the Owner-Employee or the Contract Staff, and it is necessary to apply the connecting factors test as established by the courts.

In Bell v. the Queen (2018 FCA 91), the courts stated:

“In my view, 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.” [emphasis added]

When applying the connecting factors test to business income the courts have indicated that the most significant connecting factors are:

• where the income earning activities of the business take place
• the type of business and the nature of the business activities
• where the management and decision-making activities of the business take place
• where the customers are located

Other connecting factors that the courts have found to be less significant are:

• whether or not the business owner lives on a reserve
• whether the business maintains an office on a reserve or take business orders from a location on a reserve
• whether the books and records are kept on a reserve
• whether the administrative, clerical, or accounting activities take place on a reserve.

The above connecting factors are not exhaustive, since there are other potential connecting factors that could apply depending on the fact situation. In addition, a connecting factor will have different relevance and weight depending on the specific facts of each case. As a result, there is no standard test that can be used to determine if business income is situated on a reserve. This can only be determined by a review of all the relevant facts at the end of each year and is beyond the scope of a technical interpretation.

However, we can offer the following general comments to assist you in making that determination. Based on our understanding of the information provided, a significant portion of the Corp’s income-earning activities takes place off-reserve. As noted above, in applying the connecting factors test to business income, the courts have given most weight to the location where the income-earning business activities take place rather than the location where the administrative activities take place or the location of the head office. In our view, most of the Corp’s income likely will not be situated on a reserve.

That said, the income tax exemption under section 87 of the Indian Act may be prorated. This means the Owner-Employee’s income received from the Corp will likely be tax-exempt to the extent that the Corp’s income-earning activities take place on-reserve. Similarly, the Contract Staff’s self-employment income will likely be tax-exempt to the extent that their income-earning activities take place on-reserve.

We trust these comments will be of assistance.

Yours truly,

Ms. Nerill Thomas-Wilkinson, CPA, CA

Manager
Non-Profit Organizations and Indigenous Issues Section
Specialty 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 Indian Act Exemption for Employment Income Guidelines - Canada.ca