Canada: Aboriginal Taxation: Reasonableness Of Bonuses

Last Updated: November 9 2016
Article by Carl P. Deeprose

Most Read Contributor in Canada, October 2018

Bell v. The Queen 2016 TCC 175 is a Tax Court of Canada decision regarding whether employment bonuses paid to a status Indian by a corporation situated on a reserve were exempt from tax. The Court held that the bonuses were not sufficiently connected to the reserve because they were unreasonable in relation to the employment duties performed.

The case is particularly interesting because it appears to have been quite narrowly decided, and while the specific decision was unfavourable to the taxpayer, it provides insight into how status Indians in similar situations might structure their affairs. 

Background

The taxpayer, a status Indian, owned 51% of a corporation ("Reel Steel") that maintained its office and storage facilities on a reserve in British Columbia, but completed all of its work off the reserve. Reel Steel was a construction company that specialized in placing rebar. The taxpayer was the sole director, the President, and an employee of Reel Steel who worked out of the Reel Steel office. As an employee, the taxpayer's responsibilities included the supervision and management of the business and the financial activities of Reel Steel.

The other 49% of Reel Steel was owned by the taxpayer's spouse (the "Spouse"), who was also an employee of Reel Steel, working primarily on projects outside of the office. As an employee, the Spouse's responsibilities included planning, scheduling and placing rebar. The Spouse was not a status Indian.

The location of the Reel Steel office on a reserve was deliberately chosen so that the remuneration of the taxpayer would be exempt from tax by virtue of the Indian Act. Both the taxpayer and the Spouse were remunerated equally by salary, but the taxpayer also received bonuses equal to 100 percent of the estimated income of Reel Steel. The Spouse received no bonuses.

The Court found that the taxpayer and the Spouse both held central and important positions in Reel Steel, but that the taxpayer did not hold a greater role than her Spouse.

Law at issue

Paragraph 87(1)(b) of the Indian Act exempts from taxation the personal property of a status Indian situated on a reserve. The issue in Bell was whether the bonuses received by the taxpayer were situated on the reserve.

Ratio

The Court determined that the bonuses were employment income, and that, to qualify as tax-exempt, there must be "significant substantive connections between the bonuses and the [reserve]". The taxpayer's position was that the bonuses, like her salaried employment income, was situated on the reserve because her employment duties were carried out at Reel Steel's office on a reserve.

The Court rejected this argument because the taxpayer had "already received adequate compensation for her employment in the form of bi-weekly pay. The bonuses are on top of reasonable compensation":

[54]        The purpose of the exemption is to protect an Indian's entitlements from reserve land. On the facts of this case, the bonuses are not an entitlement from reserve land by virtue of the Appellant's employment because there is no substantive connection between the land and the bonuses.

[55]        Further, I find that it is abusive of the exemption for the Appellant to receive bonuses which exceed reasonable remuneration. Reel Steel has undertaken a transaction that has the appearance of a strong connection between the bonuses and the employment. In reality, there is no substantive connection. This is abusive.

The Court held that there was no evidence that the bonuses were reasonable remuneration or that the bonuses were even intended by the parties to reasonably compensate the taxpayer for her employment duties. The evidence indicated that the taxpayer did not have a greater role in the business than the Spouse, who received no bonus. For the bonuses to be reasonable in the circumstances, the taxpayer should have made a greater contribution to Reel Steel than the Spouse. In the view of the Court, the reasonable implication of a high amount of bonuses in the circumstances is that they were tax motivated and designed to avoid income tax at the level of the corporation as well as at the level of the shareholder.

The Court elaborated, stating that "it would run counter to the purpose of the exemption in the Indian Act to give weight to remuneration that exceeds what is reasonably earned on the reserve".

Implications

Although the Court held against the taxpayer, the decision provides helpful guidance on how status Indians can arrange their affairs to fully benefit from the tax exemption of the Indian Act.

First, the Court rejected the CRA's position that it was abusive to move the Reel Steel office to a reserve, even though it was clear that the office was moved to the reserve for the purpose of taking advantage of the exemption, and even though the reserve was for a band of which the taxpayer was not a member.  The Court held that "[i]f an Indian chooses to situate property on a reserve, the income should qualify for the exemption regardless of the individual's motivation for doing so".

Second, the Court considered a secondary argument that, given that the bonuses were in substance simply corporate distributions to a key shareholder, the operation of the business should be a key connecting factor for the purposes of the exemption. Had Reel Steel operations been predominantly linked to the reserve, the bonuses may have been exempt whether they were reasonable or not.

Third, and most importantly, the bonuses were only barred from the exemption because they were unreasonable, and this analysis appears to have rested largely on the employment income imbalance between the taxpayer and the Spouse despite what the Court found were their equal contributions to the business. The Court viewed the two as equal or near-equal partners, and judged the taxpayer's bonus to be unreasonable by comparison to the Spouse's total remuneration. Had the taxpayer and the Spouse received equal bonus income, or equal employment income in general, the taxpayer likely would have had a much stronger argument that the bonuses were reasonably connected to her employment, which was accepted as being situated on reserve.

Bell provides useful guidance for future tax planning opportunities for status Indians by establishing helpful guide-posts. The taxpayer in Bell was denied the exemption because her bonuses were unreasonable, but this leaves the implication that bonuses paid to a status Indian commensurate with the level of involvement of the individual in the activities of the company should be tax exempt. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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