Canada: Taxation Law @ Gowlings - June 22, 2009

Last Updated: July 16 2009

Edited by Mark L. Siegel

  • Case Comment: The Elusive Exemption from Taxation on Investment Income under the Indian Act
  • Considerations in the Trading of Carbon Credits

Case Comment: The Elusive Exemption From Taxation On Investment Income Under The Indian Act
By: Maxime Faille

When the right to vote in federal elections was finally extended to status Indians in 1960, many First Nation leaders were concerned that this would lead to an erosion of treaty rights and legislative protections including, specifically, the protection from taxation and seizure of personal property under ss. 87 and 89 of the Indian Act.

Since 1850, legislation in Canada has in some form shielded the property of "an Indian" from taxation and seizure. These exemptions are borne from the Crown's duty to protect First Nations from the incursions of First Nation property that marked the late 18th and early 19th century. They also form part of the complex web of arrangements with First Nations that are the basis of our shared existence within what has become Canada.

The concerns that representation would lead to taxation were warranted, particularly since the right of a status Indian to vote had since 1950 been conditional on executing a waiver by which the status Indian would surrender the right to be tax exempt. Explicit assurances had been given by the government, however, that these fears were groundless, and that "existing rights and treaties... possessed by the Indians, will not in any way be abrogated or diminished in consequence of their having the right to vote."

The fears of First Nation leaders have, however, been borne out. CRA and the courts have taken an increasingly narrow view of the scope of the exemption from taxation. Underpinning this narrowing of the exemption is the very rationale that First Nation leaders feared would come to pass: the view that First Nation peoples, in joining "mainstream" Canadian society, could no longer expect to enjoy the special "privileges" conferred upon them.

The onset of the erosion can perhaps be traced back to Williams, in which the Supreme Court of Canada endorsed a malleable "connecting factors" test for determining whether property is "situated on a reserve." This approach opened the way to a subjective and discretionary assessment by CRA and the courts, in which any connection between the property and the "outside world" has generally lead to the conclusion that the property is not "situated on a reserve."

The courts have grafted onto this "connecting factors" test a "commercial mainstream" filter, by which the exemption is limited to property that is of an "Indian nature" and relates to a "traditional way of life," despite the absence of such qualifiers in the legislation. When a status Indian engages in economic activity that is outside this so-called "traditional way of life," he or she is deemed to have entered the "commercial mainstream" and to have chosen, in effect, to renounce his or her rights and entitlements as a status Indian. He or she has chosen, by this logic, to be treated like "other Canadians" and should therefore pay tax "like other Canadians."

Such an approach evokes an ignominious past in which status Indians were involuntarily "enfranchised" and stripped of their status upon attaining a university degree or being admitted to a profession. It has its roots in the now-discredited policies of assimilation that sought to absorb First Nation peoples into "mainstream" Canadian society.

The Bastien Case

The "commercial mainstream" approach is applied most vigorously in the area of investment income, as first set out in Recalma, and as now re-affirmed in Bastien.

In Bastien, the taxpayer was a status Indian, a member of the Huron-Wendat nation, who had lived his entire life on the Wendake reserve. He engaged in the business of making and selling moccasins through a company that operated on reserve. The profits from the business were invested in the on-reserve "caisse populaire".

All the income's "connections" pointed to an on-reserve location, except for the fact that a majority of the caisse populaire's investments were placed in Canadian and global capital markets. This factor was enough, the court ruled, to situate this property "off reserve" and therefore expose it to taxation.

This confirms an approach by which status Indians cannot participate in the Canadian or global economy without thereby renouncing their rights as status Indians. In the words of Megan O'Brien, the effect of this approach is "to reduce the 'protected reserve system'.... to a separate, ring-fenced, exclusively traditional economy...".

Leave to appeal to the Supreme Court of Canada has been sought and denied in several similar cases. It is hoped that the Court will see fit to hear a case in the near future in which the existing approach can be re-evaluated.

Tax Considerations In The Trading Of Carbon Credits
By: Simon Labrecque

In this series of three articles, we will address certain tax considerations related to the trading of carbon credits. First we will address general comments on the Carbon Credit Market and the tax consequences of the initial allocation of emission allowances.

Introduction: What is the Carbon Credit Market?

In both Canada and the United States, markets for green house gas emission reductions or offset credits ("Carbon Credits") and emission allowances are emerging. Although relatively unknown to the general public at the present time, these markets may take on an increased level of importance in the months to come.

In April 2007, the Canadian federal government announced a regulatory framework that will require certain companies to reduce their green house gas ("GHG") emissions over a ten year period beginning on January 1st, 2010. The framework also introduces an intensity based "Cap and Trade system". Thus, companies that are able to reduce their GHG emissions below the required standards, or which voluntarily reduce when they have no obligation to do so, will be able to sell the additional GHG emissions avoided or offset to companies who are unable to meet their required GHG targets in the given period. In this way, there would be a system-wide intensity cap on GHG emissions with different market players trading Carbon Credits to offset others' reduction shortfalls.

Unlike other "Cap and Trade" systems developed and in application around the world, Canada has, for the time being, decided to use an intensity based cap on emissions as opposed to an absolute cap or "hard cap". Under Canada's proposed intensity based cap, regulated entities are required to reduce their emissions per unit of production. For example, if, in its baseline year (2006) the Acme Pen Co. produces 1 ton of GHG per pen, then by January 1, 2010, that company will have to have demonstrated an 18% reduction in the amount of GHG emissions per pen. In other words, it must, by January 1, 2010, emit only .82 tons of GHG per pen. Many have been critical of this system since it permits total GHG emissions to rise in absolute terms if industrial production increases, so long as emissions are produced more efficiently. Proponents of this system argue that in times of economic slowdown, an intensity system works better since it continues to require reductions from regulated entities, whereas a "hard cap" can be met through reduced commercial output.

As a signatory to the multilateral Western Climate Initiative, Quebec is likewise expected to put in place limits on GHG emissions by the year 2012. These limits will eventually affect an even broader spectrum of companies than those currently being targeted by the federal framework.

One does not however have to wait for these measures to come into force to see Carbon Credits being traded; already a market has been developing for such products. More specifically, standards are in place to validate the emission reduction results of voluntary efforts by companies, following which the company can sell the Carbon Credit in the primary market. Although, different certification standards and prices exist Carbon Credits certified at the same standard as will be required by the proposed federal framework have sold recently for $6 to $10 a tonne in over the counter forward contracts transacted in Canada.

If it is not already the case, most companies will soon seriously consider their own emissions and upcoming emissions reduction requirements and look to the Carbon Credit markets for both opportunities to capitalize on their emission reductions and to make up for any possible shortfalls. At that time, it is important that they also keep in mind the possible tax consequences of trading in Carbon Credits as they may have an important impact on the profitability or cost, as the case may be, of GHG emission reduction efforts.

This text will deal specifically with the tax consequences of buying or selling emission allowances and Carbon Credits. Obviously other tax consequences may attach to the emission-reduction efforts that a company must undertake in order to generate that credit and this is also an issue that needs to be followed closely. Also, we did not address the other tax considerations related to certain "green" initiatives, such as investment in plants, equipment and research and development.

Tax Treatment of the Initial Allocation of an Emission Allowance

An emission allowance is a permit or a quota issued by the regulating authority that conveys to the holder the right to pollute. It is anticipated that Canada will allocate a portion of the allowances to existing emitters and keep a portion to offer for sale at an auction. In result, a GHG emitter having emissions which exceed its allowances will have to either reduce its emissions to the allocated level or buy additional allowances on the Carbon Credit markets to cover the emissions in excess of the allocated level.

For income tax purposes, the initial allocation of an emission allowance would likely not have any direct acquisition cost, but may have indirect costs that would be considered to form part of the cost of the allowance. Certain of these indirect costs may be fully deductible under subsection 20(1)(cc) of the ITA as representing the costs of obtaining a permit, license, and so forth.

However, the value of the allowances granted (if any) might be required to be included in income for tax purposes under paragraph 12(1)(x) of the Income Tax Act ("ITA") as an amount received from a government, municipality, or other public authority.

The allocation of emission allowances should be an exempted supply for sales tax purposes since it should be made by a public sector body for a nil consideration.

In the next article, we will address the tax considerations for a buyer and seller of emission allowances and Carbon Credits.

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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