http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/169121/index.do
Bell v. The Queen (July 27, 2016 – 2016 TCC 175, Woods J.).
Précis: The taxpayer was a status Indian. She did not live on a reserve. She received bonuses in each of the 2005-2008 taxation years from Reed Steel Ltd. (the “RSL”). During the years in question RSL’s office was located on a reserve and the taxpayer carried out the duties of her employment at the reserve office. RSL’s business activities were mostly carried on off reserve. RSL was owned, as to 51%, by the taxpayer and as to 49% by the taxpayer’s husband (who was not a status Indian). Her husband did not receive any bonuses during the years in question. The taxpayer claimed that both her salary and the bonuses were exempt pursuant to section 87 of the Indian Act as being personal property situate on a reserve. CRA allowed an exemption on her salary but assessed the bonuses as taxable and the taxpayer appealed to the Tax Court. The Tax Court concluded that even though RSL had located its office on a reserve, the bonuses were not additional compensation for her employment duties and were not, on the evidence, situate on a reserve. The bonuses were therefore not exempt. The appeal was allowed only to implement some issues agreed upon by the parties. Costs were awarded to the Crown.
Decision: The facts at issue were not complex:
[2] This appeal under the Income Tax Act concerns Ms. Bell’s entitlement to the exemption with respect to annual bonuses received by her from Reel Steel Ltd. (“Reel Steel”). The question is whether the bonuses are situate on a reserve.
[3] Reel Steel is a construction company that is owned and operated by Ms. Bell and her spouse, Michael Bell. Mr. Bell is not a status Indian and does not qualify for the tax exemption.
[4] Reel Steel is a subcontractor that specializes in placing rebar (reinforcing steel) in high rise buildings. During the relevant period, which was from 2005 to 2008, Reel Steel employed up to 50 individuals on various construction sites, mainly in Greater Vancouver and in the B.C. southern interior. Almost none of the construction sites were located on reserves.
[5] Mr. Bell worked on the construction sites in the Greater Vancouver area. Ms. Bell worked in Reel Steel’s office, which in the relevant period was located on a reserve.
[6] Reel Steel paid regular bi-weekly employee remuneration to Ms. Bell and her spouse. During the years at issue, Reel Steel also paid the balance of its annual income to Ms. Bell in the form of year end bonuses.
[7] For income tax purposes, Reel Steel claimed deductions for the regular pay and the bonuses and these deductions were allowed by the Minister. As for Ms. Bell, she claimed the tax exemption with respect to her regular pay and the bonuses. The Minister allowed the exemption with respect to the regular pay and disallowed the exemption with respect to the bonuses.
[8] The issue to be decided is whether the Minister’s treatment of the bonuses was correct. The assessed amounts are slightly less than the actual bonuses paid but nothing turns on this in this appeal.
The structure employed was clearly designed to enhance the tax shelter available from section 87 of the Indian Act:
[24] The Appellant had been advised that her remuneration from Reel Steel would qualify for a tax exemption under the Indian Act if she worked on a reserve. She decided to act on this in 1996 at which time she obtained her status card as an Indian and Reel Steel’s office was moved to the Capilano Indian Reservation #5 (the “Capilano Reserve”) in West Vancouver. The location was not as convenient for the business but it was manageable. The Appellant did not have a prior connection with this reserve.
[25] As mentioned earlier, Reel Steel’s construction work was located in two main locations – the Greater Vancouver area and the B.C. Southern Interior. Almost none of this work took place on a reserve.
[26] In addition to the office on the reserve, Reel Steel had use of storage facilities on reserves. The main storage facility was a rental unit adjacent to the office which was used for general office storage and construction supplies. Another storage facility was rented on a reserve in the southern interior for the work in that part of the province.
[27] Reel Steel also employed a long-time administrative assistant for the Appellant. The assistant, Lil Saranchuk, was originally a friend of the Appellant’s and she was employed full time in the office during the period at issue.
[28] From the time of its incorporation, Reel Steel’s shares were held by the Appellant and Mike on a 50/50 basis. At that time, Mike was the sole director and President.
[29] Beginning around the time of the move of the office to the reserve, certain changes were made to the management structure, as follows.
(a) In November 1996, the shareholdings of Reel Steel were changed from 50/50 to 51 percent for the Appellant and 49 percent for Mike.
(b) In 2002, the Appellant became the sole director and President of Reel Steel, replacing Mike in these roles.
(c) Effective January 1, 1997, the Appellant and Mike each entered into services agreements with Reel Steel. Under these agreements, the Appellant’s services were to include the supervision and management of the business and financial activities of Reel Steel and Mike’s services were to include the planning and scheduling of the rebar activities and placing the rebar. For these services, the Appellant and Mike were each to be paid an equal sum of $4,500 per month, plus benefits. In addition, the Appellant was to be paid 50 percent of Reel Steel’s estimated annual income by way of bonus. Mike’s contract did not provide for bonuses.
[30] The actual amounts paid as bonuses to the Appellant in the taxation years at issue were 100 percent of estimated income, which is twice the amount provided for in the 1997 agreement.
The Crown’s attack on the structure was, to some extent, a shotgun approach:
[33] The Respondent submits that the bonuses are not remuneration from employment but are business earnings from a rebar installing business. These earnings are included in the Appellant’s income as business income under section 9 of the Income Tax Act.
[34] The Respondent further submits that the bonuses are not situate on a reserve regardless of whether they are characterized as employment income or business income.
[35] The Respondent submits that, if the bonuses are characterized as business income, the business income lacks sufficient connecting factors to a reserve because Reel Steel’s business activities did not take place mainly on reserves.
[36] The Respondent also submits that, if the bonuses are characterized as employment income, they are not strongly connected to a reserve. It is suggested that since the establishment of the office on the reserve was tax-motivated, it was an improper manipulation of the connecting factors test and the office should not be considered a significant connecting factor.
The taxpayer’s position was somewhat more surgical:
[37] The Appellant submits that the Respondent should not be permitted to argue that the bonuses are business income. She submits that this would be unfair because she was assessed on the basis that the bonuses were employment income and the Respondent did not take a different position in the Reply.
[38] As for whether the bonuses are situate on a reserve, the Appellant submits that the connecting factors point more toward the bonuses being situate on the Capilano Reserve. It is there, the Appellant suggests, that she predominately performed her employment duties and where important management decisions took place.
[39] Finally, the Appellant submits that issues of impropriety and artificial connections have no bearing on a case such as this. They are only relevant if the Crown alleges sham or that the general anti-avoidance rule applies: Shilling v. The Queen, 2001 FCA 178.
The Court rejected the Crown’s argument that the bonuses were income from business:
[47] Further, this argument is not in the Reply. To the contrary, there is an admission in the Reply that the bonuses are paid by virtue of employment (para. 1 of Reply). It would be unfair for the Respondent to take a different position at trial without setting forth the argument in the pleadings.
However the Court found that the attempt to structure the bonuses so that they appeared to be part of the taxpayer remuneration from the business was abusive:
[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.
…
[76] Based on the evidence as a whole, I have concluded that the bi-weekly pay that the Appellant received was adequate (or more than adequate) compensation for the duties that she performed.
Nevertheless the Court rejected the Crown’s argument that establishing the office on a reserve was abusive:
[78] Finally, I would comment that I do not agree with the Respondent’s submission that it was abusive to move Reel Steel’s office to a reserve. It is clear on the evidence that the office was moved for the purpose of taking advantage of the exemption. This is not abusive in my view. This is not a case where the office has little substance; Reel Steel’s office was substantial.
[79] The Respondent’s argument attempts to read a business purpose test into the Indian Act exemption. This is neither explicit nor implicit in the legislation. If 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.
The Court went on however to reject the taxpayer’s contention that the bonuses were closely connected to the reserve:
[84] Virtually all of Reel Steel’s business is generated and performed off reserve. Mike arranges the business contracts and hires the employees off reserve. Reel Steel’s construction workers work mostly off reserve. There are only two employees that work mainly on the reserve and their role is primarily administrative.
[85] Second, this is not a case in which joint actions taken by the owner-managers are the key drivers of the business. For the most part, business opportunities came to Reel Steel and it was not difficult for Mike to make business decisions with administrative input from the Appellant. These circumstances may be contrasted with the facts in Pilfold in which case a key driver of the business was the owner’s efforts to obtain business contracts which efforts took place on a reserve. Reel Steel’s business operated in an entirely different manner. For the most part, the work came to Mike and he arranged for it to be done, with the assistance of the office.
[86] I find that the operation of the Reel Steel business was more closely connected to the off reserve locations. This factor weighs heavily in connecting the bonuses to the off reserve locations where the construction activities were managed and performed.
The Court found that the other connecting factors argued by counsel for the taxpayer were not persuasive:
[87] Counsel for the Appellant referred to other connecting factors such as the residence of Reel Steel, the residence of the Appellant, and the location where the Appellant was paid.
[88] In my view, the residence of Reel Steel is not a significant connecting factor in this case. The determination of corporate residence, which is the central management and control test, is a judge-made test designed to determine nexus for the ability of a country to impose income tax. The exemption in the Indian Act is essentially a search for substantive connections. This search would be needlessly muddied if the complex test for central management and control were imported into this analysis.
[89] In any event, I find that the central management and control of Reel Steel is split between Mike and the Appellant. Each of them made decisions within their area of responsibility, and occasionally the decisions were joint. Further, the director’s role is not a substantive role in this case. Central management and control is not predominately on the reserve.
[90] As for the residence of the Appellant, which is off reserve, I find that this is not a significant connecting factor with respect to the bonuses. The residence of the Appellant really has very little connection with the bonuses.
[91] As for the place of payment of the bonuses, I find that this is also not a significant connecting factor. The act of paying is a clerical type of action that is easily manipulated. It would be contrary to the purpose of the exemption if this were to be given significant weight.
In the result the bonuses were not exempt:
[92] I conclude that the bonuses paid to the Appellant do not qualify for the exemption in paragraph 87(1)(b) of the Indian Act. The appeal will be allowed only with respect to the issues agreed between the parties. The Respondent is entitled to costs.
Comment: This may be the last reported Tax Court decision of Justice Woods who was elevated recently to the Federal Court of Appeal. She will be a strong and reasoned voice on the Court of Appeal and I wish her the best of luck.