Is your investment income taxable?

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Did you know that based on recent developments with Revenue Canada, it is now more difficult for First Nation people to be exempt from taxation on investment income?

For many years "status" Indian people have relied on Revenue Canada Taxation's policy that "interest on a bank account is earned at the location at which the funds are on deposit." For example, interest is earned based on the address of the branch. Accordingly, interest earned by First Nations people on an account that was situated on-reserve was considered to be exempt, even if the head office of the bank may have been located off-reserve. The 1998 Federal Court of Appeal decision in Recalma vs. The Queen overturns this policy and the effects are now being felt.

As a result of the1992 Supreme Court of Canada decision in Glenn Williams vs. The Queen, Revenue Canada is of the view that the location of a savings account on-reserve would not, in itself, be sufficient to exempt the interest income earned. There could be other factors that would connect the income to a location off-reserve. For instance, you may live off-reserve and earn only taxable income, and use an automated teller machine located off-reserve to deposit funds into a bank account located on-reserve. In this example, it is Revenue Canada's view that the interest income would be taxable, even though the head office of the financial institution may be located on-reserve.

In Recalma vs. The Queen, the following were considered in determining the "location" of the investment income:

? the residence of the taxpayer;

? the origin or location of the capital used to buy the securities;

? the location of the bank branch where the securities were bought;

? the location where the investment income is used;

? the location of the investment instruments;

? the location where the investment income payment is made;

? the nature of the securities; and in particular

(i) the residence of the issuer;

(ii) the location of the issuer's income-generating activity from which the investment is made; and

(iii) the location of the issuer's property that could be subject to seizure in the event of a default.

As you can see, there are more criteria that are considered than just the address of where an account is held. In any given situation, a few of these factors might support an argument for exemption. However, the court has placed considerable weight on where the investment income is being earned.

In Recalma, the income in question was interest from banker's acceptances and income from mutual fund units. Basically, the court concluded that income from these investments started with companies off-reserve and was passed through a bank on-reserve to the investor. Therefore, it was held that the investment income of the investor was not personal property situated on-reserve. The court concluded that in making these investments the investors chose to invest in business conducted off-reserve.

Revenue Canada Taxation recently declared that, based on the Recalma decision, investment income of First Nations could be considered personal property and therefore non-taxable if the funds are situated on a reserve and the income was "exclusively or mainly" connected with a reserve. This is the taxation department's stance so long as almost all of the activity is from loans and investments to First Nations on a reserve and that the loans and investments are "intimately connected" to a reserve. Meaning that if the funds are loaned to off-reserve First Nation people, non-First Nation organizations or invested in securities off the reserve, the investment income is taxable. It is also taxable if the funds are routed through other companies that in turn invest it off-reserve and into economic business activities off-reserve.

Based on these recent developments, it is now more difficult to be exempt from taxation on investment income. However, with careful tax planning and consideration, taxation on your investments can be kept to a mnimum.