New Guidance From the Supreme Court of Canada on Interest Income Earned by Status Indians

The Supreme Court of Canada recently ruled on two cases dealing with the taxation of interest income earned by Status Indians from financial institutions located on reserves. The appeals for Bastien Estate v. Canada (2011 SCC 38) and Dubé v. Canada (2011 SCC 39) were heard at the same time and the decisions were released concurrently. In both cases, the Supreme Court ruled that interest income was “personal property of an Indian situated on a reserve.” Under section 87 of the Indian Act, “personal property of an Indian situated on a reserve” is exempt from taxation.

In Bastien Estate v. Canada, Mr. Bastien was a Status Indian who lived on a reserve. He invested a portion of the profits and proceeds from the sale of a moccasin business operated on the reserve. Mr. Bastien invested in certificates of deposit with a caisse populaire (credit union) located on the same reserve. The certificates of deposit paid interest that was deposited into a savings account at the credit union.

In Dubé v. Canada, Mr. Dubé lived part time on a reserve and also owned real property off the reserve. As there was no financial institution on the reserve, he decided to invest at a credit union on another reserve nearby. As in the Bastien case, Mr. Dubé held certificates of deposit that paid interest which was deposited into a savings account at the credit union.

The Dubé case differed from the Bastien case in that Mr. Dubé did not reside on the reserve where the investment income was earned, he did not spend the interest income on the reserve, and he was unable to substantiate that a considerable amount of the invested capital was earned on a reserve.

In both cases, the Tax Court of Canada and the Federal Court of Appeal had held that the interest income earned on the term deposits was taxable, primarily because the credit unions generate their investment income in the economic mainstream and not on the reserve. Therefore, the interest income was not connected to a reserve and subject to taxation.

However, the Supreme Court focused on the nature of the taxpayer’s property rather than the source of revenue for the credit unions. The income from the term deposits derived from a contractual obligation entered into on a reserve with an institution carrying on business on that reserve to pay fixed sums of money on that reserve. Mr. Bastien and Mr. Dubé were creditors only of the credit unions, and not investors in the wider market beyond the credit unions.

The outcomes in these cases appear to raise additional questions that will likely have to be addressed by the Canada Revenue Agency (CRA) in the very near future. For example, will the CRA's assessing policy be extended to include all types of investment income, like dividends and capital gains? Will the CRA issue refunds for interest income that was taxed previously? How will investment income be reported by financial institutions for interest income that is tax exempt?

It will also be interesting to see how the Dubé case will affect the CRA’s future assessing policy. In that case, very little weight was given to Mr. Dubé’s place of residence and the fact that the bulk of the capital invested was not derived from tax exempt activities earned on a reserve. The outcome of the case appears to suggest that Status Indians will have the ability to earn interest income free of tax by investing with a financial institution located on the reserve, regardless of how the capital was earned. It is not entirely clear if the same result would apply if the Status Indian did not reside on a reserve (at least on a part-time basis).

Stay tuned to Tax Alert for more information as this development unfolds.

Tony Alberton is a CA and Senior Tax Manager in the Sudbury-Nipissing office of Collins Barrow.