Publication

Indigenous Peoples Economic Development: A Business Structuring Solution

Published:

26 novembre 2024

Author(s):

• Matthew Orrell
• James Gogan

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Understanding the taxation of Indigenous Peoples’ governments and structuring of their economic development initiatives is more relevant than ever before. According to Statistics Canada:

• In 2020 the gross domestic product attributable to Indigenous people was $48.9B.
• 7% of private-sector businesses operating in Canada were majority owned by First Nations people, Inuit or Métis.

Indigenous Peoples’ governing bodies are increasingly involved in for-profit business ventures. But while non-Indigenous parties can rely on a simple corporate structure when structuring a business carried on by two or more entities and receive the same after-tax revenue and liability protection, the same isn’t true for Indigenous parties. For Indigenous governments collaborating with non-Indigenous entities, strategic structuring is necessary to achieve the goals of both maximizing profitability and minimizing liability exposure. 

Indigenous Tax Exemptions

A basic understanding of two tax exemptions available to Indigenous governments and their businesses is crucial.

Employment Income. Subsection 87(1) of the Indian Act exempts from taxation the employment income of an “Indian” (the terminology used and defined by the Act) peoples and their bands “situated on a reserve”. Courts have been clear that the determination whether income is exempt from taxation under subsection 87(1) must be made on a case-by-case basis, considering each of four relevant factors both individually and in totality:

• The employer’s residence.
• The employee’s residence.
• The location where the work is performed.
• The nature of the services performed and the special circumstances in which they’re preformed.

While the Indian Act tax exemption can be beneficial, its restricted application to “Indians” limits this benefit to those who meet that definition, their governments and their businesses. Furthermore, it applies only to “on reserve” income, in most circumstances limiting its value when an “Indian” government or for-profit business engages in off-reserve economic development opportunities – increasingly the situation – whether on its own or in collaboration with a non-“Indian” entity.

Public Body Income. Paragraph 149(1)(c) of the Income Tax Act (Canada) exempts from taxation the income of a “public body performing a function of government in Canada”. Since 2016, the Canada Revenue Agency’s policy has been that “Indigenous” (broader than the Indian Act tax exemption) governments qualify as such a public body and thus for this tax exemption. However, paragraphs 149(1)(d.5) and 149(1)(d.6) of the Income Tax Act exempts the income earned of a public body within its boundaries. The boundaries of an Indigenous government is “on reserve”. Paragraph 149(1.2)(b) of the Income Tax Act does offer an exception to this geographical income test; however, it’s limited to cases where the income is derived from an activity carried on in a province as a producer of electrical energy or natural gas, or a distributor of electrical energy, heat, natural gas or water and where the activities are regulated under the laws of the province. Furthermore, paragraph 149(1)(d.5) of the Income Tax Act requires both:

• The public body business be 90% owned by the Indigenous government.
• 90% of the business’s income be earned on the reserve or treaty lands of that Indigenous government.

The Corporation Structure Problem

Where an Indigenous government is undertaking a wholly owned project that meets the paragraph 149(1.2)(b) geographical exception criteria, structuring as a corporation is a viable option: it both maximizes profit objectives through tax efficiencies and limits liability exposure as a shareholder. But where the Indigenous government intends to use that corporation to engage in that same project together with non-tax exempt shareholder, or to do so on non-Indigenous lands, that corporation doesn’t necessarily qualify for the paragraph 149(1)(c) public bodies tax exemption due to the limitations of paragraph 149(1)(d.5). In these circumstances, the Indigenous government must use a different business structure to achieve both the objectives of maximizing profit through tax efficiencies and limiting liability exposure.

The Limited Partnership Structure Solution

An Indigenous government undertaking a business venture with a non-Indigenous party can use a limited partnership structure to achieve both its profitability and liability objectives – at no loss to the non-Indigenous partner(s).

To be a legal partnership, any business must satisfy four elements:

• Two or more parties.
• Carrying on business.
• In common.
• With a view of a profit.

The applicable partnership legislation and the partnership agreement establishing the partnership governs partnership relationships. Partnership legislation typically requires a “limited partnership” be registered and have at least one general partner and at least one limited partner The general partner is typically a corporation that holds the business’s assets and is subject to all its liabilities. The limited partner(s), however, is only liable for the amount it invests in or loans to the partnership. The limited partnership offers Indigenous governments a business structure that allows them to collaborate with non-Indigenous, non-public body entities in off-reserve activities in a way that both maximizes profit and limits liability exposure: 

• The Canada Revenue Agency has ruled on multiple occasions that income earned by an Indigenous band through a limited partnership structure can be tax exempt, if properly structured.

• Under subsection 96(1) of the Income Tax Act, a partnership is not a person – but partnership income is calculated as though it were and is allocated to the partners for tax purposes. The partnership agreement can be structured in a way to allocate virtually all the business’s profit to a limited partner if justified by the partnership agreement and relationship between the parties. One accepted justification is the limited partner’s provision of all investment capital for the business startup. Business profits are allocated for tax purposes to each limited partner’s capital account in accordance with the partnership agreement’s terms. For example, if a limited partner has a tax advantageous position – such as an Indigenous government under section 149(1)(c) of the Income Tax Act – that limited partner can earn its profit on a tax free or tax reduced basis. A corporate limited partner can effectively meet all requirements of paragraph 149(1)(c) if organized correctly. 

• The partnership’s liabilities remain with the general partner and can’t be traced back to the limited partner. This liability protection for the limited partner continues so long as the limited partner doesn’t engage in the management of the business.

In its most basic structure – a single Indigenous community partnering with a single non-Indigenous partner – would have this form:

• The Indigenous government forms a corporation with its registered office on its lands (“Indigenous Co.”).
• The non-Indigenous partner forms a corporation (“Non-Indigenous Co.”).
• Indigenous Co. and Non-Indigenous Co. jointly create a third corporation to act as a General Partner (“General Partner Co.”).
• Indigenous Co., and Non-Indigenous Co. (the “Limited Partners”) enter into a partnership agreement with one another and with General Partner Co. (the “Limited Partnership).
• The Limited Partnership generates income.
• The Limited Partnership income is allocated to the Limited Partners pursuant to the partnership agreement.
• Indigenous Co. receives its Limited Partnership income tax free.

This basic structure is sufficiently flexible, with modifications, to accommodate multiple Indigenous and non-Indigenous parties and to protect broader Indigenous economic initiatives achieving the objectives of tax efficiencies to maximize profitability and minimize liability, and ultimately, the flow of benefits to the Indigenous community.

Please contact your McInnes Cooper lawyer or any member of our Aboriginal & Indigenous Law Team @ McInnes Cooper to discuss structuring your Indigenous business in the most advantageous way.

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