Shilling Decision: Tax-Planning Arrangements Based on Section 87

The Rachel Shilling case dealt with an "employee-leasing" arrangement, whereby an individual who lived and worked off reserve, was employed through an on-reserve employment agency. The latter agency provided status Indian workers to off-reserve organizations.

In a June 2001 decision, the Federal Court of Appeal unanimously concluded that the employment income at issue in the Shilling case was not exempt from tax under section 87 of the Indian Act. The court found that all of the significant connecting factors pointed to an off-reserve location for the income. In March 2002, the Supreme Court of Canada refused to hear an appeal of this decision. However, some related litigation continues.

In the Shilling case, the Federal Court of Appeal said that Indians are entitled to make tax-planning arrangements to take advantage of the section 87 exemption. The court advised that, unless an arrangement is a sham or comes within the general anti-avoidance rule in section 245 of the Income Tax Act, there should be no discounting of the weight to be accorded a connecting factor simply because it was motivated by tax-planning and a desire to avoid the payment of income tax.

However, the court in Shilling also held that contracting with an on-reserve employer will be given only limited weight as a connecting factor, in the absence of evidence that would support giving this factor any additional weight. (Such evidence might include demonstrating substantial business activities carried out on reserve, or significant benefits flowing to the reserve from the presence of the employer.) In another decision in 2001, The Queen v. David Monias, the Federal Court of Appeal also stated that "an employer's location of convenience on a reserve will do little to connect the employment income to a reserve."

As a result, a leasing arrangement with an on-reserve employer will generally not be sufficient by itself to make employment income exempt under section 87 of the Indian Act. To be exempted under s.87, an Indian employee in such a leasing arrangement would need to show:

1. other factors connecting the income to a reserve; or
2. specific evidence that would give greater weight to the employer as a connecting factor.

Refer to the Federal Court of Appeal reasons for judgment in Shilling and Monias.