Employment income earned by First Nations employees can be fully or partly exempt from income tax under section 87 of the Indian Act. Getting it right affects every pay stub and the year-end T4. Here's how the exemption works and how PayCub handles it.
What the section 87 exemption is
Section 87 of the Indian Act exempts the personal property of an Indian, including employment income, from tax when that property is situated on a reserve. For payroll, it means some employees' wages are exempt from income tax, either completely or in part.
It can apply when the employee is registered, or entitled to be registered, under the Indian Act. It doesn't apply to treaty beneficiaries of a First Nation whose final or self-government agreement ended the exemption.
Deciding whether income is exempt
Ask the employee to complete Part 1 of Form TD1-IN, Determination of Exemption of an Indian's Employment Income. The CRA's guidelines cover the most common situations:
- At least 90% of the duties performed on a reserve: the employment income is usually fully exempt.
- Less than 90% of the duties on a reserve, with no other guideline applying: the exemption is prorated to the part of the income for duties performed on the reserve.
- Other guidelines can also make income exempt, for example when both the employer and the employee are resident on a reserve.
Unusual situations can give different results. See the CRA's employment income guidelines for more examples, or check with the CRA directly.
What to deduct
Exempt income isn't exempt from everything. The CRA's rules are:
- Income tax: not withheld on exempt income. For partly exempt income, withhold on the taxable part only.
- EI: withheld on all income, exempt or not.
- CPP: not deducted on exempt income unless the employer has filed Form CPT124 to provide CPP coverage to its First Nations employees. For partly exempt income, CPP is deducted on the taxable part.
Source: CRA, payments to First Nations workers.
Reporting it on the T4
- Fully exempt: report the income under code 71 in the Other information area of the T4. Don't include it in Box 14.
- Partly exempt: put the taxable part in Box 14 and the exempt part under code 71.
- Fully taxable: Box 14 only.
Source: CRA, Indians: tax-exempt employment income.
How it works in PayCub
PayCub handles the income tax side of exempt and partly exempt pay, and the T4 split, without spreadsheets or manual adjustments.
1. Turn on the exemption for the employee
On the employee's profile, under the tax exemptions, turn on Indian Act Tax Exempt. Use it for employees who are registered, or entitled to be registered, and whose employment income is exempt under section 87.
2. Set the exempt percentage on each pay stub
Every pay stub for that employee has a field for the % of this pay exempt under Section 87. Enter 100% when all of the work for that pay qualifies, or the share of duties performed on a reserve when only part of it does. Because it's set per stub, it can change from one pay period to the next as the work changes.
3. PayCub splits the pay
PayCub divides each pay into its exempt and taxable parts and withholds income tax only on the taxable part. The pay stub shows the exempt percentage and dollar amount, so you and the employee can see how the pay was treated.
4. The T4 is split for you
At year-end, PayCub totals the exempt amounts and reports them under code 71, with only the taxable earnings in Box 14. There's no need to work out the split by hand in February.
References
All from the Canada Revenue Agency:
- Information on the tax exemption under section 87 of the Indian Act
- Indian Act Exemption for Employment Income Guidelines
- Form TD1-IN, Determination of Exemption of an Indian's Employment Income
- Payments to First Nations workers (payroll deductions)
- Indians: tax-exempt employment income (T4 reporting)
This post is general information, not tax or legal advice. If your situation is unusual, check with the CRA.
Learn more
For a quick reference, see our Indian Act exempt income guide in PayCub Resources. If you have questions about setting up an employee, email [email protected].