If you run payroll for an organization that employs First Nations workers, Section 87 of the Indian Act is one of the most important (and most misunderstood) rules you’ll come across. Get it right and qualifying employees keep income they’re legally entitled to. Get it wrong in either direction and you’re looking at over-taxed employees or reassessments from the Canada Revenue Agency (CRA).

The good news: the fundamentals are learnable. This guide covers who qualifies, what “employment income earned on reserve” actually means in practice and the myths that catch even experienced payroll teams.

A quick note on terminology. The Indian Act uses the legal terms “Indian” and “Status Indian,” and CRA guidance and forms follow that language. We use “First Nations employees” or “employees registered under the Indian Act” wherever we can and the legal terms only where precision requires it.

What Section 87 actually says

Section 87 of the Indian Act exempts the personal property of a person registered under the Act, when that property is situated on a reserve, from taxation. The courts have confirmed that employment income counts as personal property, which means that when a registered employee earns employment income on a reserve, that income can be exempt from federal and provincial income tax.

Two conditions have to be true at the same time:

1. The employee is registered (or entitled to be registered) under the Indian Act.
2. The income is sufficiently connected to a reserve — most commonly because the work is physically performed there.

Miss either condition and the exemption generally doesn’t apply. That’s where most of the confusion starts.

What “employment income earned on reserve” means in practice

The location of the work matters more than anything else. The CRA assesses how connected the income is to a reserve using what it calls connecting factors, published as the Indian Act Exemption for Employment Income Guidelines. In broad strokes:

• When all or substantially all of the duties are performed on a reserve, the income is typically fully exempt.
• When duties are split between on-reserve and off-reserve locations, the exemption is usually prorated, so an employee working 25% of their time on reserve may have 25% of their income exempt.
• Where the employer is located and where the employee lives can also strengthen the connection in specific circumstances set out in the guidelines. For example, where the employer is resident on a reserve.

The proration point deserves emphasis, because it’s where payroll gets hard. An exemption isn’t always all-or-nothing. One employee, one job, two tax treatments – a portion of every pay exempt, the rest taxed normally. Applying that split accurately, every pay run, is exactly the kind of detail that manual processes miss.

The employer is responsible for making and documenting the determination. The TD1-IN form (Determination of Exemption of an Indian’s Employment Income) is the CRA’s tool for working through it with the employee and it belongs in your records — if the CRA ever asks why you didn’t withhold tax, the TD1-IN is your answer.

The myths that catch payroll teams

Myth 1: All income earned by First Nations employees is automatically exempt. The most common misconception and it cuts both ways. Registration under the Indian Act alone doesn’t exempt income – the income must also be connected to a reserve. An employee who is registered but works entirely off reserve generally doesn’t qualify. Assuming they do creates reassessment risk; assuming registered on-reserve workers don’t qualify costs those employees money on every pay.

Myth 2: The exemption covers all Indigenous employees. Section 87 applies to people registered (or entitled to be registered) under the Indian Act. It does not generally extend to Métis, Inuit or non-Status First Nations individuals. Terminology matters here and so does documentation.

Myth 3: Everything comes off the pay. Section 87 can exempt income tax and Canada Pension Plan (CPP) contributions have their own treatment tied to the exempt income — but Employment Insurance (EI) premiums still apply. EI is not exempted by Section 87 and it must be deducted as usual on exempt income. Getting this wrong is one of the fastest routes to a year-end mess.

Myth 4: Set it and forget it. Work patterns change. An employee who was fully on reserve might start splitting time off reserve and the exemption percentage should change with them. The determination needs to be revisited whenever circumstances do.

What this means for your payroll process

Administering Section 87 properly comes down to four disciplines:

1. Document eligibility before the first pay: confirm registration, complete the TD1-IN and record the basis for the exemption percentage.
2. Apply the right split every pay run: exempt and taxable portions calculated consistently, with CPP treated correctly and EI always deducted.
3. Keep an audit trail: you should be able to show, for any pay run, why an employee’s tax was reduced and by how much.
4. Report correctly at year-end: exempt income has its own home on the T4 (Code 71 in the “Other information” area), separate from regular employment income. 

For teams doing this manually – overriding tax on every pay run, employee by employee — those four disciplines are a real workload and the risk of a missed cycle grows with every qualifying employee you add. That administrative burden is why we built Section 87 support directly into Employment Hero payroll: exemptions recorded once, applied automatically every pay run.

Here’s what that looks like in practice. Once you’ve made your determination, you record the employee’s treaty status and exemption percentage on their payroll profile — once. From there, every pay run automatically splits their pay into exempt and taxable income at the documented percentage and withholds tax only on the taxable portion, whether they’re fully exempt or working 25% on reserve and 75% off. 

CPP exemption settings are configurable for each employee, and EI is deducted as required, because Section 87 doesn’t exempt it. A visible S87 badge marks each qualifying employee in every pay run, and exempt earnings are shown on their payroll detail, so the audit trail that manual overrides never gave you is simply there. And with exempt income tracked all year, year-end Code 71 reporting flows from records you can stand behind rather than a February reconstruction.

In short: the eligibility determination stays with you, as it should — and everything after it stops being a manual task.

Ready to explore Employment Hero for your business?