3 June 2003 2002-014675A50 - Computation interest on bonds/estate

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: (1) How much interest should have been included in the income of an estate with respect to a bond on which a premium was paid. (2) How is the premium factored in the calculation of the capital gain that arose on the sale of the bond? (3) How is the income earned on the stripped bond taxed? (4) Issues related to the final period of the estate.

Position: (1 and 2) All the interest income has to be included in income, but a deduction may be claimed with respect to the accrued interest that was included in income by the transferor (par. 20(14)(b) of the Act). The accrued interest is a right or thing that has to be included in the terminal return. The estate may claim a deduction with respect to that interest (ss. 20(14) of the Act). The premium paid on the purchase of a bond is added to its ACB, and any amount deducted under ss. 20(14) of the Act reduces the ACB. (3) The owner of a strip bond is required to include the interest that accrued at the end of the anniversary day of the contract (ss. 12(4) of the Act) and that amount is included in the ACB of the bond (ss. 52(1) of the Act. (4) An estate may deduct the amounts payable to a beneficiary and the appropriate T3 or NR4 slips have to be issued. (5) Various considerations.

Reasons: Wording of the Act.

		2002-014675
XXXXXXXXXX 	Gwen Moore
		Yves Moreno
June 3, 2003

Dear XXXXXXXXXX:

Re: Computation of interest income on bonds by an estate.

This is in reply to your letter of March 4, 2002, wherein you requested clarification of the rules related to the computation of the income and gain earned by an estate in respect of some bonds purchased at a premium and of some stripped bonds. The taxation year of the estate ends December 31. You mention in your letter that the estate has acquired the bond for a capital amount of $5,000 in October 1996 for a price of $5,151.50 (plus accrued interest). The estate received $355 (7.1% of $5,000) in respect of that bond every year and that amount was included in the income of the estate. That bond was sold for $5,345.50 in September 2001 when all the assets of the estate were disposed of. The estate also owns strip bonds. You indicate in your letter that the estate will be terminated by the end of March 2002 by the transfer of all its assets to its beneficiaries. You finally indicate that it is your intention to report the tax of the estate as zero with respect to the taxation year ended in December 31, 2001, and to issue T-5 slips to the beneficiaries with respect to the interest and other income of the estate.

You ask the following information: (1) How much interest should have been included in the income of the estate, $355 or an amount that takes into account that part of the amount disclosed in the T5 slip received by the estate is a return of the $151.50 premium that was paid on the purchase of the bond? (2) How is the premium factored in the calculation of the capital gain that arose on the sale of the bond? (3) How is the income earned on the stripped bond taxed? (4) Is it appropriate to issue a T5 slip to the beneficiaries for the 2001 year of the estate? (5) If the income of the estate was not properly reported in the past, how can that be fixed?

While a verbal response was provided to you on July 11, 2002, you have asked that we also provide a written response. Your request appears to relate to an actual transaction and, accordingly, should have been referred to the local tax services office for reply. Consequently, while we are unable to comment on your specific situation, we can offer the following general comments.

Questions 1 and 2

As discussed with you on July 11, 2002 (XXXXXXXXXX \Storry), as the general rule, interest income must be included in an individual's income for tax purposes when it is received or receivable pursuant to paragraph 12(1)(c) of the Income Tax Act (the "Act"). As such, where a debt obligation is purchased and an amount is paid by the purchaser (the "transferee") to the vendor (the "transferor") in respect of accrued interest, which is payable after the time of purchase, the transferor is required to include in income any interest payable including interest that accrued on the bond prior to the time of purchase. However, it is the position of the Canada Customs and Revenue Agency that the transferee will be entitled to a deduction in respect of the accrued interest pursuant to paragraph 20(14)(b) of the Act to the extent that the interest is included in the income of the transferor of the interest-bearing obligation.

If an individual paid a premium on a provincial bond upon its acquisition, that premium would be added to the adjusted cost base ("ACB") of the bond. A capital gain would arise upon the disposition of the bond if the proceeds of disposition exceed the ACB. A capital loss would arise if the proceeds of disposition were less than the ACB.

In the situation where a bond was acquired by an estate for face value plus accrued interest, you have enquired as to how a gain/loss would be calculated on the disposition of the bond.

As stated in paragraph 7 of Interpretation Bulletin IT-410R,

Regardless of the method followed in computing income, subsection 70(1) brings into the income, for the year of death of a taxpayer, the value of all amounts of interest (other than, after November 12, 1981, an amount with respect to an interest in an annuity contract to which paragraph 148(2)(b) applies) that accrued but were not payable on or before the date of death (see IT-210R). Where the provisions of subsection 70(1) apply with respect to interest on a debt obligation, which is transferred to the estate or a beneficiary of the deceased, the Department considers that, for the purpose of subsection 20(14), the deceased taxpayer is to be regarded as the transferor and the estate or the beneficiary, as the case might be, is to be regarded as the transferee. Accordingly, in these circumstances the estate or beneficiary will be entitled to the deduction under the rules of subsection 20(14) applicable to a transferee...

Therefore, upon the death of a taxpayer, if a debt obligation is transferred to the estate and all accrued interest is included in the income of the deceased taxpayer pursuant to subsection 70(1) of the Act, the estate will then be entitled to a deduction pursuant to subsection 20(14) of the Act for interest that accrued on the bond prior to the time of purchase.

If an estate is entitled to a deduction under subsection 20(14) of the Act, paragraph 53(2)(l) of the Act requires the ACB of the debt obligation owned by the estate to be reduced by the deductible accrued interest. If no accrued interest is deductible under subsection 20(14) of the Act, the ACB of the property owned by the estate will equal the amount paid to acquire the bond (i.e., the face value of the bond plus accrued interest).

Question 3

You have asked how to determine the interest income and capital gains with respect to the strip bonds. A strip bond acquired by an individual is an "investment contract" pursuant to the definition in subsection 12(11) of the Act and a "prescribed debt obligation" as defined in subsection 7000(1) of the Income Tax Regulations.

Subsection 12(4) of the Act requires a taxpayer, holding an interest in an investment contract on any anniversary day of the contract, to include in income for the year the interest that accrued to the end of that day to the extent that it has not already been included in computing the taxpayer's income for the year or any preceding year.

The amount of interest so included in income is added to the cost of the investor's debt obligation by virtue of subsection 52(1) of the Act. On the disposition of a strip bond, a capital gain could result if the proceeds of disposition are greater than the ACB of the bond. Similarly, a capital loss could result where proceeds of disposition are less than the ACB.

Question 4

An estate may deduct in the computation of its income the amount of income that is paid to its beneficiaries or on which the beneficiaries are entitled to enforce payment (subsections 104(6) and (24) of the Act). Accordingly, provided all the income earned by an estate is payable to its beneficiaries before its year-end, the income of the estate would normally be nil.

Before all the property of an estate is distributed, the executor is required to obtain a clearance certificate, unless no tax was owed or property having a value equal to the tax liability is left in the estate (page 14 of the 2001 T4013 - T3 Trust Guide, hereafter the "Guide"). The clearance certificate can be requested by filing form TX19 "Asking for Clearance Certificate". If those conditions are not met, the executor is personally liable for the payment of those amounts to the extent of the value of the property distributed.

However, contrary to what is indicated in your letter, the executor would be required to use the T3 Summary and to issue the related T3 slips and not T5 slips with respect to amounts allocated to resident beneficiaries (Section 204 of the Income Tax Regulations). If those amounts are paid or credited to a non-resident beneficiary, the executor would be required to issue a NR4 Summary (Return of Amounts Paid or Credited to Non-Residents of Canada) and the related NR4 slips (Statement of Amounts Paid or Credited to Non-Residents of Canada for Services Rendered in Canada). Penalties are payable if the appropriate returns were not filed or if the appropriate slips were not issued, but subsection 220(3.1) of the Act might apply to waive those penalties, provided the estate's situation is along the guidelines of Information Circular IC 92-2 "Guidelines for the Cancellation and Waiver of Interest and Penalties".

With respect to reopening or reassessing past taxation years of an estate, the general rules set out in the T3 Trust Guide under the heading "After you file" are applicable.

This opinion is provided in accordance with the comments in paragraph 22 of Information Circular 70-6R5.

We trust our comments will be of assistance.

Theresa Murphy
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
- 6 -