13 June 1991 External T.I. 9103705 F - Stripped Bonds and Coupons

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.

5-910370

Dear Sirs:

Re:  Stripped Bonds and Coupons

This is in reply to your letter of February 5, 1991 wherein you requested confirmation of your interpretation of various interest provisions in the Income tax Act (the "Act").  We apologize for the delay in replying.

You mentioned, by way of background, that Canadian investment dealers have engaged in the practice of removing the interest coupons from bonds issued or guaranteed by the federal and provincial governments in Canada and selling the residual or stripped bond separately from the interest coupons to investors. You also mentioned that because the stripped bond no longer bear any interest, it is sold at a substantial discount to its face value.  This discount produces a return to the investors of the bond and similarly the interest coupons are sold at a discount to their face value to compensate for the length of time during which they must be held to their respective payment dates.

We will now respond to each interpretation in the order in which the appear in your letter.

1.        we agree with your interpretation that each of the stripped bond and the interest coupons is a "prescribed debt obligation" (P.D.O.) by virtue of paragraph 7000(1)(b) of the Regulations, with the result that by virtue of paragraph 7000(2)(b) of the Income Tax Regulations (the "Regulation") and subsections 12(4) and 12(9) of the Act, the interest thereon must be included in income over the period of ownership of the P.D.O.  Hence, the total amounts so included in income to the maturity of the P.D.O. should equal the discount.

2.     We agree that the amount so included in income each year for the purposes of subsection 12(9) of the Act is added in computing the cost to the investor of that P.D.O. by virtue of subsection 52(1) of the Act.

3.     We agree that according to subsection 12(9.1) of the Act, when an interest coupon matures, the portion of the proceeds of disposition that may reasonably be considered to represent a recovery of the cost for the investor need not to be included in income.

4.     We agree that when an investor disposes of the P.D.O. prior to its maturity, an amount is required to be accrued as interest income in the year of disposition for the period prior to the date of transfer, according to subsections 12(4) and 12(9) of the Act and section 7000 of the Regulations.

5.     We also agree that on a sale of a P.D.O. prior to its maturity date, a capital gain could result if the proceeds of disposition are greater than the adjusted cost base of the security (adjusted by any increase under subsection 52(1) of the Act).

6.     Finally, when an interest in a debt obligation is disposed of for consideration equal to fair market value at the time of disposition, and where a taxpayer has accrued and reported interest income on that debt obligation, an amount may be deducted under subparagraph 20(21) of the Act in computing the taxpayer's income corresponding to the amount, if any, by which the aggregate of the amounts of interest from that debt obligation that was included in the taxpayer's income for the year of disposition and all previous years exceeds the total interest actually received thereon or receivable.  Where, however, the taxpayer has deducted an amount under paragraph 20(14)b), in respect of the obligation, the deduction under subsection 20(21) is reduced by this amount. Finally, if the proceeds of disposition are less than the adjusted cost base of the debt obligation (adjusted by any increase under subsection 52(1) of the Act), a capital loss will normally result.

We trust our comments will be of assistance to you.

Yours truly,

for DirectorBilingual Services and ResourceIndustries DivisionRulings Directorate