3 January 1992 Income Tax Severed Letter 9133845 - Interest Income - Stripped 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.

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

Subject: INTEREST INCOME- STRIPPED COUPONS Section(s): REG 7000, 12(9)]

913384
L. Holloway
(613) 957-2104

XXX

January 3, 1992

Dear XXX

Re: Stripped Bonds and Coupons

This is in reply to your enquiry concerning the tax treatment accorded to stripped bonds and coupons.

As you know, 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. As the stripped bond no longer bears any interest, it is sold at a substantial discount to its face value 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.

The Income Tax Act (the "Act") requires that in the case of "prescribed debt obligations" (PDO), amounts deemed to be interest must be included in income over the period of ownership of the security. In our opinion both the stripped bond and the interest coupons are PDO's, consequently the totals so included in income, to the maturity of the security should equal the discount.

For all purposes the distinction between principal and interest on the obligation from the perspective of the issuer is ignored, and it is as if all of the payments by the issuer are considered to be a series of zero coupon obligations. A zero coupon instrument refers to a debt obligation in respect of which no interest is stipulated to be payable on its principal amount. This zero coupon instrument is issued to investors at a discount from it's face value and the discount represents the investors yield.

The interest included in income each year is added to the investor's adjusted cost base of the security. On the sale of a stripped obligation prior to maturity, the seller is required to include in his income the amount deemed to accrue as interest in respect of the property to the time of sale except to the extent that it had previously been included in income. A capital gain could result when a PDO is sold prior to its maturity date if the proceeds are greater than the adjusted cost base of the security. Similarly a capital loss could result where proceeds of disposition are less than the adjusted cost base.

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 from the investor's income equal to the amount, if any, that the amount included in his income for the previous years exceeds the total interest actually received thereon.

As for the reporting requirements associated with stripped coupons we concur with the information provided to you in a letter dated June 4, 1991, from the Information Returns Group of our Department. In addition we must agree with the suggestions given to you by your broker on preparing a schedule to include with your tax return showing the reconciliation of reported interest on the T5 slip to the amount reported on the tax return.

We trust our comments will be of assistance to you.

Yours truly,

E. Wheeler
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch