23 October 1989 Income Tax Severed Letter RCT 7-4195

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.

This is in reply to your memorandum dated July 28, 1989, in which you requested our views on the reporting requirements applicable to three hypothetical situations involving stripped bonds. All three situations involve bonds that are stripped into constituent principal and interest elements, which are then sold at a discount. The discussion in this memorandum is based on the hypothetical situations submitted to us and do not purport to be exhaustive of all possible reporting requirements that could arise.

GENERAL

Subsection 12(9) of the Income Tax Act (the "Act") provides for the deemed accrual of interest on "prescribed debt obligations" ("PDO's") described in subsection 7000(1) of the Income Tax Regulations (the "Regulations"). Generally, obligations stripped from interest-bearing bonds qualify as PDO's by virtue of paragraph 7000(1)(b) of the Regulations. To the extent that paragraph 7000(1)(b) applies, the deemed interest accrual is calculated under paragraph 7000(2)(b) of the Regulations. This calculation is made for both the coupon and residue elements of the bond. The deemed accrual rules operate for purposes of subsections 12(3), (4), (8) and (11) and 20(14) and 20(21) of the Act. These provisions of the Act include the annual reporting requirement for corporations and the triennial reporting requirement for individuals. Bill C-28 proposes to change the triennial reporting requirement for individuals into an annual reporting requirement (see subclause 4(2) of Bill C-28).

The deemed accrual rules do not apply to non-residents. However, deemed interest may arise under subsections 214(6)-(7.1) of the Act.

In the following discussion, it is assumed that bonds are stripped by someone other than the original issuer.

PART I: BEARER BONDS

This situation involves municipal or corporate bonds issued completely in bearer format. The interest coupons are stripped from the bonds and sold in bearer form at a discount. The remaining principal (or bond residue) is also sold in bearer form at a discount.

You wish to know the sections of the Act or Regulations that impose reporting requirements on a person who

• a) redeems the coupons from the bearers; or
• b) redeems the bond residue from the bearers.

You also want us to identify the relevant prescribed forms in each case.

Coupons Redeemed From Residents

By virtue of paragraph 201(7)(b) of the Regulations, subsection 201(6) of the Regulations does not apply to the redemption of either the coupons or the bond residue.

Section 234 of the Act and section 207 of the Regulations apply to a bearer coupon upon its presentation for payment by or on behalf of a Canadian resident. This requires the completion of an ownership certificate (form T600 or T600B). The certificate must be delivered to the debtor or encashing agent, who must forward the certificate to the Minister on or before the 15th day of the following month. If an agent negotiates the bearer coupon without disclosing the name of the beneficial owner on the ownership certificate, subsection 201(3) of the Regulations requires the agent to file a separate information return.

Bond Residue Redeemed From Residents

No reporting requirement currently arises when the bond residue is redeemed, even though a portion of this residue may represent deemed interest under subsection 12(9) of the Act and section 7000 of the Regulations. We have considered an argument that the word "coupon" in subsection 234(1) of the Act might also include the bond residue. However, the Random House College Dictionary (Revised Edition, 1975) defines a "coupon" as follows:

• one of a number of small certificates calling for periodical interest payments on a bond.

The definition of a "coupon" appears to encompass stated (i.e. actual) rather than deemed interest. The coupon is that which is detached and the bond residue is that which remains after detachment of the coupon. Even though the stripped residue may result in deemed interest when sold at a discount, it does not come within the conventional meaning of the term "coupon". Subsection 234(1) of the Act refers to a coupon representing interest "payable by any debtor"; while the recipient may be receiving deemed interest, the payor is paying principal.

On its enactment, draft section 230 of the Regulations will introduce a reporting requirement on the redemption of bond residues occurring after December 31, 1990. A bond residue will come within paragraph (b) of the definition of "security" in draft subsection 230(1) of the Regulations. The reporting requirement on redemptions is contained in draft subsection 230(3) of the Regulations. Draft subsection 230(6) of the Regulations obligates nominees and agents to report on behalf of their principals if the transaction is carried out in the name of the agent or nominee. While this new reporting requirement will be subject to several exemptions, stripped bond residues will not qualify for the exemption in draft paragraph 230(7)(e) of the Regulations [see subparagraph (iii) thereof].

Coupons Redeemed From Non-Residents

The coupon represents the payment of stated interest. Even though the coupon may have been stripped by a subsequent holder and sold at a discount, the full amount of the coupon is interest being paid by the issuer. Paragraph 202(1)(b) of the Regulations applies to every Canadian resident who pays or credits interest to a non-resident. This provision requires the payor to file forms NR4-NR4A Summary and NR4 Supplementary. Refer to subsections 202(4)-(6) of the Regulations for additional rules regarding persons deemed to be resident in Canada for this purpose. The requisite forms must be filed on or before March 31 of the calendar year following the year of payment.

Subsection 202(3) of the Regulations requires an agent who receives interest for or on behalf of a non-resident to file an information return.

By virtue of subsection 207(3) of the Regulations, an ownership certificate must be completed under section 234 of the Act in respect of a bearer coupon negotiated by or on behalf of a non-resident if the non-resident is subject to Part XIII tax in respect of the coupon. Form NR-601 is generally applicable, although Form NR602 should be used in respect of specific types of non-resident payees. The certificate should be delivered to the debtor or encashing agent, who must forward the certificate to the Minister on or before the 15th day of the following month.

Subsection 203(1) of the Regulations applies to every Canadian resident who (as nominee, agent or custodian) receives income derived from a source within the United States on behalf of a person whose address is outside Canada. The Canadian resident must file Form NR1 in respect of the payment on or before March 15 of the year following payment.

Bond Residue Redeemed From Non-Residents

To the extent interest is deemed to arise on the bond residue under subsections 214(6)-(7.1) of the ITA, the interest should be reported under paragraph 202(1)(b) of the Regulations. However, deemed interest may not arise on the residue. Deemed interest would arise under subsection 214(7.1) of the Act if the non-resident transferred the bond residue back to the person who had stripped the residue and assigned the stripped residue to the non-resident. However, the non-resident will be disposing of the bond to the original issuer. Deemed interest would arise under subsection 214(7) of the Act only if the redemption price exceeded the amount for which the bond residue was issued. Even though the bond residue may have been stripped and discounted subsequent to its issue, it will likely be redeemed for an amount equal to its original issue price. Subsection 214(6) of the Act applies only in respect of stated interest and does not apply to the bond residue.

PART II: FULLY REGISTERED BONDS

In this situation, a broker purchases government coupon bonds issued in fully registered form and with coupons attached. The broker is entitled to receive all interest payments as well as the proceeds of redemption. The broker notionally separates these entitlements and sells them at a discount in the form of certificates. As the broker receives interest and principal, he distributes them to the certificate holders.

You wish to know the sections of the Act or the Regulations that impose reporting requirements on

• a) the government; or
• b) the broker

when interest and principal are paid to the broker and later distributed by him to the certificate holders.

Payments by Government

Section 16 of the Interpretation Act (Canada) provides that no federal act or regulation is binding on the Crown except to the extent the Crown is referred to therein. While subsection 227(11) of the Act makes withholding requirements binding on the federal and provincial Crown, no provision in the Act or the Regulations expressly binds the Crown in respect of reporting requirements. It may be possible to argue that reporting requirements are part of the obligation to withhold; however, the strength of this argument is open to some doubt. The Crown cannot be bound by necessary intendment alone. As well, the withholding and reporting obligations are contained in separate provisions in the Act and Regulations. Accordingly, Part II of the Regulations should not currently apply to the federal or provincial governments in respect of payments to the broker.

Draft subsection 230(4) of the Regulations will impose a reporting requirement on the Crown in respect of purchases, sales, redemptions, acquisitions or cancellations of securities occurring after December 31, 1990. Under draft subsection 230(3) of the Regulations, a government that redeems, acquires or cancels a debt obligation issued by it will have to make an information return. Exceptions apply if the redemption, acquisition or cancellation occurs in the context of specified "rollover" transactions.

For discussion purposes, the rest of Part II will deal with the reporting requirements that would apply to a corporate issuer of a fully registered bond.

Payments By the Issuer to a Resident

If the issuer issues the bond at a discount, deemed interest will accrue under subsection 12(9) of the Act in respect of the discount. Any deemed interest will have to be reported together with any coupon interest. One of two reporting requirements may apply: subsection 201(4) or subparagraph 201(1)(b)(i) of the Regulations.

Subsection 201(4) of the Regulations applies if the registered owner is a taxpayer other than a corporation, partnership, unit trust or any trust of which a corporation or partnership is a beneficiary. For example, this provision will apply if the registered owner is an individual other than a trust. Pending the passage of Bill C-28, such individuals must include accrued interest in income on at least a triennial basis. In any year in which a "third anniversary" of the bond occurs, the issuer must report the accrued interest that the registered owner would have to report if (i) the registered owner were under an obligation to include accrued interest in his income on every third anniversary date of the bond; and (ii) the registered holder had a taxation year corresponding with the calendar year. This applies whether or not the holder has elected to include interest in income on an annual basis.

The "third anniversary" of a bond is defined in paragraph 12(11)(b) of the Act and includes the date on which the bond is redeemed or otherwise disposed of. However, Bill C-28 will replace the triennial reporting requirement under subsection 12(4) of the Act with an annual reporting requirement. This change will come into effect for investment contracts acquired after 1989 and will require consequential amendments to subsection 201(4) of the Regulations.

Subsection 201(4) of the Regulations will not apply in all circumstances (for example, if the registered owner is a corporation or a partnership). To the extent that subsection 201(4) of the Regulations does not apply, the issuer must report under subparagraph 201(1)(b)(i) of the Regulations at the time it makes a payment as or on account of interest. This includes a payment on account of deemed interest, but the reporting requirement arises only on the actual payment.

To the extent holders are individuals other than a trust, the combination of subsection 201(4) of the Regulations and subparagraph 201(1)(b)(i) of the Regulations essentially requires the issuer to report interest on the earlier of a paid or triennial basis.

Interest should be reported on form T5 Supplementary, with accompanying T5 Summary and T619. The due date for filing is the end of February in the following year.

Payments by the Broker to a Resident

The reporting requirements applicable to distributions by the broker depend on the exact relationship between the broker and the certificate holders.

If the broker holds the bond and related coupons as nomineee or agent of the various certificate holders, the broker will have to report under subsection 201(4) of the Regulations [to the extent that subsection 201(4) is applicable].

If the broker holds the bond as a trustee for the various certificate holders, the broker will have to file T3 and related forms under section 204 of the Regulations.

Since the certificates are themselves sold at a discount, they likely are separate debt obligations and PDO's. Assuming that the certificates do not carry a stated interest rate, they would fall within paragraphs 7000(1)(a) and 7000(2)(a) of the Regulations. If the certificates do not qualify as fully registered bonds or debentures, subparagraph 201(1)(b)(i) of the Regulations will not apply. Subsection 201(4) of the Regulations apply only if the certificates are not in bearer form. If the certificates are in bearer form, section 234 of the Act will apply only if the certificates represent "coupons" on a debt: however, the certificates may well represent separate debt in their own right without any reference to the bond issued by the original issuer. We assume that the certificates do not themselves carry coupons. Accordingly, no reporting requirement currently appears to apply to the certificates.

However, the broker will be obligated to file form T600 or T600B under section 211 of the Relations if the certificates represent bonds, debentures or "similar" securities. This reporting requirement is triggered by a financial company making a payment in respect of accrued interest on the redemption, assignment or other transfer of the security. The return must be forwarded by the 15th day of the month following payment.

Assuming it is enacted and to the extent that no other reporting provision applies, draft section 230 of the Regulations will apply on the redemption of certificates occurring after December 31, 1990.

Payments by the Issuer to a Non-Resident

Payments of interest by the issuer to a non-resident must be reported under paragraph 202(1)(b) of the Regulations.

Payments by a Resident Broker to a Non-Resident

The reporting requirements applicable to distributions by a resident broker to a non-resident will depend on the exact relationship between the broker and the certificate holders.

If the broker holds the bond and related coupons as a nominee or agent of the various certificate holders, subsection 202(3) of the Regulations will apply. If the broker is acting as a trustee, section 204 of the Regulations will apply. If the certificates constitute separate debt, paragraph 202(1)(b) of the Regulations will apply.

Section 211 of the Regulations will apply to the broker if the certificates qualify as a "similar security" for purposes of subsection 211(1).

PART III: PARTIALLY REGISTERED BONDS

In a partially-registered bond, the holder of the residue is registered but the registration does not extend to interest coupons attached to the bond. The interest coupons are stripped from the bond and sold at a discount in bearer form. The bond residue remains in registered form.

You wish to know the sections of the Act or the Regulations that impose reporting requirements on a person who

• a) redeems the interest coupons from the bearers; or
• b) redeems the bond residue from the registered holders.

You also want us to identify the relevant prescribed form in each situation.

Bearer Coupons Redeemed From Residents and Non-Residents

The reporting requirements applicable to the redemption of the bearer coupons are the same as those discussed in Part I above for bearer coupons.

Bond Residue Redeemed From Registered Holders

If the bond residue was not issued at a discount, no interest will accrue in respect thereof and no reporting requirement will arise on its redemption.

If the bond residue was issued at a discount, subsection 201(4) of the Regulations may apply to any deemed interest arising on the discount (see discussion in Part III above). If subsection 201(4) of the Regulations does not apply, no reporting requirements arise in respect of the residue.

Subparagraph 201(1)(b)(i) of the Regulations does not apply to the residue because the bond is not "fully registered". A perusal of several financial, economic and accounting dictionaries yielded the following lone definition of "fully registered" (Lewis E. Davids, Instant Business Dictionary, Illinois: Career Institute, 1971, at p. 151):

• A term generally applied to bonds which are registered as to principal and income. In this form, a bond is not negotiable and interest is remitted by the disbursing agent to the registered owner.

The following definitions are set out by Sloan and Zurcher in A Dictionary of Economics (4th ed) (New York: Barnes & Noble, Inc., 1968, at p. 34)

• A registered bond is recorded in the name of the owner. Interest is paid by check, and transfer of ownership requires formal notice. A registered coupon bond is registered in the name of the owner, but it has coupons attached, payable to the bearer.

This definition indicates that a mere "registered bond" must be registered as to both principal and interest. Of necessity, a "fully registered bond" would have to be registered to at least that extent.

Kohler's Dictionary For Accountants (6th ed) (New Jersey: Prentice-Hall, Inc., 1983) supports the above view. At page 66, it defines "bond" and indicates as follows:

• Bonds are issued in the form of coupon or bearer instruments, or are registered in the name of the owner as to principal only (registered coupon bonds) or as to both principal and interest (registered bonds).

See also the definition of "registered bond" at p. 425 of Kohler's.

Several dictionaries defined a "registered bond" in substantially the manner set out below (Jerry H. Rosenberg, Dictionary of Business and Management. John Wiley & Sons: New York, 1978, at p. 375

• a bond that is entered on the books of the issuing company in the name of the owner. It can be transferred only when endorsed by the registered owner.

To the same effect, see

• a) David Crane, A Dictionary of Canadian Economics. Edmonton: Hurtig Publishers, 1980, at p. 25 ("bond") and p. 289 ("registered security").
• b) Alan Gilpin, Dictionary of Economic Terms. London: Butterworths, 1973, at p. 183 ("registered bond").
• c) Black's Law Dictionary (5th Edition). Minnesota: West Publishing Co., 1979, at p. 163 (under "bond", sub-entry for "registered bond").

These definitions of registered bond do not indicate whether the registration relates only to the bond residue or to both the residue and interest entitlement. Even if the registration of a merely "registered" bond relate only to the bond residue, one would expect a "fully" registered bond to be registered as to both principal and interest entitlement.

If enacted, draft section 230 of the Regulations will apply to redemptions occurring after December 31, 1990.

Conclusion

We trust that the above comments are satisfactory for your purposes. If you have any further questions, please do not hesitate to contact us.