Principal Issues: [TaxInterpretations translation] 1. What is the tax treatment of a premium paid by an investor on the acquisition of a bond in the secondary market?2. Does subsection 12(9.1) apply in the particular situation?
Position: 1. The premium forms part of the cost of the bond for the purpose of determining the adjusted cost base. The loss on disposal of the bond relating to the premium is a capital loss.
2. No.
Reasons: 1. Text of the Act.
2. The wording of 12(9.1).
Financial Strategies and Financial Instruments Roundtable,
2006 APFF CONFERENCE
Question 2
Bond purchased at a premium and section 12(9.1) of the Act
An individual acquired a bond, bearing interest at 7% and with a face value of $100, for investment purposes. The security was purchased on the secondary market and the investor paid a price equal to the market value at the time of purchase which differed from the issue price of the bond. The cost of the bond was $124, including the premium, to generate a return of 4% per annum that reflected market conditions at the time. Each year, the individual receives the 7% interest amount which he includes in his income under paragraph 12(1)(c).
a) What is the tax treatment of the premium paid by the investor on the acquisition of the bond? b) Can subsection 12(9.1) apply on the maturity or disposition of the bond in the particular situation?
CRA Response
In a situation where an individual acquires an interest-bearing bond in the secondary market as an investment at a premium, it is the CRA's view that the premium paid is an amount that forms part of the cost of the debt obligation for the purpose of determining the adjusted cost base of the debt obligation. Accordingly, the loss realized on the disposition of the debt obligation resulting from the premium on the disposition of the obligation (at maturity or on assignment) will be considered a capital loss. Furthermore, the length of the holding period of the bond does not change the nature of the premium.
However, where an individual holds a bond as a trader or dealer, it is CRA's view that any loss realized on the disposition of the bond that is attributable to the payment of a premium will be on income account.
Subsection 12(9.1) provides that where a taxpayer disposes of an interest in a debt obligation in respect of which the taxpayer's share of the principal payments is unequal to the taxpayer's share of the interest payments on that obligation, the portion of the proceeds of disposition that can reasonably be considered to represent a recovery of the cost to the taxpayer of the interest in the debt obligation will not be included in computing the income of the taxpayer.
In accordance with the Explanatory Notes issued by the Department of Finance, subsection 12(9.1) was introduced in the Act to prevent a taxpayer who cashes a stripped bond or a residual bond (including such debts that are indexed debt obligations) from having to include the entire amount received in computing income. A residual bond and a stripped bond are types of debt obligations where the interest coupons and the principal of the bond are sold separately and are prescribed debt obligations under paragraph 7000(1)(b).
The CRA is of the view that an obligation such as the one described in the above example is not an obligation described in paragraph 7000(1)(b) and therefore the provisions of subsection 12(9.1) do not apply.
Adèle St-Amour
(613) 998-0290
2006-019703
October 6, 2006