| January 18, 1990 | ||
| Assessing and Enquiries | Financial Industries Division | |
| Directorate | C. Robb | |
| 8th Floor- 400 Cumberland Place | 957-2744 | |
| Attention: N. O'Donnell | ||
| Chief, Taxpayer Assistance Section | ||
| YOURS HAV 4000-2 | ||
| HAV 4971-2 HAV 4971-2 | OURS 7-4589 |
Subject: Comments on "Debt Obligations in Bearer Form" Information Sheet
We are writing in response to your memorandum of December 15, 1989 in which you requested our comments concerning an information sheet which you intend to publish concerning the reporting and tax treatment of debt obligations in bearer form. Our comments are applicable to the investment acquired before the 1990 taxation year.
1. In the second sentence of paragraph 4 on page 1, you may wish to acknowledge that long-term bonds issued without coupons are also referred to as zero coupon bonds and that long-term notes, issued at a discount without a stipulated rate of interest, are also subject to the provisions of paragraph 7000(1)(a) of the Regulations.
2. We believe a modification of the last sentence of paragraph 1 on page 2 is required. In our opinion, it is only a certainty that the difference in the redemption amount and the issue price is to be considered solely as interest where a debt obligation described in paragraph 7000(1)(a) of the Regulations (a "PDO") is held to maturity.
3. We suggest that the second and fifth paragraphs, on page 2 be omitted. It is our opinion, as noted in 6 below, that subsection 20(21) would not ordinarily apply upon disposition of a debt described in paragraph 7000(1)(a) of the Regulations, due to the application of subparagraph 12(11)(b)(iii) and subsection 12(4).
4. We suggest an amendment of the commentary in the first paragraph on page 3, related to disposal of the treasury bill prior to maturity, since subsection 20(21) does not apply.
The facts related to the treasury bill are as follows:
| Purchase date | November 1, 1989 |
| Cost | $49,535 |
| Value at maturity | $50,000 |
| Effective yield if held to maturity | 11.42% |
| Disposal date | November 15, 1989 (15 days) |
| Proceeds | $49,900 |
| Date of maturity | December 1, 1989 |
Subsection 12(4) requires a taxpayer who holds an interest in an investment contract on any third anniversary of the contract to include in his income the interest that accrued to him to that time. In this example, the third anniversary is November 15, 1989, pursuant to subparagraph 12(11)(b)iii). The interest deemed to accrue by virtue of subsection 12(4) can be arrived at as follows:
| 11.42% x | 15 x $49,535 = $232.48 365 |
An acceptable alternative calculation would be:
| 15 30 | x $465 (interest, if held to maturity) = $232.50 |
Subsection 20(21) is not applicable because the taxpayer is required to include $232.48 in income as interest and this is also the amount that can reasonably be regarded as having been received in respect of interest. Therefore, there would not have been an excess accrual of interest in this case for purposes of subsection 20(21).
It could be noted on page 3 after the capital gain example, that it is possible for a holder of a PD0 to realize a capital loss if it is disposed of prior to maturity. A capital loss would occur in the example set out above if the proceeds of disposition were less than $49,767. This figure is arrived at as follows:
Cost at date of purchase $49,535 Adjustment to ACB for interest required by subsection 12(4) to be included in income (subsection 52(1)) 232 Adjusted cost base (ACB) $49,767
If the proceeds of disposition were $49,700, the following would result:
(i) Interest income (subsection 12(4)) $ 232
(ii) Capital Loss Cost $49,595 Adjustment subsection 52(1) 232 ACB 49,767 Proceeds of disposition 49,700 Capital loss $ 67
5. We believe a qualification should be added on page 3 to the sentence "The interest deemed to accrue in 1993 is, ..., $910.28." In our opinion, this statement is only true for a taxpayer who has made an election under subsection 12(8) with respect to the investment contract or a taxpayer who is on the accrual basis.
6. The reference to subsection 20(14) in the last paragraph on page 3 should be deleted. Subsection 12(4) requires all the income that accrued to the date of transfer to be included in the taxpayer's income. Therefore, subsection 20(14) is not applicable.
7. We do not believe that the reference to subsection 20(21) in the comments on page 4 is correct. Assume the following:
| Issue date | January 1, 1988 |
| Cost | $ 5,644 |
| Principal amount at maturity | $10,000 |
| Maturity date | December 31, 1993 |
| Date of disposal | December 31, 1991 |
| Proceeds of disposition | $7,000 |
The above example will result in
(i) Interest income (subsection 12(4)) $2,619
(ii) Capital loss Cost $5,644 Adjustment subsection 52(1) 2,619 ACB 8,263Proceeds of disposition 7,000 Capital loss $1,263
Please contact Clayton Robb at 957-2744 if you have questions concerning the foregoing comments.
J.C.ClarkChiefFinancing and Leasing SectionFinancial Industries DivisionRulings Directorate