Stocks, Bonds etc. -> Investing Tax Issues -> Interest-paying bonds
Tax Treatment of Income From Investments in Interest-Paying Bonds
This information is regarding bonds which are held outside of RRSPs or other registered accounts.
You must pay tax every year on the interest income received, whether you buy the bond at face value, at a discount, or at a premium.
The amount that you pay for the bond will include the price of the bond, plus any interest accrued on the bond since the last interest payment date. The adjusted cost base (ACB) of your bond will be the total amount paid less accrued interest. To determine the amount of interest income to include in your taxable income, deduct the accrued interest purchased (when you bought the bond) from the first interest income received.
If you purchase the bond at face value and hold it to maturity, there will be no capital gain or loss on the bond.
When the bond is purchased at a discount or premium, and is held to maturity, you will have either a capital gain or a capital loss. If you purchased the bond at a premium, the premium amount will be the capital loss when the bond matures. For instance, if you paid $11,000 for a $10,000 face value bond, you will have a $1,000 capital loss when the bond matures. If you purchased the bond at a discount, the discount amount will be a capital gain when the bond matures.
When bonds are sold prior to maturity, there will be a capital gain or loss. Part of the proceeds will be for interest accrued since the last interest payment date. This will be included in your income as interest income. Your adjusted cost base is deducted from the proceeds (excluding interest) to determine your capital gain or loss.
Capital losses cannot be deducted from other income. They can only be used to reduce or eliminate capital gains. See also the article on Capital Losses on our Filing Your Return page.
Example: Assume you have $11,000 that you want to invest for one year in interest-bearing bonds. You have found 2 different bonds that have the same yield. For one of them you would pay a $500 premium, the other would be purchased at a $500 discount.
| Premium | Discount | |
| Maturity value | $10,500 | $11,500 |
| Interest rate | 12.81% | 3% |
| Interest income | $1,345 | $345 |
| Price paid | $11,000 | $11,000 |
| Capital gain/(loss) at maturity | ($500) | $500 |
| Total income for the year | $845 | $845 |
| Yield | 7.68% | 7.68% |
| Taxable income (interest income + 50% of capital gain or loss) | $1,095 | $595 |
As you can see, the above bonds will result in the same total income, but the taxable income will be higher with the bond purchased at a premium. This assumes that the taxpayer has capital gains against which to offset the capital loss. If not, the taxable income would be $1,345 in the case of the bond purchased at a premium.
See also:
Tax treatment of investments in non-interest paying bonds (strip bonds)
Tax Tips
Keep bonds inside a registered account (RRSP, RRIF, TFSA, etc.). They are not tax efficient, and the bookkeeping is complicated! No bookkeeping is required when they are inside a registered account.
If you buy bonds in a non-registered account, when choosing between similar bonds with the same yield to maturity, the best choice would be the one with the highest discount, because the taxable income will be lower.
Revised: September 19, 2017