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Canadian Tax and
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Tax Treatment of Income From Investments in
Non-Interest Paying Bonds (Strip Bonds)
Tax Act s. 12(4), 12(9), s. 12(11), s. 52(1)
Income Tax Regulations s. 7000(1)(b), s. 7000(2)(b)
The tax treatment information presented here is regarding bonds which
are held outside of RRSPs or other registered
What is a Strip Bond?
a bond is issued, a brokerage company will buy
bonds and will sometimes split them into two parts
to sell separately. One part is the interest
payment (coupon), and the other part is the
maturity value of the bonds, sold as strip
bonds. A strip bond is a bond that
pays no interest. It is purchased at a discount from face value,
and face value is paid at maturity.
Discount is Amortized and Increases Adjusted Cost Base
For tax purposes, strip bonds are treated differently
from bonds for which interest payments are received. The discount from maturity value is
amortized over the period to maturity, and a portion is
included in income each year as interest income on Line 12100 of the
tax return. Part years are pro-rated. The
cost base (ACB) of the bond will increase each year by
the amount of the discount amortized. At
maturity, the ACB will be equal to maturity value,
so there is no capital gain or loss. A capital gain or
loss can still be realized if the strip bond is sold
prior to maturity. The capital gain or loss is
determined by deducting the ACB from
the sales proceeds.
Rate of Return on Strip Bonds
To determine the amount of
to accrue and include in income each year, the interest rate must be
determined. For example, assume a Canadian taxpayer purchased a
strip bond with a maturity, or face, value of $10,000, on June 30, 2009. The purchase price of the bond is
$8,379.08, and the
maturity date is December 31, 2013, in 4.5 years. The interest rate
used to calculate the annual interest income must be determined. Our
Present Value /
Future Value Calculator can be used to determine the interest rate
when a strip bond is purchased. In this example, the "Find Rate of
Return" column in the calculator is used:
The purchase price of $8,379.08 is the present
The maturity value of $10,000 is the future
Compounding is annual, and
Time period is 54 months (4.5 years)
This results in an interest rate of 4.01% in the
calculator, which is actually slightly higher than the actual rate of
4%, due to the time period not being exactly 54 months.. The table
below uses a rate of 4%. If 4.01% were used, the ACB at the end of
2013 would be $10,004.34. This would be resolved by reducing the
2013 income by $4.34.
ACB of strip
bond at start
end of year
In 2009, the starting ACB is the purchase price on June
30. The annual income amount is $8,379.08 x 4% x 184/365 = $168.96, because the
interest is accrued for the period July 1 to December 31 inclusive.
As you see, the ACB is increased each year by the amount of
notional interest accrued to be included
in taxable income. The interest each year is calculated based on the ACB
at the beginning of the year.
Amount of Interest to Report on Tax Return
Interest is reported up to the anniversary
day each year. For instance, if the bond is purchased on March 31,
and the anniversary day is June 30, only 3 months of interest would be
reported for the year of purchase. If the same bond was purchased on
July 1, no interest would be reported for the year of purchase. In the
following year 12 months of interest income would be reported. If the
bond is not held to maturity, the date that the bond is sold is an anniversary
day, and interest income for the year of sale would be reported up to that
Tax Tip: Keep bonds (especially strip 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.