Government Bonds  

Canadian Taxation
The following information, compiled from legislation, regulations, Department of Finance announcements and other published sources, is designed to give an outline of the various tax levies in Canada that, as of May 31, 2002 affect investments in debt obligations of or guaranteed by the Canadian Federal or Provincial Governments. Because the statutory provisions relating to the taxation of interest income and capital gains in Canada contain many special rules, all of which cannot be covered in this outline, the publisher and the author make no representation as to the accuracy or completeness of any of the following comments. Taxpayers are urged to consult their own tax advisors for advice relating to their own circumstances.

Government of Canada
Income Tax
(a) Residents of Canada
Under the federal Income Tax Act, in computing income for tax purposes, residents of Canada (individuals and corporations) must include all amounts received or receivable in respect of interest depending on the method regularly used by the taxpayer in calculating profit. Notwithstanding this general rule, taxpayers are required to include accrued interest annually on debt obligations to the extent not otherwise included in income.

Issuers of registered bonds or debentures are required to provide each year to the holders of their debt obligations a form (T-5 Supplementary) reporting the total payments of interest for that year or total interest accrued to the applicable anniversary date, as the case may be.

When a debt obligation is transferred, the transferor is required to include in income the interest accrued to the date of transfer and the transferee is allowed a corresponding deduction to the extent that such interest was otherwise included in the transferee’s income.

One-half of capital gains from the sale of property, including securities, must be included in income of Canadian residents. One-half of realized capital losses may be deducted from the taxable portion of capital gains. There is provision for applying allowable capital losses against taxable capital gains of previous and subsequent taxation years. As a general rule, the gain realized by an investor on the maturity of a publicly traded interest bearing debt obligation purchased at a discount is a capital gain.

Investment dealers and financial institutions are required to recognize accrued gains and losses annually on their portfolio investments. Discounts on interest bearing debt obligations issued by tax exempt entities, governments or other public bodies or non-residents not carrying on business in Canada will be income in the hands of the first Canadian resident non-exempt holder of such obligations if the effective yield exceeds the rate of interest by more than one-third in the case of obligations issued after June 18, 1971 and if the rate of interest is less than 5% in the case of obligations issued after December 20, 1960 and before June 19, 1971.

The Income Tax Regulations deem interest to accrue on non-interest bearing debt obligations (including stripped bonds) based on the yield. Those regulations also deem adjustments to the principal amount of indexed debt obligations (defined as obligations that are adjusted for changes in the purchasing power of money) to be interest. Debt obligations that are convertible into shares or other debt obligations may qualify for rollover treatment so that no gain or loss would be realized on conversion.

There is a deemed disposition at fair market value of all capital property held by an individual on death. This may give rise to taxable capital gains and allowable capital losses. In the case of bequests to a spouse, or to a spouse trust, any such gains or losses may be postponed until the spouse disposes of the property. There is a similar deemed disposition in respect of specified capital property held by a resident of Canada upon becoming a non-resident.

Debt obligations of Canadian federal, provincial or municipal governments are eligible investments for registered retirement savings plans and other deferred income plans.

b) Non-residents of Canada
The Income Tax Act provides for a withholding tax of 25% on interest (subject to certain exemptions) paid by a Canadian resident to any non-resident. This rate is reduced to 10% or 15% on payments to residents of most countries which have entered into tax treaties with Canada. The rate will depend upon the treaty. If the amount initially withheld and remitted on account of tax to the Receiver General at the time an interest payment is made to a non-resident exceeds the amount of tax payable (as limited by the appropriate tax treaty), the non-resident payee may apply to the Minister of National Revenue for a refund of the overpayment.

Debt obligations which are exempt from the withholding provisions on interest payments to non-residents include the following:

1. Bonds of or guaranteed by the Government of Canada issued on or before December 20, 1960.
2. Debt obligations of or guaranteed by Canadian federal, provincial and municipal governments issued after April 15, 1966.
3. Debt obligations of certain Canadian educational institutions, hospitals or government controlled corporations, commissions or associations issued after April 15, 1966.
4. Debt obligations issued before December 20, 1960, where the interest is neither payable in Canadian currency, nor by reference to Canadian currency.
5. Debt obligations issued after June 23, 1975 by corporations resident in Canada where the issue meets certain conditions respecting repayment.
Coupons on such tax exempt obligations issued after July 14, 1966 bear the designation “F”. Coupons on obligations that are not exempt from withholding tax bear the designation “TX” if issued between March 29, 1961 and December 4, 1963, and the designation “AX” if issued after December 4, 1963. Anyone redeeming coupons on non-exempt obligations must withhold and remit to the Receiver General the appropriate amount on account of tax. There is also an exemption for interest paid by a prescribed financial institution that is the lender of an exempt government debt obligation under a securities lending arrangement.

The rate of withholding tax applicable to debt obligations of or guaranteed by a Province is 5% for issues on or before December 20, 1960 and for certain replacement issues subsequent to that date. Trusts and organizations that are exempt from tax in their country of residence and that would be exempt if resident in Canada may obtain a certificate of exemption covering interest on debt obligations issued by arm’s length obligors. Trusts or corporations which administer pension funds and charitable organizations may obtain such certificates of exemption even if they would not have exempt status in Canada provided they have exempt status in their country of residence.

Generally, unless debt obligations are used in the course of carrying on a business in Canada, a non-resident’s capital gains from the disposition of a debt obligation will not be subject to Canadian income tax. However, if a non-resident sells a debt obligation to a Canadian resident at a premium above the issue price, the premium may be deemed to be a payment of interest and subject to withholding tax. Similarly, the sale of a debt obligation with accrued interest (whether actual or deemed) may result in a portion of the sale price being deemed to be a payment of interest to the extent of that accrued interest.

A non-resident of Canada may be able to claim the Canadian non-resident withholding tax as a credit against income taxes payable in his country of residence.

The Canada-United States Income Tax Convention contains a provision whereby the Canadian income of United States religious, scientific, literary, educational or charitable organizations is exempt from Canadian withholding tax to the extent that such income is exempt from income tax in the United States.

c) Tax Treaties: he Government of Canada has negotiated or renegotiated tax treaties with the United States, United Kingdom, Algeria, Argentina, Australia, Austria, Bangladesh, Barbados, Belgium, Brazil, Bulgaria, Cameroon, Chile, China, Croatia, Cyprus, Czech Republic, Denmark, Dominican Republic, Egypt, Estonia, Finland, France, Germany, Guyana, Hungary, Iceland, India, Indonesia, Ireland, Israel, Italy, Ivory Coast, Jamaica, Japan, Jordan, Kazakhstan, Kenya, Kyrgyzstan, Latvia, Lebanon, Lithuania, Luxembourg, Malaysia, Malta, Mexico, Morocco, Netherlands, New Zealand, Nigeria, Norway, Pakistan, Papua New Guinea, Philippines, Poland, Portugal, Romania, Russian Federation, Singapore, Slovakia, South Africa, South Korea, Spain, Sri Lanka, Sweden, Switzerland, Tanzania, Thailand, Trinidad and Tobago, Tunisia, Ukraine, Uzbekistan, Vietnam, Zambia and Zimbabwe. In some cases, the tax treaty may not have been implemented by the enabling legislation or proclaimed in force either in Canada or the other treaty country, and consequently, specific inquiries should be made with respect to recently negotiated treaties.

Estate Tax
The estate tax imposed by the Government of Canada was repealed effective January 1, 1972, and, from that date, the only Federal tax liability arising on death pertains to the liability under the Income Tax Act arising from the deemed disposition of capital property referred to above.

Goods and Services Tax
The Federal Government enacted legislation implementing the goods and services tax effective January 1, 1991. Interest on debt obligations and proceeds from the sale of debt obligations are exempt from that tax.

Provincial Governments
Income and Corporation Taxes
All of the provinces of Canada have enacted income tax statutes. Generally, whether an individual or corporation is liable to taxation under any one or more of such statutes will depend on whether or not the individual or corporation was resident in or had a permanent establishment in a province during the year.

Capital Taxes
Canada and all the Provinces, except Alberta, Newfoundland and Prince Edward Island, impose a capital tax on corporations. Subject to meeting various term and hold conditions, investments in the debt obligations of other corporations (including Crown corporations) reduce a corporation’s taxable capital. Except for Manitoba and Saskatchewan, investments in government debt obligations do not reduce taxable capital.

Succession Duties
All provinces have withdrawn from the field of succession duties. Notes prepared by Eric G. Nazzer

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