NEW RULES FOR “LINKED NOTES”

November 2, 2016
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The March 2016 Federal Budget proposed new rules that deal with the taxation of “linked notes”. In general terms, a linked note is a debt obligation, often issued by a corporation, which pays “interest” that is linked to a reference point such as the value of a stock market index, commodity index, or some other index or property. The interest on the note is typically paid on maturity rather than on an annual basis. 

For example, a three-year note could repay the principal and pay the accrued interest on maturity, with the interest being computed with reference to the increase in the value of a stock index over the three-year period. There are interest accrual rules under the Income Tax Act that apply to debt instruments that do not pay interest annually. However, when applied to linked notes, the rules are difficult to apply because the accrued interest is not known at the end of each year that the note remains outstanding. As a result, some taxpayers who sell linked notes before their maturity at a gain take the position that the accrued gain is a capital gain rather than interest income. That position is significant, since only one-half of capital gains are included in income, while interest income is fully included in income. 

In basic terms, the new rules will provide that the pre-transfer accrued gain on a transfer of a linked note will be deemed to be interest and not a capital gain. 

The new rules are now scheduled to take effect for dispositions of linked notes after 2016. (This was originally announced as starting October 2016, but was extended 3 months by a Department of Finance news release on September 16, 2016.)

This letter summarizes recent tax developments and tax planning opportunities from a third-party affiliate; however, we recommend that you consult with an expert before embarking on any of the suggestions contained in this blog post, which are appropriate to your own specific requirements. Please feel free to get in touch with Lee & Sharpe to discuss anything detailed above, we would be pleased to help.
Adam H. Sharpe

Hello, my name is Adam Sharpe, I am a partner at Lee & Sharpe.

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