A linked note is a debt obligation in which the return is linked to the performance of one or more reference assets or indexes. The underlying asset or index can be a basket of stocks, a stock index, a commodity, a currency or units of an investment fund.
The Canadian tax legislation contains specific rules that require investors that dispose of a debt obligation to include in their income any interest that accrued on the obligation to the date of disposition. However, in the case of linked notes, investors have generally taken the position that so long as the ultimate return on the linked note was not determinable at the time of its disposition—for example, where the note is sold in a secondary market prior to maturity—no amount would be considered to have accrued as interest. Instead, the increase in value would be reported as a capital gain for which only 50 percent of the increase would be required to be included in income.
To eliminate the difference in the tax treatment of the return on linked notes held to maturity and the return on linked notes disposed of prior to maturity (where the return is uncertain), the 2016 federal budget introduced a new rule deeming any gain realized on the sale of a linked note to be accrued interest.
The 2016 federal budget proposed to apply this new measure to the sales of linked notes which occur after September 2016. However, to provide additional time for purchasers and investment dealers involved with linked notes to develop systems to accurately capture and report relevant information, the effective date of this new measure has been changed to after 2016.
If you hold linked notes with accrued gains in a non-registered account, you should consider whether it would be advantageous to sell the note prior to 2017 and get capital gains treatment on the accrued gains. However, if you hold linked notes with a maturity after 2016, you should consider whether the deferral of the taxation of such gains until the maturity of the notes outweighs the potential tax savings from capital gains treatment on a sale before the end of the year.