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When to report interest on market-linked guaranteed investments

What are market-linked guaranteed investments?

They are investments on which in all or part of the return is calculated at maturity, based on the performance of one or more stock market indexes. Capital invested is 100% guaranteed.

Market-linked guaranteed investments and taxation

Income tax on deferred interest

Interest income on non-registered investments is usually reported on your annual income tax return. Since the non-guaranteed portion of the return on market-liked investments is only known at maturity, interest must be reported in the year in which it matures. The only exception if you elect the fixed-return option.

Example*: You invested $1,000 in a Global Equity Guaranteed Investment issued in 2007 for a 3-year term. At maturity, the return was determined to be $450. Since the amount was not known prior to 2010, nothing was reported in your 2007, 2008 and 2009 income tax returns. The $450 in interest must therefore be included as income in your 2010 tax return.

Your financial institution will forward you a tax form with the amount to include in your taxable income. You may defer taxes on the income for up to 3 years. You may not, however spread out the tax due retroactively over the 3-year holding period.

Depending product features, when returns are fully or partially known before maturity, taxes are due on the interest accrued on the investment anniversary date. This is the case for the Enhanced Return Guaranteed Investment since it guarantees a yearly minimum return, paid either monthly or annually.

Income tax when the fixed-return option is elected

Investments with a fixed return option enable you to freeze the rate of return at the current index level prior to maturity, protecting you from a possible market decline. Exercising this option triggers the taxation of the interest accrued on the investment anniversary date.

From this time on, your financial institution will forward you an annual tax form with the amount to include in your taxable income. At maturity, only the interest incurred since the last anniversary date is added to your income, even if you are paid the entire return. Before you choose this option, be aware that you will have to pay taxes starting the year the return is frozen.

Example*: You have a market-linked guaranteed investment in the amount of $1,000 issued in December, 2007, for 3-year term, with a fixed-rate option available on the 2nd anniversary date.

In December 2009, you decide to exercise the fixed-rate option. From this point on, you know how much you will receive at maturity. You must therefore report the interest accrued between December 2007 and December 2009, or $219 according to the index level at the time of the freeze, in your 2009 income tax return.

The interest amount will be indicated on the tax form forwarded to you by your financial institution for the tax year 2009. In 2010, you’ll the total return established at $346 will be posted to your account, but the tax form you receive will list only the interest accrued between December 2009 and December 2010, or $127, which you will need to include in your 2010 income.

Market-linked guaranteed investments in an RRSP

Even though investment income is only taxed at maturity, why not put your market-linked guaranteed investments in your RRSP? This way, the interest will only be taxed when you withdraw from your RRSP.

When the RRSP matures, before the end of the year in which you turn 71, you may convert your market-linked guaranteed investments into an RRIF. Make sure, however, that there are enough cash holdings in your RRIF to allow for the annual minimum withdrawal.

If you opt to convert your total RRSP to a fixed or life annuity at maturity, you will no longer be able to invest in market-linked guaranteed investments.

Market-linked guaranteed investments in a TFSA

If you decide to include market-linked guaranteed investments in your Tax-Free Savings Account (TFSA), taxation will no longer be an issue because they are designed to generate tax-free income.

 

* Financial information provided is based on government tax requirements for the year 2009.

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