“ZERO COUPON” DEBT INSTRUMENTS

October 29, 2020
All Tax Articles

If you own a debt instrument like a bond, term deposit, or even a bank account, you often receive interest at least once a year. Normally, you just report the interest on your tax return in the year that you receive it.


However, there are some debt instruments that do not pay interest annually. For example, you might purchase a zero-coupon bond or term deposit that pays all the interest upon maturity.


In these cases, you must report the interest income annually on an accrual basis. The general rule is that you report the accrued interest income in a taxation year that accrues to each “anniversary date” that ends in the taxation year. Each anniversary date is basically 12 months from the date of the issue and each 12-month period after that. Due to the 12-month rule, there typically will be a deferral of tax, as illustrated in the example.


Example


On July 1, 2020, you invested in a 3-year term deposit that matures on June 30, 2023. All of the interest is payable on maturity.


The first anniversary date is June 30, 2021, so you report that 12 months of accrued interest on your 2021 tax return. You do not report any interest in 2020 because there is no anniversary date in 2020. As a result, there is some deferral because you do not pay tax in 2020 on the interest that accrued to the end of calendar 2020.


For the 12 months of interest that accrues to June 30, 2022, you report that in your 2022 tax return. For the remaining interest that accrues to June 30, 2023, you report that in your 2023 return.

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.
Sandy J. Lee

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

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