Corporate and government bonds are debt instruments that requires that the issuer of the bond (the borrower) to pay the bondholder (the lender) as specific amount of money at specified periods in time as well as re-pay the principal amount of the bond. Corporations and governments issue bonds to finance expansion or build infrastructure and will pay a stream of interest for a period of time at the end of which the principal becomes due.
How Are Bonds Taxed?
Inside an RRSP or other deferred income tax plan, there are no tax implications on the income or gains associated with investments as the withdrawals are taxed instead. However, for bonds held outside a retirement plan, the treatment varies depending on whether the bonds pay interest or not
Typically bonds pay interest and you are required to pay tax on the interest earned during the year whether you actually received the interest or not. Note that the amount you paid for the bond may include accrued interest and this accrued interest must be deduced from the interest income your would have received.
The purchase of a bond may also result in a capital gain or loss if held to maturity or if it sold prior to maturity depending on whether the bond was purchased at a discount or at a premium. Note that there is no gain or loss of the bonds were acquired at face value and held to maturity.
Strip Bonds or non-interest bearing bonds are bonds that have either had the interest “stripped” off and sold separately or bonds that are sold at a discount from the face value and do not pay interest. These bonds are amortized evenly over the number of months until the bond matures and the amortized amount is included as normal income. A capital gain or loss may result of the bond is sold prior to maturity.
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