Taxation of Interest Income

Of the three basic types of investment income, interest is by far the most straightforward, but also the least tax-advantageous, as no special tax treatment attaches to such income.

Interest, in a legal sense, is simply compensation paid for the use of borrowed funds. For most taxpayers, such interest income will be earned on funds deposited in bank accounts, on guaranteed
investment certificates (GICs), and perhaps on purchases of Canada Savings Bonds, or their provincial equivalents, or on corporate bonds. It is important to note that all interest income, no matter how small the amount, is taxable, and must be reported on the annual tax return. There’s a common misperception that interest income need be reported only where a T5 information slip has been issued in respect of that income. That’s not the case; although a payor must issue a T5 only where the amount of interest paid during a particular tax year is $50 or greater, any amount of interest paid or received must be reported. The onus is on the taxpayer to keep track of interest received and to include all such amounts on the annual tax return. Interest income earned is reported on line 121 of that return.

When interest income must be reported

Generally speaking, all interest received or earned must be reported annually. For interest earned on bank accounts, GICs with a term of one year or less, and regular interest bonds, the computation of interest earned will not pose a problem. Where the interest paid for the year is $50 or more, a T5 slip will be issued by the payor, and the interest payment for the year will be indicated on that T5.

Where interest is earned on GICs having a term of more than 12 months or on compound interest bonds, the holder of the GIC or bond must still report and pay tax on the “notional” amount of interest paid for the year, as in the following simplified examples.

On January 1, 2010, John buys a $1,000, three year GIC that pays interest at a rate of 5% per year, compounded annually, with all interest paid at maturity. On his 2010 tax return (with a filing due date of April 30, 2011), John must report and pay tax on $50 of interest income (5% of $1,000), despite the fact that he has not actually received any interest payments from the issuer of the GIC.

Of course, it’s usually the case that investments are made at different times throughout the year, and interest that accrued but that was not paid on such investments is reported for the taxation year during which the anniversary date falls. For example, a taxpayer who makes a long-term investment on June 1, 2009, will report on his or her return for 2010 the interest that accumulated to the end of May 2010, whether or not a T5 slip is received. Similarly, interest earned from June 2009 to May 2010 will be reported on the taxpayer’s 2010 return.

Like most tax rules, the rules governing the treatment of interest income have changed and evolved through the years. The annual reporting requirement outlined above applies generally to investments made after 1989. The minority of taxpayers still earning interest income on investments made before that date can obtain information on how to report such income on the Canada Revenue Agency (CRA) Web site at

Foreign-source interest income

Most interest income earned by Canadians likely still arises from Canadian sources. However, the availability of Internet-based banking and investing means that investors can easily seek out the
best returns, regardless of national boundaries. Consequently, funds can easily be invested offshore, and interest on those funds paid from foreign sources. The general rule in Canadian tax is that Canadian taxpayers are taxable on their worldwide income, and interest income is no exception to that rule. The CRA expects all interest income to be reported on the annual tax return, in Canadian dollars. Where interest is denominated in a foreign currency, it’s up to the taxpayer to make the conversion to Canadian funds. Technically, the conversion to Canadian dollars is to be made using the exchange rate in effect on the day the interest is received, but the CRA is prepared to be somewhat flexible in this regard. While the actual conversion rate for the day of receipt can be obtained from the Bank of Canada Web site at, the CRA will also accept conversions done at the average annual exchange rate for the year for the currency in question (also available on the Bank of Canada Web site at, as any difference is likely to be minimal. There is one restriction: a taxpayer who adopts a particular method, whether day-of-receipt or annual average, must use that method on a consistent basis from year to year. Switching from one method to the other to obtain the best result isn’t allowed.

Joint accounts

Very often, bank accounts, or even bonds and GICs, are held jointly by two or more taxpayers — perhaps a husband and wife or an elderly parent and adult child — and the question arises regarding how interest income from joint holdings should be reported and, especially, how to avoid double reporting of such income. The rule in such cases — a rule that is more easily applied in theory than in practice — is that the interest income is to be reported in the same proportions as the original contribution to the investment.

So, in the simplest of cases, where a husband and wife eaeach contributed exactly one-half of the balance in a bank account, each would be required to report and pay tax on 50% of the interest paid or accrued during the year on that balance. Of course, the bank will not be tracking deposits to determine who contributed what; it will simply issue a T5 slip for the full amount of interest earned. The practical solution is for each spouse to report his or her share of that interest income, perhaps with a note explaining the breakdown of such interest as between joint account holders. In other cases — typically, the case of an elderly parent and adult child — the account is actually that of the parent, and funds in the account are entirely those of the parent, with the adult child added as a joint account holder only for administrative purposes — usually to allow him or her to carry out banking transactions on the elderly parent’s behalf. In such cases, only the parent would report and pay tax on any interest income accrued in the account.

Tax rates applied to interest income

Interest income is accorded the least favourable tax treatment of any of the three major types of investment income, as it benefits neither from special credits nor from reduced inclusion rates. As with all types of income, the marginal rate applicable to interest income will vary according to the recipient’s income and province or territory of residence. That said, a taxpayer having taxable income sufficient to put him or her in the highest tax bracket (that is, over about $127,000 for 2008) will pay tax on interest income at rates ranging from about 39% to 48%.

The articles posted here provide information of a general nature. These articles should not be considered specific advice; as each vistor’s personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in these articles.

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