Ontario Opportunity Bonds
Provincial tax break attractive
Ontario's latest budget included the
introduction of something called Ontario
Opportunity Bonds. The bonds, which will be
exempt from Ontario tax, will not be directly
offered or guaranteed by the Ontario government.
Rather, they will be issued by the Ontario
Municipal Economic Infrastructure Financing
Authority (OMEIFA). On the surface these new
bonds look attractive, but they're not for
Below are the basic details on the new issue
of bonds, which closes soon.
- Term: 5 years (mature May 6, 2008)
- Interest Rate: 4.25 percent, paid
semi-annually in May and November
- Compounding: No - simple interest
- Available until: May 6, 2003
Further, the interest paid is subject to
federal tax but exempt from Ontario tax.
Just as mutual funds are sold by prospectus,
these bonds are sold via an Information
Statement. I would encourage anybody considering
these bonds to read it before buying.
After-tax yield comparisons
GICs, investment funds, conventional bonds,
strip bonds, real return bonds, preferred shares,
provincial and federal savings are common fixed
income investments but this is not a complete
list. When reviewing various fixed income
options, one must be careful to ensure that
comparisons are fair and accurate. There are two
issues to address when doing comparisons:
reinvestment and taxation.
With sufficiently large amounts of money,
income spun off from things like preferred shares
and conventional bonds can be reinvested in the
same or similar type of investment. But without
the availability of new Ontario Opportunity
Bonds, reinvestment simply isn't an option, no
matter what the amount.
If deciding between buying these new bonds or
Ontario strip bonds, a yield adjustment is
necessary. The yield on strip bonds, because the
interest is built into the price paid, is already
stated in compound annual terms. Ontario
Opportunity Bonds, on a compound annual basis,
offer a yield of 3.93 percent, before taxes.
Conventional bonds, which also pay semi-annual
interest, are directly comparable and yield an
average of 4.18 percent quoted as of May 1 for
government of Canada bonds. But such conventional
bonds can be sold at any time because they are
very liquid - not so with Ontario Opportunity
Taking taxes into consideration gets a little
trickier. Ontario's highest tax bracket for 2003
kicks in at a taxable income of $104,649. At that
level, these bonds will be relatively attractive
since they'll attract tax at an effective rate of
29 percent, versus the 46.41 percent applied to
regular interest and 31.34 percent rate attached
While the rates are slightly different, this
is the case for taxable incomes of at least
$70,000 or so. Below that, dividend income is
taxed much more favourably, though it carries
somewhat higher risk.
At lower levels of income - i.e. $25,000 - the
tax break shrinks and the mechanics of dividend
taxation make dividends a better deal, in my
opinion. In this case, dividends are taxed at a
rate of just 4.48 percent while interest from
these bonds would attract tax at a rate of 16
It should be very clear at this point that
comparisons are very individualistic.
Once purchased, there is no organized market
to facilitate the trading of these bonds.
Investors are always free to privately sell their
bonds to others, but no real market will
necessarily exist for such purposes.
Hence, don't count on any opportunity to sell
these before their five-year term expires.
OMEIFA's basic purpose is to make it easier
and cheaper for Ontario municipalities to borrow
money. OMEIFA will borrow funds from the general
public through the sale of these Ontario
Opportunity Bonds. The rate payable on these
bonds, which is 4.25 percent per year, is also
OMEIFA's cost of acquiring funds. Further, up to
50 percent of the interest costs on loans from
OMEIFA to municipalities are expected to be
subsidized by the Ontario government through
subordinated loans to OMEIFA. The result:
municipalities pay a lower rate of interest to
OMEIFA, than if they raised money through
Most of OMEIFA's assets and cash flow will be
dependent on amounts receivable from the
municipalities to which it lends money. Put
another way, OMEIFA's credit rating will be a
reflection of the credit ratings of the various
municipalities. Despite their name, these bonds
should not be associated with the province - in
terms of safety - because they provide no
guarantee of interest or principal for these
The nature of the tax exemption is awkward.
When filing a tax return, investors must claim
the full amount of interest, and pay tax thereon
at both the federal and provincial levels.
Ontario will then deem the provincial tax on the
interest from these bonds to be an
"overpayment of tax", resulting in a
refund. The refund, however, won't be received
until six to eight months after tax returns are
These bonds are most suitable for higher
income investors wishing to hold safer
investments outside of tax-deferred savings
plans. For the middle-to-low income class, the
attractiveness of these bonds diminishes. For
everybody else, there's no rule of thumb, so keep
in mind the limitations with respect to liquidity
and the potential default risks. As a result,
make sure the after-tax yield that you will enjoy
sufficiently compensates for these limitations
Opportunity Bonds | OMEIFA | Information
Dan Hallett, CFA, CFP is the President of Dan Hallett and Associates Inc., an independent investment research firm based in Windsor, Ontario. Dan can be reached at email@example.com.