One of the hottest topics of discussion stemming from the release of this year’s federal budget a few weeks ago is the future of linked notes and whether investors will still see them as attractive once the tax rules change this autumn, as proposed in Budget 2016.

See: Feds to end tax-planning opportunity associated with linked notes

Linked notes are debt obligations issued by financial institutions that provide a rate of return that’s “linked” to the performance of one (or more) assets or indices over the term of the note. The underlying linked asset or index is often a basket of stocks, a stock index, a commodity, a currency or even units of an investment fund.

There are two main types of linked notes: Principal-protected notes, in which the amount payable to the investor at maturity is equal to the principal amount invested plus a return (if any) that’s either fully or partially linked to the performance of the underlying asset or index. Principal-at-risk notes are similar, but there’s a risk, depending on the performance of the underlying asset or index, that the amount payable to the investor at maturity can be less than the principal amount invested.

The current tax rules governing linked notes require an investor to accrue the maximum amount of interest that could be payable on the note each year. Investors, however, have generally taken the position that there’s no deemed accrual of interest on a linked note prior to the maximum amount of interest becoming determinable. Rather, the full amount of the return on the note is only included in the investor’s income in the year in which it becomes determinable, which is generally at, or shortly before, maturity (the “determination date”).

When a note is sold before maturity, a specific tax rule requires interest accrued to the date of sale to be included in the income of the vendor for the year of sale. However, some investors selling linked notes on the secondary market prior to maturity take the position that no amount received is accrued interest as the determination date has not yet occurred. As a result, these investors include the full amount of return on the note as proceeds of disposition used to calculate the capital gain on sale. The government views this as effectively converting the return on the notes from ordinary income to a capital gain, of which only 50% is taxable.

Budget 2016 proposes to change the tax laws governing these investments to treat a gain realized on the sale of a linked note as interest that was earned on the debt obligation. This new measure will apply to the disposition of linked notes after September, giving you and your clients almost six more months to consider whether to dispose of their linked notes prior to the rule change to claim capital gains treatment.

That being said, there are still many other benefits in linked notes, including providing access to underlying assets/sectors that investors cannot efficiently access themselves, deferring unrealized income, potentially outperforming traditional underlying benchmarks and providing varying degrees of principal protection, depending on the structure of the linked note.