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Do any Canadians trade US stocks and have phantom foreign exchange gains?


scorpioncapital
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For many years now I've used the standard method of calculating capital gains of taking the cost at purchase converted to CDN and then taking the price at disposition converted to CDN. Yet I realize that this results in phantom gains which one is taxed on. For example, if I keep the US funds and stocks in US dollars even after selling it, if the exchange rate changes alot (as it has recently from 1:1 to 1.25), but keep the funds in US dollars, does this mean that you pay a capital gains tax even if you have not converted the funds to Canadian dollars, having to pocket the tax from your reserves?

 

 

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As I understand it, at the end of the year you are supposed to declare the capital gains on any foreign currency held throughout the year. As you can imagine, this gets very ugly if do a lot of transactions.

 

I hadn't heard that before. After a quick search, I found this: http://www.cra-arc.gc.ca/E/pub/tp/it95r/it95r-e.html

 

Looks like you are correct for "income accounts". For "capital accounts", you cannot declare gains / losses on currency held throughout the year. You convert transaction amounts to Canadian dollars when you buy or sell something to calculate the gain / loss. My understanding is that an investment account is a "capital account".

 

For example, if I keep the US funds and stocks in US dollars even after selling it ... but keep the funds in US dollars, does this mean that you pay a capital gains tax even if you have not converted the funds to Canadian dollars, having to pocket the tax from your reserves?

 

Yes, I believe this is the case.

 

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Tengen, your interpretation is correct (AFAIK), assuming that IT-95 still applies 35 years later. The key thing is that the USD cash you hold is subject to capital gains whenever a transaction occurs. So both the foreign cash you hold and the securities you buy have an ACB. When you buy a stock with foreign funds, you are selling US cash (at current exchange rate) and buying a US security (at current exchange rate).

 

 

 

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it's more complicated for me.  I borrow USD and buy undervalued US stocks. After the value stocks are sold,  my gain is in USD.  Then I convert this USD to CAD.  Use the CAD to buy bonds. Rinse and repeat.

This USD wasn't converted from CAD and its cost is the interest cost.  What's my cost base for this USD in CAD?  1:1 ?

 

E.g. Let's say for a $100 USD capital gain on borrowed USD,  and I convert $100 to $128 CAD at current exchange rate,  my FX capital gain is 128CAD  - 100 CAD = 28 CAD?

 

 

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it's more complicated for me.  I borrow USD and buy undervalued US stocks. After the value stocks are sold,  my gain is in USD.  Then I convert this USD to CAD.  Use the CAD to buy bonds. Rinse and repeat.

This USD wasn't converted from CAD and its cost is the interest cost.  What's my cost base for this USD in CAD?  1:1 ?

 

E.g. Let's say for a $100 USD capital gain on borrowed USD,  and I convert $100 to $128 CAD at current exchange rate,  my FX capital gain is 128CAD  - 100 CAD = 28 CAD?

 

AFAIK. When you borrow, the USD has a cost basis based on the current XE rate.

 

Borrow $1000 USD (at $1.1 CAD) = 1100 CAD

Repay $1000 USD (at $1.2 CAD) = 1200 CAD

Capital Gain (Loss) = ($100)

 

Buy 100 BAC @ $10USD (at $1.1 CAD) = 1100 CAD

Sell 100 BAC @ $11 USD (at $1.2 CAD) = 1320 CAD

Capital Gain = $220

 

Net Capital Gain = $120 CAD

 

In this case, you are basically hedging out the FOREX so your gain calculation is pretty easy. The interest paid would complicate things slightly.

 

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it's more complicated for me.  I borrow USD and buy undervalued US stocks. After the value stocks are sold,  my gain is in USD.  Then I convert this USD to CAD.  Use the CAD to buy bonds. Rinse and repeat.

This USD wasn't converted from CAD and its cost is the interest cost.  What's my cost base for this USD in CAD?  1:1 ?

 

E.g. Let's say for a $100 USD capital gain on borrowed USD,  and I convert $100 to $128 CAD at current exchange rate,  my FX capital gain is 128CAD  - 100 CAD = 28 CAD?

 

AFAIK. When you borrow, the USD has a cost basis based on the current XE rate.

 

Borrow $1000 USD (at $1.1 CAD) = 1100 CAD

Repay $1000 USD (at $1.2 CAD) = 1200 CAD

Capital Gain (Loss) = ($100)

 

Buy 100 BAC @ $10USD (at $1.1 CAD) = 1100 CAD

Sell 100 BAC @ $11 USD (at $1.2 CAD) = 1320 CAD

Capital Gain = $220

 

Net Capital Gain = $120 CAD

 

In this case, you are basically hedging out the FOREX so your gain calculation is pretty easy. The interest paid would complicate things slightly.

 

Thank your for  your insight.  I didn't think about the FX gain/loss when repaying the borrowed USD. It makes perfect sense  now.  It's equivalent to  (11USD - 10USD) X1.2 = 120 CAD. But since CRA wants us to convert to CAD before calculating capital, we have to do it the hard way. I think complicated tax rules were created to create "work".

 

To simplify things, I'll use annual FX rate instead of daily rate.

 

I never studied currency hedging. I just do what make sense. That is locking in the elevated FX rate for portion of the portfolio,. The FX rate can go up more and I am missing out or it could come back down and I keep the FX gain. As long as it's at a relative high level, I'll keep selling USD.

 

 

 

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For many years now I've used the standard method of calculating capital gains of taking the cost at purchase converted to CDN and then taking the price at disposition converted to CDN. Yet I realize that this results in phantom gains which one is taxed on. For example, if I keep the US funds and stocks in US dollars even after selling it, if the exchange rate changes alot (as it has recently from 1:1 to 1.25), but keep the funds in US dollars, does this mean that you pay a capital gains tax even if you have not converted the funds to Canadian dollars, having to pocket the tax from your reserves?

 

 

I  have an idea to make it simple: never hold USD cash.  Put the USD cash in bond or bond funds if you want cash equivalent. It's easier to keep track than USD cash.

For me, my USD cash balance will almost always be negative or zero.

 

or

how to keep track of ACB of foreign currency: http://www.adjustedcostbase.ca/blog/calculating-adjusted-cost-base-for-foreign-currency-cash/

 

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The situation is more like this:

 

US Dollars: $100

Buy a stock ($100 @ 1.1) = $110 Canadian Cost.

Sell stock later ($100 @ 1.3) = $130 Canadian Cost.

US Dollars: $100.

$20 capital gain (assume no principle appreciation)

Taxed: $20 * 0.5 * (e.g. 20%) = $2.

You actually have an after-tax loss even though you hold the same amount of US dollars and technically no profit.

 

 

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The situation is more like this:

 

US Dollars: $100

Buy a stock ($100 @ 1.1) = $110 Canadian Cost.

Sell stock later ($100 @ 1.3) = $130 Canadian Cost.

US Dollars: $100.

$20 capital gain (assume no principle appreciation)

Taxed: $20 * 0.5 * (e.g. 20%) = $2.

You actually have an after-tax loss even though you hold the same amount of US dollars and technically no profit.

 

It seems to be the case. It's up to tax payer to take advantage to actually convert the fund.

 

"This means that when calculating ACB, all amounts should be converted into Canadian dollars.  This occurs even if you use a cash balance in foreign currency to purchase a security (as opposed to converting Canadian dollars to make the purchase) or leave the proceeds from the sale of a security in foreign currency (as opposed to converting the proceeds into Canadian dollars)."- http://www.adjustedcostbase.ca/blog/calculating-adjusted-cost-base-with-foreign-currency-transactions/

 

 

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