WARNING: ALL T5008s are incorrect at IB

[rb]

This post may belong in the Personal Finance section. However I posted here instead to get more coverage since I know that a lot of board members use IB. If Sanjeev deems that I've erred I figure he will move it and I apologize in advance.

 

In preparing the T5008s IB uses the FIFO method. This is wrong and it will presumably result in higher taxes in a lot cases. In Canada you must use average cost for your cost basis.

 

I spoke to IB and they confirmed that they use FIFO accounting for all T5008s. They also said that they've received approval from CRA to do that. I then reached out to my contacts at CRA and they confirmed that you must use average cost and that it is the only method they'll accept. They further confirmed that no approval has been issued to anyone to use a different method of accounting of capital gains.

 

Cheers.

[scorpioncapital]

so which is it? did they or did they not get approval?

I find it very unusual that T5008 information year after year would be incorrect.

What matters is consistent treatment. If they change it now, it would create another mess.

 

[rb]

so which is it? did they or did they not get approval?

I find it very unusual that T5008 information year after year would be incorrect.

What matters is consistent treatment. If they change it now, it would create another mess.

In case i was unclear CRA confirmed that they issued no such approval. So the people at IB are either lying or don't know what they're talking about. It's not like I can reach the VP of tax on the phone.

 

Consistent treatment is not what matters. "I have been filing my taxes incorrectly and will continue to do so in future for the purpose of consistency" is not an argument the CRA usually accepts. Furthermore, in Canada an individual is personally responsible the ensure the accuracy of his or her tax filing. Though the CRA is not likely to look kindly on an entity that consistently issues incorrect slips.

 

As to why the T5008s are incorrect I presume that that's how they do it in the US and they simply slapped the same engine in Canada. A mess is a correct description, but that's what happens when you don't do things right in this area.

[KCLarkin]

In preparing the T5008s IB uses the FIFO method. This is wrong and it will presumably result in higher taxes in a lot cases. In Canada you must use average cost for your cost basis.

 

You are both right. IB can use the FIFO method for reporting the T5008. Many brokers just leave the cost basis blank because it is impossible for them to know your cost base. You may have the same security in multiple accounts, you may have transferred in low cost basis securities, you might have certificates in a drawer, you might have superficial losses. So, it is irrelevant what IB reports to the CRA, you must use average cost for your cost basis.

 

I spoke to IB and they confirmed that they use FIFO accounting for all T5008s. They also said that they've received approval from CRA to do that. I then reached out to my contacts at CRA and they confirmed that you must use average cost and that it is the only method they'll accept. They further confirmed that no approval has been issued to anyone to use a different method of accounting of capital gains.

 

Again, I think you are both right. IB is probably aware that it impossible to provide an accurate cost basis, so they asked CRA whether they could just use FIFO to fill the form. CRA probably said yes. BUT, you still need to report ACB. NEVER rely on T5008 or any capital gains reported by IB or any other broker. Personally, I've never even looked at a T5008.

 

In this case, FIFO will usually benefit CRA, so you probably wouldn't have too much hassle if you got audited.

 

--

 

Also, if you have foreign currency transactions, not that you need to adjust for currency. Which is another headache. Note that T5s for USD accounts are reported in USD, so you need to manually adjust for currency before entering into tax forms.

[rukawa]

I've never relied on any Broker to calculate capital gains. I always just calculate the ACB myself. The think I don't like doing is the FX since you are supposed to account for your foreign currency gains in a relatively confusing and complicated manner.

 

For instance if you buy a stock with US dollars theoretically its considered equivalent to converting your USD to CAD and when you sell it, its equivalent to buying US dollars. So you have to calculate and adjusted cost base for each of your foreign currencies and each time your buy a stock it can trigger a foreign currency gain/loss. It weird that buying something can trigger capital gains but that is the way the CRA rules work. I would guess that very few people do this correctly.

 

This is my first year with IB and I haven't even really considered the implications of their automatic loans of foreign currency. In theory I guess when you buy a stock you would be entering into a short position in the currency...in this case "buying the short currency" and the when you sell the stock you would be "selling the short currency" so in the IB its seems to be a lot more straightforward since you would never trigger a capital gain from buying a stock. This weekend I'll try and write up an example on this since I imagine its confusing to many people.

 

If anyone already knows this, please share.

 

[rb]

As far as I know TD and Questrade accurately calculate the adjusted cost base based on the information they have. I haven't seen enough slips from Scotia to be sure but they seem to do it fine too. Obviously if you have other accounts that is beyond their control.

 

The reason I've posted this is that while some smartly ignore T5008s and do their own work, but many others don't. Instead they rely on T5008s and just simply key the info in some software. So I just wanted to put this information out there for people to be aware.

 

Of course the downside to all of this is that CRA gets the information from the T5008s. If one is correctly using ACB, one is on average reporting lower cap gains than the FIFO T5008s should indicate. This has the potential to turn into a hassle with the CRA.

[rb]

I've never relied on any Broker to calculate capital gains. I always just calculate the ACB myself. The think I don't like doing is the FX since you are supposed to account for your foreign currency gains in a relatively confusing and complicated manner.

 

For instance if you buy a stock with US dollars theoretically its considered equivalent to converting your USD to CAD and when you sell it, its equivalent to buying US dollars. So you have to calculate and adjusted cost base for each of your foreign currencies and each time your buy a stock it can trigger a foreign currency gain/loss. It weird that buying something can trigger capital gains but that is the way the CRA rules work. I would guess that very few people do this correctly.

 

This is my first year with IB and I haven't even really considered the implications of their automatic loans of foreign currency. In theory I guess when you buy a stock you would be entering into a short position in the currency...in this case "buying the short currency" and the when you sell the stock you would be "selling the short currency" so in the IB its seems to be a lot more straightforward since you would never trigger a capital gain from buying a stock. This weekend I'll try and write up an example on this since I imagine its confusing to many people.

 

If anyone already knows this, please share.

FX ACB is not really confusing. It works much the same as the ACB for stocks works. Here's a couple of things.

 

You are incorrect in your assumption that you have to take a cap gain on currency of you buy stock. Assuming you already have the currency and you have a cap gain on the currency, if you buy a stock in a currency you will not have to declare a capital gain on the currency. You only have to declare capital gain or loss when you actually sell the currency. In the example I've just mentioned, assume that your foreign currency appreciates while you hold the stock. When you sell the stock you will report the cap gain on the stock as well as the cap gain on FX. But at the same time the ACB on your FX position will go up by the equivalent of the FX capital gain you reported on the stock.

 

While the above is pretty straight forward it can become a pain in the ass because you have to track all the dividends, interest payments, interest received, fees etc in  foreign currency which can amount to a lot of transactions to keep track. One way to simplify it is that CRA offers you the option to use the FX rate of the transaction date, average FX rate for the month, or average FX rate for the year. Using average for the year simplifies the calculations a lot. But I prefer to use daily rates because then I can trigger precise cap gains and losses.

 

I don't really understand what you mean with your example of taking loans from IB. Yes, if you buy a foreign stock IB will lend you the currency and you would go short the currency. If you don't do anything else you'll report cap gain/loss on both the position and FX. But if you don't want to bother you can buy the stock with the loan and the buy the currency shortly after buy the currency and cover the short and it's all good.

 

Keep in mind, you do not have to report FX cap gains/losses below 200 CAD equivalent.

[scorpioncapital]

So basically IB just has to flip a switch and produce T5008's with avg cost as required by the government since other brokers can do it? Not sure why a company would produce a government mandated form using a method that is explicitly not allowed by said government. It's almost useless to even go through the effort to generate it. If it wasn't a tax form, I'd say it didn't matter. T5008 instructions says, "The preparer is expected to take reasonable measures in order to ensure that the amount reported in box 20 is correct."

 

What does it mean correct? and reasonable measures? I would say CRA is also partly to blame for this very vague instruction for preparers of this form on how to fill in this box since they could just explicitly say that average cost method must be calculated in the box. The conspiracy theorist in me makes me think they dont' say so that if FIFO is used and peope use that they'll just get more tax revenue over time since over many years, first lots will have low cost basis and shares tend to rise over time.

 

[wondering]

I am in public accounting.  Thanks for posting.  I will watch out for this in the coming weeks.

[KCLarkin]

As far as I know TD and Questrade accurately calculate the adjusted cost base based on the information they have.

 

Are you sure? How do they handle return of capital, superficial losses, spinoffs, mergers?

[KCLarkin]

You are incorrect in your assumption that you have to take a cap gain on currency of you buy stock. Assuming you already have the currency and you have a cap gain on the currency, if you buy a stock in a currency you will not have to declare a capital gain on the currency. You only have to declare capital gain or loss when you actually sell the currency.

 

Actually, I believe this is incorrect. See final page of this document:

https://ca.rbcwealthmanagement.com/documents/258147/258168/Currency+Tax+Reporting+-+Foreign+Exhange+Gains+and+Losses+%282016%29.pdf/f6445bb7-fdcf-4c4c-9a0d-d617f6fcfa4a

 

you ... withdraw the funds from the HISA to purchase a publicly- traded stock...the CRA considers that a foreign exchange gain or loss has occurred. You must report all foreign currency capital gains related to cash...

[rukawa]

I think it is incorrect. You can see what RBC is saying...I would have quoted this:

 

RBC link

The CRA considers that a foreign

exchange gain or loss has occurred:

a) at the time of conversion of funds in a foreign currency into another foreign currency or into Canadian dollars; or

b) at the time funds in a foreign currency are used to make a purchase or a payment.

 

Or if you don't believe that ... AdjustedCostBase.Ca tells us:

AdjustedCostBase Link

A capital gain or loss is also realized  when the funds are used to purchase securities that trade in the foreign currency, or when the funds are used to pay expenses or make a purchase.  In these cases a deemed disposition of the foreign funds is considered to have occurred, even though they may not have been converted into Canadian dollars.

 

Or finally you could check the CRA itself which as is often the case is really not easy to parse:

CRA Link

13. The Department considers that a taxpayer has "made a gain" or "sustained a loss" in a foreign currency only where there has been a transaction resulting in a gain or loss. Subsection 39(2) does not apply where a loss has been made "on paper" but no transaction has taken place. As a result the "accrual" method of accounting for foreign exchange gains or losses is not acceptable for purposes of reporting foreign exchange gains or losses on capital account. The following are examples of the time when the Department considers a transaction resulting in the application of subsection 39(2) to have taken place.

 

(a) at the time of conversion of funds in a foreign currency into another foreign currency or into Canadian dollars,

 

(b) at the time funds in a foreign currency are used to make a purchase or a payment (in such a case the gains or loss would be the difference between the value of the foreign currency expressed in Canadian dollars when it arose and its value expressed in Canadian dollars when the purchase or payment was made), and

 

© at the time of repayment of part or all of a capital debt obligation.

 

So its not just when you convert back to canadian dollars. Its a deemed deposition of your foreign currency whenever you use it to buy goods, services, stock or bonds.

 

Consider the following admittedly ridiculous example, which demonstrates why basing foreign exchange capital gains on currency conversion alone would not work:

1) Person converts CAD to USD because he expects USD to appreciate

2) USD appreciates heavily

3) He then buy shares in company cross-listed on US and Canadian exchanges (e.g. TSGI) using his US currency on a US exchange

4) He then journals over the shares to Canadian exchange.

5) He then sells the shares.

 

In theory assuming the exchange rate and cross-listed company prices didn't fluctuate during steps 3-5 he would pay zero tax because he made no capital gain on the stock. And he would never pay any tax on the currency appreciation since he never converted the currency from USD to CAD.

 

This is why CRA requires that buying anything with a foreign currency is a deemed disposition of that foreign currency and can result in a capital gain/loss. With the CRA rules the speculator above could not avoid taxes because he would end up triggering a capital gain at Step 3)