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Canadian tax question


Cardboard
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Hi guys,

 

I am sorry to come back to the forum with a question on income taxes, but this is the season!

 

Say that you buy a U.S. stock with $10,000 CAD. Based on the exchange rate, you now have in your account $8,000 U.S. worth of this company. A few weeks later, you sell this company, but keep the proceeds in USD in your account. The stock is now worth $9,000 U.S., so you calculate your capital gain translating this $9,000 U.S. to CAD using today's exchange rate vs the original $10,000 CAD. The exchange rate is at 1.30.

 

A few weeks later, you find another attractive U.S. stock and decide to reinvest the $9,000 U.S. into it. The thing is that the exchange rate is now 1.40. Your cost basis for the new shares will be based on $9,000 U.S. times 1.40.

 

Is there a capital gain on simply holding USD in the "out of shares" period?

 

The way I see it, is that you acquired $9,000 U.S. at 1.30 and then disposed of these same USD at 1.40 to acquire the new shares. In other words, the balance of U.S. dollars in your account is similar to any other security having a cost base and value upon disposition which will generate a capital gain or loss depending on the variation of the exchange rate.

 

Does that make sense? How is the tax man treating that?

 

Cardboard

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I have spoken to several telephone staff at CRA on this issue in past years and I always seem to receive different answers.  If you call them about this issue, I would suggest ask to speak to a supervisor or area specialist.

 

I believe that as long as currency gains are moderate compared to your portfolio size and you are not trading the currency in a FOREX account (where the stated objective is currency gains) that you can ignore the gain that you had on USD while not invested in any shares.

 

I hope that someone else here can add further detail or point to a CRA tax bulletin on this.

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Hi Cardboard,

 

Once a year CRA release an official exchange rate to be used in all ACB calculations. For 2008 it is  1US$=1.06601429 $CDN. This is the rate I am using for my 2008 $US transactions.

 

Cheers, Jack W.

 

 

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I believe you can choose to use their posted average exchange rate or you can elect to use the actual rates at the transaction dates. 

 

Whichever method you use, CRA wants you to use it consistently.  You can't switch back and forth to game the system.

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Cardboard,

 

I agree with your assessment and that is how I have historically computed my FX gains/(losses). (The tax specialist at TD who helps me with my returns has not questioned my treatment and we did discuss the issue briefly in the past.)

 

It is the only logical way to compute your gains, imo. Using your example, ignoring the movement from 1.30 to 1.40 is hard to justify because it is clearly a gain.

 

The bad news, from a 2008 tax year perspective, is that you will likely experience gains from these computations. In fact, for one of my accounts, the FX gains from cash was almost as much as my capital gains from stocks! (I hope to get my revenge when the USD eventually weakens.)

 

On the point raised by others about using the average rate for the year, it is my understanding that for securities transactions, you MUST use the actual rates on the transaction dates - there is no option. (The average rate can be used for income.) Strictly speaking, you have to compute the capital gain both assuming the FX rate stays constant during the holding period and also using the actual rates. You then use the first number as your cap gain on the trade; you use the difference between the two numbers as the FX gain on the trade.

 

Finally, you add up all your FX gains (on securities and on cash) and ignore the first $200 of gain or loss. (The first $200 of FX gain/loss is exempted/disallowed.)

 

I cannot refer you to a CRA bulletin but I feel that if you do it consistently, you cannot be faulted by CRA. And, if you, like me, believe that the CAD will in the long run appreciate against the USD, it is to your advantage to adopt this treatment.

 

That will be $500/hr for the opinion. ;)

 

oec

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Cardboard,

 

I agree with your assessment and that is how I have historically computed my FX gains/(losses). (The tax specialist at TD who helps me with my returns has not questioned my treatment and we did discuss the issue briefly in the past.)

 

It is the only logical way to compute your gains, imo. Using your example, ignoring the movement from 1.30 to 1.40 is hard to justify because it is clearly a gain.

 

What about when your $US account is margined, and the $CDN dollar rises?  Do you recognize a capital gain when you re-pay your margin (afterall, the value of the margin debt in $CDN declined)?  Logically this would make sense, but does anyone actually do it?

 

SJ

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SJ,

 

I do treat it the same way even when my USD account is in negative balance (which I did do deliberately late last year to hedge my currency risk when the C$ weakened sharply). Imo, it's consistent and it's fair. I'm quite happy to pay taxes on my gains as long as I'm allowed to claim my losses. The problem when you don't account for the gains/losses on cash is that you could end up paying taxes even when you have suffered a real loss. Of course, it could work out in your favour but I don't like rolling the dice.

 

 

 

 

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oec2000,

 

Thanks for the opinion! ;) I agree with you on everything (including the $200 thing) and that is how I will treat it. The only part that I don't bother doing is the following:

 

"Strictly speaking, you have to compute the capital gain both assuming the FX rate stays constant during the holding period and also using the actual rates. You then use the first number as your cap gain on the trade; you use the difference between the two numbers as the FX gain on the trade."

 

I have read about the need to do that somewhere else too. However, on an economic standpoint there is no difference for the CRA, so I don't break it down. I figure that I waste enough time for them already including the stupid T-1135.

 

StubbleJumper,

 

If you have a $US account and you carry a negative cash balance at some point, it will be like short selling U.S. dollars using the math that oec2000 and I have discussed.

 

Cardboard

 

 

 

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The only part that I don't bother doing is the following:

 

"Strictly speaking, you have to compute the capital gain both assuming the FX rate stays constant during the holding period and also using the actual rates. You then use the first number as your cap gain on the trade; you use the difference between the two numbers as the FX gain on the trade."

 

 

Cardboard, it seems we are in complete agreement. I don't bother to do the above either for the same reason you've given.

 

I also agree with you about the amount of time we waste preparing our returns. ;D (I was up until 3am last Thursday trying to make sure I had not miscalculated my FX gains. I had not expected the amount to be so significant.) And the T1135 - I'm pretty sure they just make a bonfire from all the forms every year.

 

oec

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I keep it as simple as possible.  I use the average exchange rate for the year for all conversions.  Generally, I am neither buying or selling a whole position at once, but in stages, and sometimes selling some, and buying more back if it drops.  To work out the exchange rate for every transaction would take a huge amount of time.  I use the trading summary the discount broker provides and the average number that they provide for the year. 

 

I dont do any US trades with the currency in mind and keep all the US stocks in my US margin account.  I have never worked it out but I suspect if I accounted for each transcation by the exact currency value on a given date, versus just averaging it, the difference would not likely be significant, and probably shakes out over time.  Should I get audited at some point I will let everyone know the outcome.  Something tells me that as long as I pay the huge amount of tax I pay every year RC is not going to care.  Its if (when?) I start claim huge losses that I expect the audit. 

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To work out the exchange rate for every transaction would take a huge amount of time.

 

It's not hard if you have your transactions on Excel. Daily exchange rates are available from Bank of Canada - download them to a worksheet and just use the VLOOKUP function in excel. It's a snap.

 

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oec, Can you carry the excel program over to your tax software and avoid retyping everything.  This is my major issue.  I tried using quickbooks at one point but a certain number of the stocks I was going to have to imput manually because QB couldn't access them.  If I have to do the same with Excel then I might as well do it the way I have been. 

 

The ideal would be if my broker gave me statements that could be input directly to the software programs. 

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Al, I haven't done it so I don't know the answer to your question. (Due to some quirks in my tax situation, I have not been able to use off-the-shelf tax software for my returns.)

 

Perhaps, someone else here knows the answer?

 

 

 

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