For Canadians buying US funds for a trip south of the border, an improving exchange rate can be a welcome turn of events but for those holding investments or conducting business in USD having currency-related gains or losses that, if realized, need to be include them in their tax returns.
Early in the millennium we saw the value of the Canadian dollar increase by approximately 30% against the US dollar. During the past couple of years the Canadian dollar has been close to par against the US dollar.
For Canadians buying US funds for a trip south of the border, the improving exchange rate was a welcome turn of events.
On the other hand, Canadians holding investments or conducting business in US dollars have unanticipated currency-related gains or losses that, if realized, need to be included in their tax returns.
Two major taxation issues are commonly encountered in reporting foreign exchange gains and losses: deciding whether the gains or losses are on income or capital account; and timing of the realization for income tax purposes.
Because the Income Tax Act does not have specific rules for determining whether a foreign exchange gain or loss is on income or capital account, the basic principles of determining income from a business or property must be applied.
A gain/loss arising from the purchase or sale abroad of business-related goods or services is on account of income.
If the gain/loss arises as a result of the purchase or sale of capital assets, it is a capital gain or loss. In most cases, gains or losses on income are 100% taxable or 100% deductible. Capital gains are 50% taxable, and capital losses are 50% deductible against capital gains, with carry-forward and carry-back provisions.
Foreign exchange gains or losses on income account are normally included in income for tax purposes on an accrual basis. Foreign exchange gains or losses on capital account are usually reported for tax purposes when they’re actually realized.
If you’ve invested in US bank deposits, term investments, or bonds over the past couple of years, the rising Canadian dollar likely will have caused their value to drop even if they showed a positive return in US dollars.
For example, if you invested $10,000 Canadian in a one-year US dollar term deposit in late 2010, it would have had an initial value of about US$9,800. By the time the deposit matured in late 2011, the funds would have grown to, say, US$,900. If you cashed in the deposit and took the proceeds in Canadian funds, you would have received only about $9,950 – a capital loss of about $50 on your original investment.
A capital gain or loss on foreign currency is incurred, however, only when an actual transaction has occurred or is realized, a paper gain or loss on paper does not count. The loss is normally realized when US funds are converted to Canadian dollars or another foreign currency.
No realization occurs while invested funds remain “on deposit”. So if you opted to roll over your US term deposit for a new term or moved the funds into a US bank account, US guaranteed investment certificate, or other non-negotiable US investment, you would not have realized a capital loss at that time.
On the other hand, if you had bought US capital assets such as stocks, bonds or other negotiable instruments and then decided to sell them, a capital loss or gain would have been realized at the time of sale. That is true even if you used the sale proceeds to buy other US stocks or bonds.
For example, suppose you’d bought 2,500 shares in a U.S. company for US$20 ($24) per share. Then the shares grew to a value of US$22 ($23). If you sell those shares today it would result in a capital loss for Canadian tax purposes of $2,500 (2,500 x $1).
Other personal sundry dispositions of foreign currency, such as conversion of US dollar travelers’ cheques to Canadian dollars upon return home, are also considered to be on account of capital. Gains/losses incurred are taxable/deductible on the amount of gain/loss over $200.
Foreign exchange losses on the repayment of a debt incurred to acquire a personal-use property such as a condo in Arizona are also deemed to be capital losses.
You must report each foreign exchange capital loss or gain transaction on your tax return in the Canadian dollar equivalent. The exchange rates to be used are the rates in effect at times of acquisition and disposition.
Another issue around foreign exchange transactions is deciding which accounting method to use in reporting these items for tax purposes. For determining foreign exchange gains or losses on income account, the Canada Revenue Agency (CRA) accepts any method as long as it follows generally accepted accounting principles and is used consistently for both financial statements and tax return preparation.
Because foreign exchange capital gains or losses are realized only when a transaction has actually taken place, however, it is not acceptable to use the accrual method of accounting for these transactions. (See CRA’s Interpretation Bulletin IT-95R, “Foreign exchange gains and losses”.)
The tax ramifications of foreign exchange transactions are quite complex. It’s always wise to review the tax consequences of such transactions with a tax specialist before they are undertaken. That helps you identify planning strategies to optimize your tax position.