With clients increasingly invest-ing abroad, it is important for them to understand how to calculate and report their foreign-currency gains and losses on various types of securities and cash. This is especially true in an environment such as today’s, in which the Canadian dollar has been strong relative to its U.S. counterpart.
Typically, foreign-exchange gains or losses on investments held in a foreign currency are triggered by fluctuations in the foreign-exchange rate, says Allison Marshall, senior manager, financial advisory support, with RBC Wealth Management in Toronto.
And regardless of what currency your clients invest in, all gains and losses must be converted to C$ for tax-reporting purposes, says Derryn Burtenshaw, tax accountant with Toronto-based Harvey Cantor Professional Corp.
In some instances, the financial services institution issuing the relevant tax slips would do the necessary conversions. But in other situations, your clients will be left with this task — “which can get quite complicated,” cautions Michael Fromstein, chartered accountant with Toronto-based Integrated Tax Specialists.
Normally, most investors would receive two tax slips for use in filing their tax returns: the T5, which identifies the various types of investment income — for example, dividends or interest income; and the T5008, which reports a transaction — buy, sell or maturity — or more than one transaction involving identical securities. If your client is an active trader, some institutions will provide a summary of security dispositions, which lists all sales, redemptions and maturities for the tax year. This summary may also provide book value, as well as information on gains and losses.
If Box 27 of the T5 slip indicates “CAD” or is empty, then the all the amounts on the slip are in C$ and no currency conversion is required, Marshall says; otherwise, Box 27 will specify the currency used. The same applies to the T5008 slip, on which case Box 13 specifies the currency used.
Meanwhile, the summary of security dispositions provided by some institutions may report transactions in the foreign currency associated with the transaction. “Without a summary of security dispositions in C$, you would have to maintain a spreadsheet that calculates the gain and loss on each security, so it is important to ensure that your financial institution offers this report in C$,” says Fromstein, adding that this task becomes especially “cumbersome if [clients] are investing in several currencies.”
If your clients must do their own currency conversions, they should recognize that there are different treatments for different types of securities or cash, Marshall advises. For example, if a publicly traded security denominated in a foreign currency is sold, she says, “You must convert the adjusted cost base and sale proceeds of the security into Canadian dollars in order to calculate any capital gain or loss.”
Adds Burtenshaw: “The conversion is done using the foreign exchange rate on the settlement date of the transaction.”
This includes the rate on the settlement date of the purchase as well as on the date of the sale. Typically, the Bank of Canada’s noon exchange rate is used.
If several purchases of a security are made at different times throughout the year, the average annual exchange rate — available from the Canada Revenue Agency — may be used to calculate the cost base in C$, says Marshall. Otherwise, the value of each transaction must be converted to C$ using the BofC’s daily noon exchange rate. However, she adds, “You must use a consistent method — that is, either same-day or average exchange rate.”
Even though the fair market value of a security might be higher than its adjusted cost base at the time of a sale, Marshall points out that it is still possible to realize a capital loss as a result of foreign-exchange fluctuations, which many clients do not immediately recognize. “This is a common mistake,” she says. “Some clients only look at current market value.”
For example, if your client acquired 100 shares of the U.S.-based Company ABC Inc. at US$10 a share when the exchange rate was US$1.30 to the C$, the adjusted cost base of the stock would be (100 x US$10) x 1.30 = C$1,300. If the price of ABC stock rises to US$12 in Year 2, it would be a 20% gain (or US$200) if the exchange rate remained the same. However, if the client sold the 100 shares of ABC at US$12 a share at an exchange rate of US$1.02 to the C$, the client would realize a capital loss of $76 ([100 x US$12] x 1.02 = C$1,224). Effectively, a stronger C$ has resulted in a capital loss.
It is possible to realize a capital gain or loss even if the fair market value of a security has not changed at the time of sale, Marshall advises. For example, if your client redeems units in a U.S. money market fund, the proceeds of the redemption would be the same in US$ as the amount invested. However, if C$ were used to invest in the fund, then a capital gain or loss would result if the exchange rates were different at the time of acquisition and redemption.
In almost all cases, similar foreign-exchange conversion rules apply for different types of investments — including interest income and dividends — once there is an actual conversion of currency. IE