Last week's column about calculating capital gains and losses on U.S. securities generated more than the usual number of questions from readers. Because many of these questions were technical in nature, I once again reached out to John Waters, head of tax and estate planning with BMO Nesbitt Burns, to help answer them.
I had read somewhere that I can use the average exchange rate for the year when calculating capital gains on U.S. stocks. Is that true?
No. The Canada Revenue Agency issued an interpretation in October, 2014, that expressly disallowed this practice. "An average rate may be acceptable for items of income, but not for capital gains," the CRA said.
When calculating capital gains or losses on U.S. stocks, you are required to use the specific exchange rate that was in effect when you bought the shares, and the specific exchange rate when you sold them. You can use the noon exchange rate as published by the Bank of Canada and available online. To determine your capital gain or loss, calculate your proceeds of disposition in Canadian dollars and then subtract your adjusted cost base (ACB) in Canadian dollars, using the above methodology. Don't forget to include brokerage commissions, which increase your ACB and reduce your proceeds.
When accounting for U.S. income from dividends or interest, the CRA also suggests that the exchange rate in effect on the day you received the income should be used. "However, if there are a multitude of smaller transactions throughout the year, the CRA generally accepts the use of the average annual exchange rate," Mr. Waters said.
On your tax slip, income from U.S. securities is often reported in U.S. dollars, so you would need to convert these amounts to Canadian dollars. You could use still use the specific exchange rates for each payment, but using the average exchange rate for the year would be more convenient, where appropriate.
Also remember that, in a non-registered account, most U.S. dividends are subject to a 15-per-cent withholding tax. However, you can claim this amount as a foreign tax credit to reduce your Canadian taxes otherwise payable, Mr. Waters said.
Do I use the exchange rate in effect on the trade date, or the settlement date?
For stock transactions, the CRA stipulates that you should use the settlement date, which is three business days after the trade date.
I have U.S. stocks enrolled in a dividend reinvestment plan. Do I need to use the specific exchange rate in effect for each reinvestment to calculate my ACB, or can I use an average annual rate?
"It's a good question, and you could make arguments for either," Mr. Waters said. "However, the safe thing to do is to account for dividend reinvestments using the exchange rate in effect on the date for each transaction. That way you know it is correct. There may be some leniency from the CRA depending on how impractical that is."
Can I have a capital gain or loss even if I only hold U.S. cash (versus stocks)?
Yes. Say you sell a U.S. stock but leave the money in U.S. cash for a year. If the Canadian dollar moves up or down appreciably in that time, you are technically required to report a capital gain or loss if you then: a) convert the cash to Canadian dollars; b) purchase another U.S. stock; or c) use the funds to pay expenses or make a purchase. You would calculate the capital gain or loss using the same methodology as you would with a U.S. security – by converting both the proceeds and the ACB into Canadian dollars – but for currency transactions the CRA only requires you to report the amount of your net gain or loss for the year that is more than $200 (Canadian). "If the net amount is $200 or less, there is no capital gain or loss and you do not have to report it on your income tax and benefit return," the CRA said. For currencies, use the exchange rate on the day of the transaction.