When I wrote about some low cost ways to convert your valuable US Dollars (USD) back into Canadian dollars (USD), there was a comment about the potential for capital gains tax which caught some readers by surprise. At a high level, if there is any sort of “profit” from doing a conversion from USD to CAD within a non-registered account, then there will be taxes owed. Lets get into the weeds a little more.
What is Capital Gains Tax?
This tax only applies to investments in non-registered accounts and U.S based investment real estate. If you sell a position in a non-registered account, and there is a profit (capital gain), then there will be capital gains tax owed when you file taxes for that year. How is capital gains tax calculated? At the simplest level, 50% of your capital gain is added to your income for the year. If you are at the highest tax bracket, then you will pay approximately 25% of your capital gain in tax.
Say you purchased $1,000 worth of a Canadian publicly traded company in a non-registered account and later sold it for $1,500. In this simplified example, the capital gain would be $500. The next step would be to take 50% of your capital gain and add to income for the year to determine your marginal tax rate.
Say that your marginal tax rate for the year is 40%, then your capital gains tax payable is $250 x 40% = $100. In this case, your tax would be 20% of your capital gain, or half your marginal rate. This calculation can get a bit more complicated because your buy price can change if you add to your position or make renovations when it comes to an investment property. This is called calculating your adjusted cost base and you can read more about it here. Otherwise, you can read more about capital gains tax here.
How does Capital Gains Tax Apply to Foreign Exchange?
So back to the original issue of taxation of doing foreign exchange (FX). It can get confusing thinking in terms of a foreign currency and trying to calculate profit. Buying and selling USD is very similar to buying and selling an equity as the value of USD relative to CAD changes over time.
Say that back in 2011/2012, you had the foresight to buy $10,000 USD when CAD/USD was at par. Being the astute capitalist, you figure with CAD being around 1.40 would be a good time to sell USD and convert back to CAD. Since you purchased $10,000 USD with $10,000 CAD, and sold for $14,000 CAD, your capital gain is $4,000 CAD. Hint: convert everything to CAD first before doing your calculations.
Typical capital gains tax calculations apply here (see above), but with a small wrinkle. Canada Revenue Agency (CRA) does not require that you report FX gains/losses unless it is greater than $200. So in this case, you would report $3,800 ($4,000 – $200) as your capital gain, then taxed on the $1,900 (50% of $3,800). If using the same marginal tax rate as the first example, you’re looking at about $760 in taxes.