Dealing with foreign income and gains on your tax return
Completing a tax return when all your income and tax slips are in Canadian dollars can be a difficult task on its own. But if you received foreign income during the year or sold a foreign stock, your tax calculations can be a bit more complicated.
Here’s a quick guide on how to deal with foreign currency income and gains ( losses) on your Canadian return.
If you received foreign income, either from a foreign employer, a foreign pension plan or from owning foreign investments, you must report this income on your return in Canadian dollars.
The Canada Revenue Agency ( CRA) says that you are to use the Bank of Canada exchange rate in effect “on the day you received the income.” If, however, the amount was essentially paid evenly throughout the year, you can use the average annual rate for the year, which can be found on the same site. For example, if you received U. S. dividends throughout 2017, your average Canada/ U. S. foreign exchange rate would be 1.2986.
Any foreign taxes withheld on your non- registered foreign income may entitle you to claim a foreign tax credit when you calculate your federal and provin- cial or territorial taxes. You would also use the same rates that were used for the income to calculate the Canadian equivalent of the foreign taxes paid. Note that if you had foreign taxes withheld on foreign dividends paid to your TFSA, you cannot claim a foreign tax credit for those taxes, which is why it’s best to hold foreign ( including U. S.) dividend paying stocks outside a TFSA.
But just because the average annual exchange rate is convenient, does it mean that you have to use that rate for the year? Just over a decade ago, the Canada Revenue Agency was asked whether a taxpayer was required to use the Bank of Canada annual average exchange rate to convert pension and investment income to Canadian dollars.
The taxpayer wanted to know if she could ignore the average annual rate for the year and use the actual exchange rates she received from her bank when she deposited her foreign pension and investment income into her Canadian bank account. The CRA responded that there was nothing in the Income Tax Act nor in the CRA’s published material that actually requires a taxpayer to use the Bank of Canada annual average exchange rate to convert pension or investment income to Canadian dollars. Indeed, the current 2017 General Income Tax and Benefit Guide states that you should “use the Bank of Canada exchange rate in effect on the day you received the income.”
With the fluctuating Canada/ US rate, you may wish to take a closer look and determine which conversion method ( actual vs. average) gives you the best tax result based on the timing of your payments.
For example, l et’s say Sarah received a total of US$ 3,000 of U. S. dividend income in 2017. If she were to use the average annual Bank of Canada exchange rate of 1.2986 for 2017, she would report $3,896 of income on her 2017 return.
But if we were to dig a bit deeper, we see that this for- eign income was the result of a dividend Sarah received on Sept. 15, 2017 when the Canada/ US rate was 1.2182. Using the actual rate would result in Sarah reporting income of $ 3,655, a reduction in income of $241 compared with the “average rate.
While the average rate method is certainly more convenient, it may be worth the trouble of hunting down those historical rates as it might save you some tax.
SELLING FOREIGN PROPERTY
The other cause of foreign currency tribulations is properly calculating the gain or loss on the sale of foreign stocks, bonds, or even real estate. For these transactions, you are supposed to use the actual foreign exchange rate that was in effect on the day of the transaction.
In other words, to properly report a gain ( loss) on a foreign property, you would convert t he proceeds to Canadian dollars using the exchange rate on the date of sale and compare that to the adjusted cost base ( ACB) or tax cost of the property using the foreign exchange rate on the date of purchase of the property.
Let’s say Finn bought 1,000 shares of a U. S. stock on Nov. 8, 2012 when the price was US$ 10/share and the U. S. dollar was at par with the Canadian dollar ( the actual exchange rate was 1.0004, if we want to be precise!) By May 2017, the price of the shares had fallen to US$ 8 and Finn decided he wanted to do some tax loss harvesting ( or so he thought at the time…) to use the US$ 2,000 ( US$ 10 - US$ 8 = US$ 2 x 1,000) accrued capital loss against other gains he realized in 2017.
So, on May 11, 2017, when the exchange rate was $1 U.S. = $ 1.3707 CDN, Finn sold the U. S. shares for US$8,000 yielding proceeds of $10,966. So, what initially appeared to be an accrued capital loss of US$ 2,000 ( US$ 10,000 – US$8,000) turned out to be a capital gain of $962 ($10,966 — $10,004) for Canadian tax purposes!
Finally, keep in mind that the taxman requires you to report your foreign exchange gain ( loss) on your 2017 securities transactions on your 2017 tax return even if you don’t actually convert the foreign funds back to Canadian dollars, which may be the case if you trade U. S. stocks in a U. S. dollar, non- registered trading account.