Imagine the following: When the Canadian dollar was at US$0.85 in early 2015, you invested C$25,000 in a 1-year U.S. dollar GIC paying 0.50% interest. By the end of the GIC’s term in 2016, the loonie had plummeted to US$0.70. You then decided to convert the money back to Canadian dollars.
First, the good news. You’re clearly a currency rock star, having managed to get onboard the U.S. dollar just as it started a mighty ascent against the Canadian currency. As oil prices crashed, taking our dollar with it, you managed to profit.
You actually made more than $5,000 due to good timing. Here’s how we calculate this. We start by figuring out how many U.S. dollars were received by the initial conversion. In this case, it’s $25,000 multiplied by $0.85 which equals US$21,250. Next, we divide this figure by the exchange rate at the time the GIC matured ($21,250 / $0.70 = $30,357.14) and subtract the initial investment ($30,357.14 – $25,000 = $5,357.14). Not bad at all.
But now for the bad news. Once the money is converted back to Canadian funds, you’ll have to pay tax on your gains, according to Advisor.ca.
Importantly, only capital gains in excess of $200 are taxable by the Canada Revenue Agency (CRA). Subtracting the $200 exemption leaves you with a reportable capital gain of $5,157.14.
So how much tax will you have to pay? This depends on your income tax bracket. For the sake of argument, let’s say you live in Manitoba and earn $75,000 per year. In this case, you’d fall in the 37.9% tax bracket. However, because only 50% of capital gains are taxable, the taxable capital gain is half of that or $2,578.57. At the 37.9% marginal rate, it means you would owe $977.28.
Keep in mind that you will also owe tax on the interest you earned from the U.S. dollar GIC. This is payable at your marginal tax rate. Assuming you were paid interest in one lump sum at the end of the term, you would earn US$212.5 ($21,250 x 1%). At the prevailing exchange rate, this equals $303.57 Canadian ($212.5 / $0.70). Multiplied by the marginal tax rate of 37.9% for Manitoba means you’ll pay $115.05 in tax on your interest earnings.
Here’s a summary of all the calculations involved in our scenario:
|Value of U.S. dollar GIC at maturity (interest excluded)||$30,357.14|
|Value of U.S. dollar GIC at start of term||-$25,000|
|Taxable capital gain||$5,157.14 x 0.5 = $2,578.57|
|Multiplied by marginal tax rate||$2,578.57 x 0.379|
|Capital gains tax payable||$977.28|
|Interest earned in U.S. dollars||$21,250 x 1% = $212.50|
|Divided by exchange rate at end of term||$212.5 / $0.70 = $303.57|
|Multiplied by marginal tax rate||$303.57 x 0.379|
|Tax payable on interest income||$115.05|
It’s worth remembering a few things with regards to foreign currency GICs and savings accounts. First, having to pay tax may seem like a pain but it also means you’ve made money. You’d much rather have a gain and owe tax than be sitting on a large capital loss. Second, if you’re interested in owning a U.S. dollar GIC, odds are you won’t make much in interest because rates tend to be paltry. Still, it’s not a bad idea to at least consider some currency diversification. If the Canadian dollar does continue to stumble (there are no guarantees, mind you), you’ll be glad you didn’t have all your eggs in one currency basket.