Taxable Consequences of Norbert’s Gambit

Norbert’s gambit with the Horizons US Dollar Currency ETF (DLR/DLR.U) is often the most cost-efficient way to convert Canadian dollars to US dollars, or vice-versa. Our series of white papers focused on performing the gambit in an RRSP, but if you’re swapping currencies in a non-registered account, you should be aware that it can have tax consequences.

At brokerages such as RBC Direct and BMO InvestorLine, you can place the buy and sell trades within minutes of each other. But several other brokerages do not allow you to journal the ETF from the Canadian side of your account to the US side (or the other way around) until the buy trade settles. In both cases, however, there will be at least three business days for the transaction to be complete, and the US-Canadian exchange rate can move significantly during that time. A big swing could stick you with a capital gain or loss when you make the sale.

What’s more, calculating this gain or loss can be tricky, because both the purchase and sale need to be reported in Canadian dollars. That means any transaction in DLR.U needs to be converted from US dollars. For example, if you’re selling DLR.U, you would look up the Bank of Canada exchange rate on the settlement date and use this value to report the proceeds in Canadian dollars. The difference between this amount and your original purchase price is your capital gain or loss.

Play it a gain

Let’s assume Mallory wants to convert $50,000 CAD using Norbert’s gambit. She buys DLR on February 17, when the US dollar is worth $1.238 CAD, so DLR is trading at $12.38. Ignoring the trading commission, her order looks like this:

Trade Date Settlement Order Security Shares Price (CAD) Total (CAD)
Feb 17 Feb 20 Buy DLR 4038 12.38 49,990.44

Mallory waits three business days and then journals DLR to the US side of her account on the settlement date, February 20. She then immediately places an order to sell all 4038 shares of DLR.U, which is trading at $10.00 USD:

Trade Date Settlement Order Security Shares Price (USD) Total (USD)
Feb 20 Feb 25 Sell DLR.U 4038 10.00 40,380.00

To see if there is any capital gain or loss, Mallory will need to convert the proceeds of the DLR.U sale to Canadian dollars using the exchange rate on the settlement date, February 25. Note that it has now been eight days since she placed the buy trade, and currencies can move sharply over that time frame. We’ll assume the US dollar has climbed almost three cents to $1.264, which means the proceeds of Mallory’s sale are worth $51,040.32 CAD (that’s $40,380 USD × 1.264). When we subtract the value of the original purchase ($49,990.44 CAD) we’re left with a capital gain of about $1,050. If Mallory is in a 40% tax bracket, that will cost her more than $200 in taxes.

Don’t trust your brokerage

The example above is a bit extreme: $50,000 is large amount, and a three-cent change in the exchange rate in just eight days is a tad pessimistic (though certainly possible). If you’re doing a smaller gambit, chances are your gain or loss will be relatively minor. For what it’s worth, in 2014 I used Norbert’s gambit twice to convert small amounts of USD in a non-registered account. Using the method described above, I calculated a $13 loss on the first trade and a $25 gain on the second, for a trivial net gain of $12.

Unfortunately, my brokerage (Scotia iTRADE) saw things differently. I’ve written before about why you should not trust your brokerage to accurately calculate the adjusted cost base on your ETFs, and I found that out first-hand when I received my annual Realized Gain/Loss Report for 2014. It inexplicably indicates a $420 gain from the two DLR trades. I have no idea how they calculated the book values they’re using, and an email to customer service didn’t help. It’s no wonder the report includes the following disclaimer:

Scotia iTRADE provides cost basis and associated realized gain and loss information to you as a courtesy service and for informational purposes only and not for official tax purposes. Such information may not reflect all adjustments necessary for tax reporting purposes. You should verify cost basis and corresponding gain/loss information provided by Scotia iTRADE against your own records when calculating reportable gain or loss resulting from a sale.

One other issue may come up in this discussion. The CRA has a $200 exclusion on capital gains from foreign exchange, which means you don’t need to report any gain under that amount. You might be tempted to invoke this rule and elect not to claim a small gain you incurred doing Norbert’s gambit. However, this rule applies to cash conversions and was designed to avoid creating a taxable event every time Morty and Helen exchange a couple thousand bucks before heading to Del Boca Vista. While any gains or losses on DLR are due only to the exchange rate, it’s an investment fund, not cash. If you want to invoke the $200 exception and avoid claiming a capital gain on DLR, well, that’s between you and your accountant. I wouldn’t recommend it.

 

63 Responses to Taxable Consequences of Norbert’s Gambit

  1. Canadian Couch Potato May 18, 2015 at 2:55 pm #

    @Troy: No effect. Horizons does this regularly to keep the unit price of DLR.U as close as possible to $10 USD.

  2. Troy May 18, 2015 at 2:58 pm #

    Ah. Thanks for the quick reply. I was concerned because I track DLR and DLR.U on Google Finance, but DLR has recently disappeared from Google Finance. I thought maybe something more drastic had occurred.

  3. Arthur August 30, 2015 at 3:48 pm #

    Hi, I couldn’t comment on the Complete Guide to Norbert’s Gambit and I wanted to ask something related:

    Why are DLR and DLR.U the ideal vehicles for Norbert’s Gambit? How do they compare with other interlisted stocks such as TD, RY, POT, BBRY?

    DLR/DLR.U are investment funds but they only hold cash, right? (related to tax consequences and interpretation)

    It seems that for some brokerages such as BMO IVL, using an interlisted stock such as TD will let you sell through the online platform instead of having to call in to sell DLR.U
    http://forums.redflagdeals.com/reverse-norberts-gambit-rbc-direct-investing-1726979/2/

  4. JRS August 30, 2015 at 6:00 pm #

    I believe the reason is so that you only face currency risk, rather than both currency and security risk. That being said – I have used the gambit several times with DLR and DLR.U in my TD Direct investing account (non-taxable) accounts – and the entire transaction usually takes about 4-5 days. I can do the buy and sells online, but I have to journal the shares from one side of my account to the other, by calling into the brokers, and I have to wait for the journaling to settle (about 2 days) before I can sell on the other side. Given the time delays involved, the risk of currency fluctuation is quite high. I have not tried the gambit using a different security, such as TD – but I would certainly consider it if both the buy and sell could be done back to back.

    Has anyone tried the gambit in a taxable account using TD Direct Investing using something other than DLR / DLR.U? I would be curious to hear the results!

  5. Canadian Couch Potato August 31, 2015 at 8:14 am #

    @Arthur: As JRS has said, the reason to use DLR is that it protects you from the possibility that the price of the stock could move during the interval between your two trades. Obviously this risk is reduced if you are using a brokerage that allows you to place the two trades online within a minute or so of each other.

  6. Janani September 3, 2015 at 2:52 pm #

    Hi..I am a canadian citizen living in USA for the past four years. I am looking at buying real estate here but banks require 20/ down. I have funds in cad savings account and rrsp.can you advice on the best way to convert cad to usd ?

  7. Arthur September 4, 2015 at 11:34 pm #

    Thanks CCP. The guide for BMO IVL says you have to call in to sell DLR.U on the same day, and I was wondering if that was only the case if using DLR / DLR.U. In May 2014, I bought and sold RY online CAD/USD without having to call in. I’ll be doing it again when markets open after Labour Day and can post an update here.

  8. Andrew October 30, 2015 at 2:15 pm #

    I have been using the Gambit for many years to move money between my US and Canadian Brokerage Accounts at TD Waterhouse. I typically used one of the interlisted big banks and performed a near simultaneous buy and short sell of the stock. It was great- almost zero risk and currency exchange with no commission.

    Unfortunately, my most recent attempt at the Gambit was blocked by TD Waterhouse. To make matters worse, they allowed the long order to go through, then cancelled the short sale on the reasoning that I was “shorting the box” against SEC rules. It left me long on the stock exposed to a large position, and despite my protestations, the brokerage refused to reverse my long position or execute my short trade.

    “Don’t trust your brokerage” so true…

  9. Southpaw February 3, 2016 at 9:35 am #

    @Julien, CCP: not sure if any further clarity on tracking ACB of USD cash sitting in the brokerage account. I’m looking to convert back to CADy and recall dozens of exchanges to USD from back in the mid 2000’s and my broker only keeps a short history of transactions. As such, I have no idea what my ACB would be. I’ve been very diligent on ACB tracking for securities but the cash thing is something that didn’t cross my mind until recently.

  10. François June 8, 2016 at 8:49 am #

    Hi Dan (not sure if you monitor old posts, but this seemed like the best place for my query)

    I understand the whole capital Gain/Loss issue. What i am unsure is wouldn’t DLR.u which is effectively US$ and US$ cash be considered similar assets and therefore not a cristallisation of G/L, and that the effective gain/loss is only realised when you use the US$ to purchase something else?

  11. Canadian Couch Potato June 8, 2016 at 7:48 pm #

    @Francois: You can realize a gain or loss any time your purchase price and sale price for a given asset are different when measured in Canadian dollars. So if you use $10,000 CAD to purchase $8,000 USD and then sell those USD for the equivalent of $10,100 CAD you will book a $100 gain.

    You can even realize a gain on foreign cash:
    http://www.adjustedcostbase.ca/blog/calculating-adjusted-cost-base-for-foreign-currency-cash/

  12. Matt October 22, 2016 at 6:48 pm #

    Could you write a similar post for the opposite case? The one where you have U.S dollars, buy DLR.U, journal it to DLR, and sell to end up with canadian dollars? Some of us at the office are interested to know where along the process you end up with that $1050 capital gain (in your example). It’s confusing.

    For example, if you start with 100k USD that you obtained when the exchange rate was at par, and do the Norbert gambit today, when DLR is 13.25, you end up with 135k and so, 35k of capital gain. Is there any gain or loss in that case? Much appreciated.

  13. Canadian Couch Potato October 24, 2016 at 8:01 am #

    @Matt: Your example is flawed, because if the currencies were at par DLR would not be at $13.25. The price of DLR.U is more or less fixed within a penny or two of $10 USD, and the price of DLR moves up and down with the exchange rate. So if the currencies were at par the price of DLR would be very close to $10 CAD.

    The key point here is that the capital gain always needs to calculated using CAD. If you buy $100K USD today and sell it immediately for $135K CAD when the exchange rate is 1.35, that is not a capital gain, because in CAD terms those two amounts are equal in value. The only time a capital gain would occur is of the exchange rate changes during the interval between the two transactions.

    Hope this helps.

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