Your Complete Guide to Index Investing with Dan Bortolotti

Taxable Consequences of Norbert’s Gambit

2017-12-02T23:27:23+00:00February 26th, 2015|Categories: Discount brokers, Foreign currency, Taxes|Tags: , , |76 Comments

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.