If your small business purchases inventory that comes from outside of Canada, often you have to pay for that inventory in the country’s native currency. Sometimes businesses maintain off-shore bank accounts or investments in foreign currencies to smooth out the buying process, or for other strategic reasons as part of their business plan. Regardless of when your small business uses foreign currency, it’s important to understand how exchange rates can affect the value of your investment.
Foreign Currency Exchange Fees
You can exchange your Canadian currency for foreign currency, but most exchanges charge a small fee for this type of transaction. For example, if you exchange physical currency at a bank, that bank levies a fee for the service. Similarly, if you use a Canadian credit card to purchase online items in a foreign currency or to make purchases while abroad, your credit card provider converts the total into Canadian currency and typically charges a small amount for the conversion. Likewise, if you have investments or savings in another country, you can expect to incur fees for the conversion of your Canadian money into the native currency.
Foreign Currency Exchange Rates
As you track the value of your investments, it’s important to stay on top of the current exchange rates. You can use a foreign currency exchange rate calculator to figure your position. Rates can vary a bit from institution to institution, so you may want to check the exact rates at the financial institution you use.
If you want to minimize the risk of losing money on the exchange, you may consider using a hedge against currency exchange rates.
Currency Investment Growth
If you are investing in foreign currency, you should keep track of both growth and how the exchange rate affects your returns. For example, let’s say you have $10,000 United States dollars (USD) in US stocks, and you made this investment when the exchange rate was $1 Canadian dollars (CAD) to 76 cents USD. As a result, you spent $13,128 CAD plus fees to purchase the $10,000 USD. Over time, the value of those stocks rises to $12,000 USD, giving you a $2,000 USD return on your investment.
Let’s say that at the time you decide to cash out, the exchange rate has changed and is now $1 CAD to 72 cents USD. When you cash out your original $10,000 USD investment, you get back $13,971 CAD, a $843 CAD increase due to the change in the exchange rate. Further, the $2,000 USD return amount converts to $2,778 CAD when you cash it out, giving you an extra $778 CAD profit on your investment.
Capital Gains from Currency Exchange
The CRA requires all taxpayers to report capital gains, which is the profit you earn when you sell an investment. For instance, if you buy stocks for $5,000 and sell them for $6,000, you have a $1,000 capital gain. This rule extends to money you earn through foreign currency exchanges, but only applies to gains worth more than $200. (The official CRA exchange rate uses figures from the Royal Bank of Canada.)
For a more detailed example, imagine you’re purchasing a property in the United States. To make the purchase, you exchange $328,072.50 CAD for $250,000, and you put these funds in a US bank account. However, the deal falls through and you close the account. In the interim, the exchange rate changed, so you receive $349,123.75 CAD for the $250,000 USD. In this case, you have capital gains of $21,051.25. Although you have a $200 exemption on these profits, the CRA requires you to report the rest as capital gains.
Investing in foreign currency can add supplemental income to your small business whether that’s your intention or not. With that in mind, knowing how exchange rates work and how to report them ensures you stay on top of your money and in compliance with the CRA. To improve their financial outlooks, 4.3 million customers use QuickBooks. Join them today to help your business thrive for free.