Nowadays many people have income from outside Canada, and when it comes to filing their income taxes must include said income. Many businesses are selling outside of Canada, too, and may receive funds in the country from which they sell. The question then becomes, ‘what exchange rate do you use?’
What is the exchange rate? The exchange rate is the price of one national currency, such as the Canadian dollar, expressed in terms of another currency, for example, the U.S. dollar, or a basket of currencies.
Canada Revenue Agency (CRA) used to recommend what exchange rate to use when filing your personal taxes, and, usually, did an average exchange rate for the year. You weren’t required to use this rate; however, it did make it easier to file your taxes. This save you of having to go to the bother of looking up exchange rates for the date you earned the income; if you even remember the date you received the income.
Now, CRA just recommends you use the Bank of Canada exchange rates. At the BOC website, you can get exchange rates for up to 26 currencies, based on a single rate reflecting the daily average exchange rate per currency pair, which will be published each day. If your foreign income is form outside these 26 countries, you will have to either find an exchange rate elsewhere, or check what the rate was on the day you received the income. There was the average exchange rate for the year, however, I can’t see on the site where this will continue nor does it say it will be discontinued, so we’ll just have to wait and see.
Using the Exchange Rate on Your Personal Taxes
When you go to file your personal taxes, look at what foreign income you have and go to the BOC website. Do you remember when you received that income? If yes, use the exchange rate, or find the amount that was deposited into your bank account, and use that rate. If it’s from multiple deposits, such as the British Pension, then you’ll have to calculate the exchange rate each time, or add up the amounts from each month.
If you just received a slip, and have no idea when the money was deposited or what it’s for, then use the average yearly rate, if it’s still available, or the rate at December 31st for that tax year.
Using the Exchange Rate for Business
For business, it’s a bit easier on when to use the exchange rate.
For sales, when you create the invoice for the customer pick the rate for that day, if available, or the previous day. Fortunately, accounting software now can link to the Bank of Canada website and pick the rate, normally it’s for the previous day and that’s okay. You could also just pick an average rate and go with that for a time, until it changes. For example, say the US dollar, you can pick an exchange rate of 1.35 and go with that until you feel it’s changed too much to keep using it.
For customer payments, use the exchange rate the bank gives you when you deposit, if into your Canadian dollar account. Otherwise, use the rate on the day of the deposit, or the previous day. Are you receiving a lot of foreign currency? You may want to setup a bank account in that currency.
For purchases, you can follow the same advice as for sales. One client I have uses an average, and then adjusts that rate up or down depending on how the Canadian dollar is doing compared to the currencies he makes purchases in. However, when he sends the supplier money, he uses the rate from the currency exchange house.
That’s something else to think about for business, if you do a lot of purchasing in foreign currencies, I suggest using a currency exchange house. They usually give better rates than the banks, and can send bank drafts and wires at much cheaper rates than the banks (many banks are charging $40+ for a wire transfer).
Also, think about purchasing forwards when you have a large volume of transactions in a currency. A forward is a contract to buy so much of a foreign currency at a fixed exchange rate. You’re basically hedging your bets about the currency going up. So, you lock in the exchange rate for a certain period, then much purchase the forward at the rate agreed upon at its creation.
For example, you agree to buy a forward on the US dollar at an exchange rate of 1.35 and it expires in three months. At the expiration, you purchase the agreed amount of dollars at the 1.35 rate, or pay a penalty for not doing so. If the exchange rate goes up to 1.40 then you’ve saved 5 points and depending on the amount quite a bit of money. However, if the rate goes down to 1.30 then you’ve paid 5 points more than you needed to. This is the risk you take doing forwards.
Having foreign income can be a great, especially when the Canadian dollar is low compared to that foreign currency. However, when it comes time to reporting that income on your tax return, or in your business, ensure you are using the correct rate.
Filed Your Tax Return? – What to do if you Forgot Something
The Personal Tax Filing Deadline is April 30th – Some Last Minute Reminders
Differences Between a Tax Credit and a Tax Deduction in Canada?
Ways to get a Bigger Tax Refund
Who is Required by the CRA to File a Tax Return in Canada?
Do we Need to File our Taxes as a Couple if we are Common-Law?
Do I Have to Report Foreign Income on my Canadian Tax Return?
Which Government Benefits do I Need to Report on my 2020 Tax Return?