Taking the tax pain out of U.S. dividends

I hold some U.S. stocks in a non-registered account and pay U.S. withholding tax of 15 per cent on the dividends. My tax slips provide the dividend and tax information in U.S. dollars. Given the currency fluctuations we’ve seen recently, how do I report these amounts on my Canadian income tax return?

Because U.S. dividends do not qualify for the Canadian dividend tax credit, in a non-registered account you would pay Canadian tax at your marginal rate on the full amount of the U.S. dividend – just as if it were interest income. To avoid double taxation, you may be able to claim the 15-per-cent U.S. tax withheld as a foreign tax credit on line 405 of your return.

For tax purposes, you’re required to convert foreign income and foreign tax withheld to Canadian dollars, using the Bank of Canada exchange rate in effect on the transaction date.

However, according to the Canada Revenue Agency, if there were “multiple payments at different times during the year,” it is acceptable to use the average annual exchange rate. This simplifies the process of converting U.S. dividends and tax withheld to Canadian dollars.

You can find a list of average annual exchange rates on the Bank of Canada website.

Tip: you can avoid withholding tax on U.S. dividends by keeping your U.S. stocks in a registered retirement savings plan, registered retirement income fund or other retirement account. But be careful: The withholding tax exemption, which is part of the Canada-U.S. tax treaty, does not apply to tax-free savings accounts or registered education savings plans.

Also, with TFSAs and RESPs, you’re not able to claim a foreign tax credit for the tax withheld.

Given that an equity mutual fund’s net asset value is set once a day after the markets close and orders to buy or sell must be entered earlier in the day, is there ever a circumstance where you can know with any degree of certainty the price that you will receive on your transaction?

Mutual fund orders must be submitted by 2 p.m. ET to be executed at that day’s closing price. Even though markets don’t close until 4 p.m., this “allows the dealer to aggregate all trades from all of their clients and make sure that they’re submitted on time,” said Dan Hallett, vice-president and principal at HighView Financial Group. Occasionally, errors occur that lead to a trade being rejected, and the dealer then has time to correct and resubmit the order.

With exchange-traded funds, you have more control over the timing of your buy and sell transactions because ETFs trade on a stock exchange throughout the day. Mutual funds, on the other hand, don’t trade on a public exchange; most trades are executed through FundServ, an electronic network that connects dealers directly to fund companies. As a result, you can’t precisely control your buy or sell price.

For long-term investors, however, the distinction is largely meaningless, Mr. Hallett said. Even if the market is experiencing wild swings as it did in 2008 and 2009, “buying on a down day or up day won’t matter if this one purchase is part of a diversified portfolio and you plan to be invested for several years,” he said. Even a big intraday move of 1 to 2 per cent is “not going to matter over time. Most of the time the daily changes are much smaller so it’s really insignificant,” he said.