Bookkeeping for Canadian DRIPs for Canadians is fairly straightforward. However, Canadians investing in U.S.-based DRIPs will encounter unique problems.
The purpose of bookkeeping is to determine capital gain or loss upon the eventual sale or disposition of a DRIP. While that might seem obvious and straightforward, when it comes to U.S. DRIPs and thanks to the Canada Customs and Revenue Agency (CCRA), there is an element of personal choice that can affect the determination and direction of your accounting.
I’d also point out that I have never sold a DRIP. My philosophy is to accumulate DRIPs to fund my retirement and to only sell them when it is tax advantaged (i.e., when my wife and I are in a lower income bracket). So, what I write about now is aimed at a future event based on the assumption that any errors will be negligible and that honesty and consistency will be appropriately treated by Canada Customs and Revenue.
Before considering U.S. DRIPs, let’s have a brief review of the basic accounting of domestic DRIPs.
Canadian Domestic DRIP Accounting
Accumulated Cost Basis is simply the total cost of share acquisition divided by the total number of shares. The total cost of shares is equal to the cost of direct purchases + dividends reinvested + purchase commissions.
Capital gain (loss) is the proceeds from sale minus commissions on sale minus total cost of shares.
In Table 1 the total cost is $255.00.This includes direct purchases plus commissions plus dividends reinvested. The total number of shares purchased is 6.75. Accumulated Cost Basis is total cost divided by total shares:
$255.00 divided by 6.75 shares = $37.78 per share.
This is the average cost per share.
Capital gain is simply proceeds on sale minus commissions on sale minus total cost. If the value of the shares was $500.00 on the day of sale and the commission to sell was $50.00, the capital gain is:
($500.00 proceeds - $50.00 commission) - $255.00 total cost = $450.00 - $255.00 = $195.00
The average capital gain per share is:
$195.00 divided by 6.75 shares = $28.89 per share.
If capital gain is simply proceeds minus costs, why is keeping a record of ACB important? Imagine all the figures (including the commission) in Table 1 multiplied by 100. In this case the total cost would be $25,500.00 and total shares would be 675. However, the ACB would still be $25,500/675 = $37.78 per share. If the owner were to sell only 100 shares there would still be 575 shares remaining, each with an ACB of $37.78. Any future capital gain (loss) on the remaining shares can be easily determined. I’ll deal with partial sells in a future article.
Non-Domestic U.S. DRIP Accounting
The major difference between domestic and non-domestic U.S. DRIP accounting comes in the treatment of dividends. Domestic dividends are reinvested pre-tax. Non-domestic reinvestment of dividends is after tax. With a properly completed W-8BEN there is a 15% withholding tax on U.S. dividends for Canadians. Withholding taxes can be treated as part of your ACB. However, before looking at this I’m going to consider a few other things first.
Canadian or U.S. Dollars: a Fairy Tale
Previously, I mentioned personal choice when accounting for U.S. DRIPs. Although it is not clearly indicated in Schedule 3: Capital Gains (or Losses) of a T-1 tax form, the CCRA allows a seller to decide whether to declare capital gains on disposition of U.S. equities in either Canadian or U.S. dollars. However, the CCRA expects sellers to be consistent. If capital gains on a U.S. DRIP are declared in Canadian dollars, all subsequent similar dispositions must be in Canadian dollars. If you chose to declare in U.S. dollars then all subsequent capital gains should be declared in U.S. dollars.
The reason is currency fluctuation. By the time a capital gain is taken the Canadian dollar might have fallen or risen relative to the U.S. dollar. Depending on the fluctuation and without the consistency requirement a seller could continuously switch methods to minimize capital gains.
Assume the Canadian and U.S. dollars are on par, ie C$1 = US$1 and a $1000 Canadian investment is made in a U.S. DRIP. So, C$1000 = US$1000 investment.
Suppose over time the value of the Canadian dollar relative to the U.S. dollar drops to $.50 and the value of the U.S. investment in U.S. dollars has not changed. If a seller were to cash out the U.S. DRIP and convert they’d receive C$2000 and have a C$1000 capital gain to declare. Taxes would be owed. However, leave the amount in U.S. dollars (US$1000) and no capital gain is taken. No tax is due.
Suppose the value of the U.S. investment fell to $900. With a $0.50 Canadian dollar the value of the investment is now C$1,800 or US$900. A curious situation exists whereby there is a capital gain in one currency (C$800) and a capital loss (US$100) in the other on the same investment.
If the value of the Canadian dollar were to increase relative to the U.S. dollar the situation reverses. Without the consistency requirement an investor could constantly switch methods to avoid tax owing. Making monthly purchases of U.S. dollars helps to average out the effects of the currency fluctuation.
As a personal choice I consistently convert all U.S. DRIP accounts to Canadian dollar amounts. I’ll now describe the methodology I use to account for U.S. DRIPs. Depending on whether you declare in Canadian or U.S. dollars, your approach might differ.
Accounting for Currency Fluctuations
At a minimum it is necessary to know how much was invested, the price per share and the number of shares purchased.
Once a month I make a purchase of U.S. dollars at the bank. This purchase is always in multiples of $100 to make accounting easier. Monthly purchases help smooth out fluctuations as well. A July 2, 2002 purchase provided US$63.84 for C$100 and a ready exchange rate of 0.6348.
If I then sent US$63.84 to Pepsi at a price of US$40 per share, my statement would show 1.5960 shares purchased. Accounting in Canadian dollars is simplified:
The only work necessary was to calculate the share price in Canadian dollars.
Dealing with Dividends
There are two main problems in dealing with U.S. dividends:
Your quarterly statement arrives and you discover a reinvested dividend occurred 45 days ago. I know no one who keeps daily records of exchange rates. As well, the rate fluctuates through the day, not to mention the bank won’t tell you exactly what their commission on exchange is. It seems to be between 0.60% and 0.80%. How can the exchange rate be determined?
It’s simple. I’ve made monthly purchases of U.S. dollars at the bank. I use the same monthly determined exchange rate for all dividends reinvested that month. For example, if I received a dividend on July 15, 2002 I use the exchange rate for that month determined on my July 2 purchase as 0.6384. The CCRA has assured me this is acceptable as they themselves use a yearly average exchange rate.
A reinvested dividend of US$8.50, regardless of company, in July equals US$8.50 / 0.6384 = C$13.31. The value of the shares purchased is also divided by the exchange rate to get a Canadian valuation. The number of shares is the same.
Sometimes my exchange rate will be high and sometimes low. Over time any errors in the exchange rate will regress to the mean or average out. As the amounts are small (ie, an exchange rate error of say 2% on a 2% dividend) and because of consistency the CCRA is satisfied. My experience with the CCRA is that honest errors are given a grace period to correct. As always verify for yourself.
U.S. reinvested dividends for Canadians are received after tax subject to 15% withholding. As such I can claim the withheld amount as part of my ACB. I use a version of Quicken that does not have a category in the register for withholding tax. For simplicity’s sake I divide the withheld tax by the exchange rate for the appropriate month, enter it as a commission and note it in the "memo" box.
Withholding on the example above would have been US$1.50. (Total dividend $10.00 @ 15% = $1.50 with $8.50 left for reinvestment.)
US$1.50 / 0.6384 = $2.35 Canadian withheld, entered as "commission".
Regular commissions are converted and then entered normally.
A Practical Example
With the knowledge that in March I converted C$100 into US$61.84, giving me an exchange rate of 0.6184, it is fairly easy to convert to Canadian by dividing all U.S. dollar amounts by the appropriate monthly exchange rate. The fact that I made my monthly purchases in multiples of C$100 simplifies this chore. For example:
Jan. 1 purchase of US$62.12 = C$100
March 15 dividend of US$8.50 / 0.6184 = C$13.75
Total cost is C$240.33 with 4.4961 shares purchased. The ACB is $240.33 / 4.4961 = C$53.45 per share.
To determine the capital gain on disposition, just convert the proceeds from sale from U.S. dollars to Canadian dollars and subtract the total cost. For example, Table 3 holdings are sold after commissions for US$300. If the US$300 is converted to C$500 the capital gain is:
Proceeds - Costs = $500 - $240.33 = $259.67
Thanks go to Douglas Lindsay, CA, Nanaimo, BC for responding to my numerous queries as I prepared this article.
George Fisher, author of All About DRIPs and DSPs has suspended publication of his newsletter Power Investing with DRIPs.
Robert Gibb, 401-2910 Cook Street, Victoria, BC, V8T 3S7 (250) 383-7075 email@example.com. Robert Gibb is a retired school teacher. He gives seminars on dividend reinvestment plans. Mr. Gibb is a frequent contributor to Internet DRIP boards under the nickname OperaBob.
Canadian MoneySaver, PO Box 370, Bath, ON K0H 1G0 613-352-7448 - Published November 2002