Tax implications of futures trading

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fizikz
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Tax implications of futures trading

Post by fizikz »

Based on article IT-346R Commodity Futures and Certain Commodities (http://www.cra-arc.gc.ca/E/pub/tp/it346r/it346r-e.html) it seems that speculators of commodity futures are taxed on their profits/losses as capital gains/losses (100% capital gains). I have also heard about the 60/40 rule for futures trading in the US, where 60% of profits/losses are taxed as long-term capital gains, and 40% as short-term (income). The above-mentioned article seems to be the closest similar rule for Canadians.

A few practical questions come to mind:

1) Would trading equity futures (eg. E-mini ES) fall under commodity futures speculation in IT-346R ?
2) Would all gains/losses be taxed as 100% capital gains/losses for:
a) someone who as other sources of income?
b) someone who does not have other sources of income?
3) Considering that the ES is traded in USD, how would currency fluctuations affect reporting, as well as gain/loss realizations and taxation in CAD?
4) Must individual trades be reported, or is it sufficient to report (the difference between) starting and ending account balances for the taxation year?

And, on a somewhat different note:

5) Can expenses such as commissions, data feeds, software, etc be deducted or is that only allowed for businesses?

6) Are the answers to the above dependent on the province of residence?
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Re: Tax implications of futures trading

Post by Kirkx »

Did you notice the date on bulletin IT-346R? It's Nov. 20th 1978. It clearly shows how much interest CRA has in futures trading. There are very few successful private traders in Canada and they are not on CRA's priority list, at least for now.

1-2) You can report 100% of your gains/losses on capital account (as capital gains/losses), regardless if you have other sources of income or not.

It doesn't matter if you trade ES, CL, GC or YM. They are all treated as "futures". CRA even has a code number for that. You can see it on T5008 from Interactive Brokers, there are separate boxes and codes for stocks, options and futures.

It seems that CRA assumes that most people who try trading full time will fail and lose money. If taxpayers reported those losses on income account they would be eligible for "business loss" refund. In order to avoid issuing those refunds CRA doesn't object to taxpayers reporting everything on capital account. In theory, if you start generating substantial profits year after year, you can expect CRA to insist on switching to reporting gains/losses on income account, but personally I have never come across a case like that mentioned on any trading forums.

The important thing to remember is that you need to be consistent. If you decided to report gains/losses on capital account then you need to do this every year.

3) If you have an account with a broker that has a Canadian office, like Interactive Brokers or RJ O'Brien, use the same currency conversion method as your broker. The total gain/loss for the year will be shown on your T5008 form issued by the broker and also sent to CRA.

For instance, Interactive Brokers Canada uses daily currency conversion. In this case you need to remember that if you hold a futures position overnight, you will need to apply the same exchange rate to both buy and sell transactions regardless of the trade date. Otherwise your numbers may be way off compared to your broker's numbers (because of exchange rate difference multiplied by futures leverage ratio). The last time I looked into it IB seemed to use the exchange rate of the day the position was opened.

If you have an account with a US broker it's obviously easier to apply official Bank of Canada average yearly exchange rate to your total gain/loss.

4) You can report the total of gains/losses for the year. This is what Interactive Brokers reports on their T5008. The file transmitted to CRA by a tax software apparently only contains the totals as well (see another thread about it). Of course you need to keep the full documentation with all trades at home, just in case.

5) Commissions, data fees etc. can not be deducted if you report on "capital" account. To deduct those expenses you would need to report on "income" account. Please wait for someone else to confirm this, I might be wrong here.

6) I'm not sure if province of residence makes any difference when it comes to futures taxation issues discussed above. I'm only aware of differences between provinces as far as eligibility to trade some instruments is concerned. For instance to trade forex in Alberta you must qualify as "accredited investor".

-----
You will find some more tips in threads from the past few years. Just scroll back the list and look for threads about Interactive Brokers, futures, forex, etc.
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Re: Tax implications of futures trading

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Kirkx wrote:5) Commissions, data fees etc. can not be deducted if you report on "capital" account. To deduct those expenses you would need to report on "income" account. Please wait for someone else to confirm this, I might be wrong here.
Commissions are deducted (i just lower proceeds of sale and raise cost base by commission amount), The data feed is not deductible but the minimum account fees should be. I claim them in years when I have them ($10 per month at IB), they go on the line of carrying charges and interest expense (221 fed).

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Re: Tax implications of futures trading

Post by Kirkx »

Trading commissions are obviously deducted, my mistake (I pasted the line from OP without paying attention to details). It has been the standard practice for years:

gain/loss = (proceeds - com's) - (cost + com's)

Data fees, charting software, trading computer and similar expenses can not be deducted if you report on capital account. These are "business expenses" that you would deduct if reporting on income account.

Newguy's tip about deducting broker's monthly fees looks interesting.

Just to clarify things for the OP. IRS is a completely different beast than CRA. In Canada we don't have all those rules specifically targeting short term traders like they have in the US. Many tax guidelines are quite old, there are lots of grey areas, some details are left to interpretation and good will. The key is to be consistent in your reporting, understand your interpretation of the rules and have all the documents at hand in case CRA requests more information.
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Re: Tax implications of futures trading

Post by ghariton »

Kirkx wrote:The key is to be consistent in your reporting, understand your interpretation of the rules and have all the documents at hand in case CRA requests more information.
Indeed. That is what we were told in law school.

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Re: Tax implications of futures trading

Post by fxplusone »

fizikz wrote:Based on article IT-346R Commodity Futures and Certain Commodities (http://www.cra-arc.gc.ca/E/pub/tp/it346r/it346r-e.html) it seems that speculators of commodity futures are taxed on their profits/losses as capital gains/losses (100% capital gains).
I would not be so sure. Another CRA bulletin says:
11. Some of the factors to be considered in ascertaining whether the taxpayer's course of conduct indicates the carrying on of a business are as follows:
(a) frequency of transactions - a history of extensive buying and selling of securities or of a quick turnover of properties,
(b) period of ownership - securities are usually owned only for a short period of time,
(c) knowledge of securities markets - the taxpayer has some knowledge of or experience in the securities markets,
(d) security transactions form a part of a taxpayer's ordinary business,
(e) time spent - a substantial part of the taxpayer's time is spent studying the securities markets and investigating potential purchases,
(f) financing - security purchases are financed primarily on margin or by some other form of debt,
(g) advertising - the taxpayer has advertised or otherwise made it known that he is willing to purchase securities, and
(h) in the case of shares, their nature - normally speculative in nature or of a non-dividend type.
........
18. The gain or loss on the "short sale" of shares is considered to be on income account.

http://www.cra-arc.gc.ca/E/pub/tp/it479r/it479r-e.html


It's about "securities", but I believe the idea of short sale or margin will be the same for futures.

And this bulletin is newer: it's only from 1984 :D

Have to admit, I am not a tax professional, but just another newbie trader.
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Re: Tax implications of futures trading

Post by fizikz »

Kirkx, thanks, that clarifies things quite a bit. I had no idea about the "accredited investor" bit for trading forex in Alberta.

For reporting, I would think that having a US broker (i.e. USD account) and using the average annual exchange rate on the total gains/losses would make things much simpler instead of having to deal with exchange rates for every trade. Of course, that would introduce more currency risk. When repatriating funds to CAD, how would any gains/losses due to changes in the exchange rate be treated?

Are there any points to keep in mind from a Canadian perspective when choosing a futures broker?

fxplusone, that bulletin is specifically addressing securities, as you pointed out, so I would not necessarily expect it to apply directly to futures, forex, etc. However, it is because of those rules for securities traders that I posted these questions in the first place.
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Re: Tax implications of futures trading

Post by Kirkx »

Fizikz: Are there any points to keep in mind from a Canadian perspective when choosing a futures broker?
1) US headquartered brokers serving retail market usually have far better technology then Canadian headquartered brokers. There are very few futures brokers with Canadian HQ.

2) If you have an account with a US broker which has an affiliate office in Canada, your account is protected under Canadian regulations (CIPF). This makes a big difference in case of broker's insolvency, which is not that uncommon in the US (MF Global and PFG Best are the latest examples).

3) If you have an account with a US broker which doesn't have an affiliate office in Canada, you will get much lower minimum margin limits with futures (regular hours) and forex.

You will find more information here:

http://www.elitetrader.com/vb/showthrea ... ost3662457

http://www.elitetrader.com/vb/showthrea ... genumber=1

http://www.elitetrader.com/vb/showthrea ... genumber=1

You can find lots of useful information about futures, forex, options and charting software on Elite Trader forums:

http://www.elitetrader.com/

http://www.elitetrader.com/vb/forumdisp ... &forumid=2

http://www.elitetrader.com/vb/forumdisp ... &forumid=3

http://www.elitetrader.com/vb/forumdisp ... forumid=12

http://www.elitetrader.com/vb/forumdisp ... forumid=38
Last edited by Kirkx on 01 Apr 2013 01:15, edited 1 time in total.
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Re: Tax implications of futures trading

Post by fxplusone »

Thank you for detailed answers, Kirkx. It seems you are quite knowledgeable in this area :)

Could you recommend a broker for selling options on futures for Canadians ?

I am with IB now. Their commissions and executions are great, but margin is not so great. They require 50%-100% higher than SPAN. And for GC it's even higher.
OptionXpress is just too expensive.
Another option would be US-based broker, but not many of them allow to sell options on futures and work with Canadians at the same time :(
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Re: Tax implications of futures trading

Post by fizikz »

Great reading list. Thanks for sharing, Kirkx.

Considering the PFGBest and MFGlobal incidents, a broker with CIPF membership offers more peace of mind. It's unfortunate that choosing brokers is like walking a minefield.

When you say US based retail brokers have better technology, do you mean better fills/slippage/execution speed or platforms or something else? How does RJO'Brien rank on those points?

Is there a list of CIPF members who are (recommended/reputable) futures brokers?


EDIT: I contacted RJO'Brien and apparently they charge $15 RT per contract in commissions and charge $100/month if I want to use NinjaTrader, and that is NOT the license fee for NT... Also, no reduced intra-day margin. Could they make it any less attractive?
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Re: Tax implications of futures trading

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fizikz wrote: EDIT: I contacted RJO'Brien and apparently they charge $15 RT per contract in commissions...
It seems IB is the most viable option in Canada. Why don't you want to go with them, fizikz ?
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Re: Tax implications of futures trading

Post by Kirkx »

We are getting off topic here, this thread is about taxes. I would suggest to open a new thread titled "Futures Brokers For Canadians" in Discount Brokers section of the forums:

http://www.financialwisdomforum.org/for ... le=desktop
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Re: Tax implications of futures trading

Post by fxplusone »

make sense, sorry for deviating offtop.
Just started new thread for option broker suggestions http://www.financialwisdomforum.org/for ... 9&t=115994
Last edited by Peculiar_Investor on 07 Feb 2014 07:04, edited 1 time in total.
Reason: replace old domain name with www.financialwisdomforum.org to reflect new domain name effective 19-Jan-2014
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Re: Tax implications of futures trading

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fxplusone wrote:It seems IB is the most viable option in Canada. Why don't you want to go with them, fizikz ?
I'm not against IB. I'm just trying to evaluate all the options.
Kirkx wrote:We are getting off topic here, this thread is about taxes. I would suggest to open a new thread titled "Futures Brokers For Canadians" in Discount Brokers section of the forums:

http://www.financialwisdomforum.org/for ... le=desktop
Good point. Regarding taxes, how would the inevitable change in CAD vs USD be treated when repatriating cash from a US broker account?
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Re: Tax implications of futures trading

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fizikz wrote:Good point. Regarding taxes, how would the inevitable change in CAD vs USD be treated when repatriating cash from a US broker account?
Repatriating has no effect. You have to report all your gains or losses no matter where your money is. You could transfer your US dollars to Canada and not sell them and then report nothing.

Selling US dollars is something you have to report and is similar to selling a stock except you don't report the first $200 of gain or loss.

In theory every time you buy a US stock (or US option) you also sell US dollars. You should report the gain or loss on that part of US currency you've just disposed of. The gain or loss due to currency while you're in a position is reported as part of the position profit as it gets converted to Canadian dollars. I don't know anyone who does this.

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Re: Tax implications of futures trading

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"Repatriating" was not the correct word choice, then.
newguy wrote: The gain or loss due to currency while you're in a position is reported as part of the position profit as it gets converted to Canadian dollars. I don't know anyone who does this.
newguy
"...is reported..." by whom?

Gain/loss due to currency is what I meant, whether it is while being in a position, or due to having an account in USD and then realizing some gain/loss when periodically converting back to CAD.
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Re: Tax implications of futures trading

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fizikz wrote:"...is reported..." by whom?
You, when you do your taxes. It's not reported by any broker I know of...yet.

I think most people just report it when they convert back to CAD.

They also report profits and losses from US dollar denominated positions in Canadian dollars. There's a little quirk at IB where they seem to only report the US$ profit converted to CAD on the day you sell it. They don't take into account the price you paid in CAD. In theory you should take the amount sold in CAD minus the amount paid in CAD and that's your CAD profit.

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Re: Tax implications of futures trading

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newguy wrote: There's a little quirk at IB where they seem to only report the US$ profit converted to CAD on the day you sell it....
newguy
AFAIK in IB you can not buy USD (or any other) denominated securities with CAD directly. Technically, you borrow from IB equivalent amount in USD, using your CAD cash to secure loan. And you pay interest to IB on this loan, even if you do not use margin. So there is no profit/loss from conversion to open and close position.
I did not trade stocks for some time, but it was the case couple of years ago, and it's still the case for futures and options.
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Re: Tax implications of futures trading

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Sorry to labour the point; I am new at this. When the funds are converted back to CAD, the gain/loss due to currency would be regarded as part of the gains/losses of the futures trade, or as a separate "currency" trade?

fxplusone, if the funds in IB are always technically CAD, I guess that makes it easier and the interest on the USD loan is just part of the trading cost?
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Re: Tax implications of futures trading

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fxplusone wrote:
newguy wrote:There's a little quirk at IB where they seem to only report the US$ profit converted to CAD on the day you sell it....
AFAIK in IB you can not buy USD (or any other) denominated securities with CAD directly. Technically, you borrow from IB equivalent amount in USD, using your CAD cash to secure loan. And you pay interest to IB on this loan, even if you do not use margin. So there is no profit/loss from conversion to open and close position.
That's one way of doing it, but not the only one and IMO not the most common one.

Regardless whether one borrows on margin USD or uses actual greenbacks, newguy's explanation remains valid: every purchase of a USD denominated security is associated with a disposal of the "US buck" security, and vice-versa.
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Re: Tax implications of futures trading

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fizikz wrote:Sorry to labour the point; I am new at this. When the funds are converted back to CAD, the gain/loss due to currency would be regarded as part of the gains/losses of the futures trade, or as a separate "currency" trade?
It's part of the futures trade and gets reported in the proceeds of disposition - they're all reported converted to CAD, by you and the broker. The other part is if you hold USD and later sell them, then you have to report that profit or loss (minus $200) on your taxes. The profit is just what they're worth now in CAD minus what they were worth in CAD when you bought them.
fxplusone, if the funds in IB are always technically CAD, I guess that makes it easier and the interest on the USD loan is just part of the trading cost?
That's not true all the time. If you buy a US listed stock and you have no USD then you will be borrowing US dollars like he said. You can also convert money into USD (or a bunch of other currencies) using IDEALPRO and then you actually have that currency in you account.

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Re: Tax implications of futures trading

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newguy wrote:If you buy a US listed stock and you have no USD then you will be borrowing US dollars like he said. You can also convert money into USD (or a bunch of other currencies) using IDEALPRO and then you actually have that currency in you account.
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True, you may keep different currencies in the single IB account, and if you buying security denominated in one of the currencies you hold in your account, IB first use available currency from your account and lend you the rest, if necessary.
And profit\loses will be credited to your account in the currency of the trade. For CL it would be USD, for FDAX - EUR, etc.
adrian2 wrote: That's one way of doing it, but not the only one and IMO not the most common one.
Sure. This was the way IB set my account by default, and I never asked them to change it, so I am simply ignorant about other possible ways.
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Re: Tax implications of futures trading

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fxplusone wrote:Sure. This was the way IB set my account by default, and I never asked them to change it, so I am simply ignorant about other possible ways.
Not really, you're talking about two different things. The only default is 'base currency' and you did choose that when you opened the account. All that is good for is on your statements some columns get reported in 'base currency' as a convenience. I opened my account in USD as base because I only trade in US products, I later realized this had nothing to do with what you traded and switched to CAD.

The other 'default' is what you fund your account with. If you sent them CAD to open the account, then they put CAD into your account. They figure you will buy USD on your own if you really want them.

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Re: Tax implications of futures trading

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newguy wrote: Not really, you're talking about two different things...
I never claimed to be omniscient :D
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Re: Tax implications of futures trading

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newguy wrote: It's part of the futures trade and gets reported in the proceeds of disposition - they're all reported converted to CAD, by you and the broker. The other part is if you hold USD and later sell them, then you have to report that profit or loss (minus $200) on your taxes. The profit is just what they're worth now in CAD minus what they were worth in CAD when you bought them.
If USD is held and sold later, how is that profit/loss reported when filing taxes?
newguy wrote: If you buy a US listed stock and you have no USD then you will be borrowing US dollars like he said. You can also convert money into USD (or a bunch of other currencies) using IDEALPRO and then you actually have that currency in you account.
Which is better for trading US listed stock/futures: converting CAD to USD, or the implicit borrowing of USD against the CAD in the account? I'm guessing that the borrowing approach might reduce exposure to USD since it is only in effect during a trade, but will incur some costs due to interest.
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