Money market funds are short-term investment products that have a mandate to provide interest income. Interest is paid periodically and is included in the unitholder’s income when it becomes payable.
However, you can have a capital gain or loss holding money market funds denominated in a foreign currency.
What Is A Mutual Fund?
Mutual funds are a basket of individual investments (the fund) held by a group of investors (unitholder’s). Any interest, dividends or capital gains earned inside of a mutual fund are allocated periodically to the unitholder’s and taxed in their hands.
What Is Money Market Fund?
Each type of fund has a “mandate” which is a policy statement that addresses what types of investments the mutual fund will purchase. Money market mutual funds normally invest in short-term interest-bearing investments such as treasury bills that provide a steady stream of income. Since the only investments are interest bearing securities the unit price remains constant.
Foreign Exchange Gains & Losses
If you own foreign denominated money market funds (that is a money market fund that is in a currency other than Canadian dollars), you can have capital gains or losses when you sell or redeem all or a portion of the fund.
Tax Rules At Play
There are two basic tax rules at play that cause a capital gain or loss. First, for most of us, the purchase investments are capital purchases. Any gain or loss realized when you sell the investment has a tax consequence.
Second, all investments must be valued in Canadian dollars at the time of purchase and at the time of sale, redemption or disposition.
With a foreign denominated money market funds, your unit cost may be unchanged in the foreign currency, but if the Canada/Foreign exchange rate has changed, you can have a gain or loss, regardless of whether you actually converted the proceeds into Canadian dollars.
Here Is An Example
You invested $1,000 USD in a US dollar money market fund when the exchange rate was 1.2. Your investment in Canadian dollars was $1,200 and this is your adjusted cost base (ACB).
A while later you redeem this money market fund and receive $1,000 US. However, the exchange rate is now 1.25 and the redemption in worth $1,250 in Canadian dollars. You have a gain of $50 (only 50% is taxable).
You can see that currency fluctuations can also have an impact your investments.
When considering any type of investment, be aware that foreign exchange can also have an impact on your investment performance. In the above example, the investor realized a gain and ended up with more than just interest. However, had the investor realized a loss, the loss could have been more than the interest income received on the funds.