Canadian Penny Discontinued | Implications

Goodbye Penny, Hello Riskless Profits

The purpose of this article is to illustrate an arbitrage opportunity that has been created by the new Rounding Guidelines suggested in the wake of the Canadian penny’s discontinuation.  The implications of this arbitrage opportunity are explored at an individual and business level.  Since business must act in the interest of their shareholders, a prediction is made: Goods priced at $0.99 will start to be phased out, and replaced by a much more profitable price of $1.00.

By Marc-James Abi-Jaoude – February 4, 2013

Canadian Penny to be discontinued on February 4th, 2013

Canadian Penny Discontinued: Feb 4, 2013 Marks the Official End of Canada’s Copper-Coloured Coin

Source:  www.huffingtonpost.ca

Canada’s penny withdrawal: All you need to know

Source: http://www.cbc.ca/

Rounding Guidelines for a Canada without the Penny via www.budget.gc.ca

Finance Canada has released Rounding Guidelines for the phasing out of the Penny

CanadianPennyGuidelines

  • Amounts ending in 1 cent and 2 cents are rounded down to the nearest 10 cents.
  • Amounts ending in 3 cents and 4 cents are rounded up to the nearest 5 cents.
  • Amounts ending in 6 cents and 7 cents are rounded down to the nearest 5 cents.
  • Amounts ending in 8 cents and 9 cents are rounded up to the nearest 10 cents.
  • Amounts ending in 0 cent and 5 cents remain unchanged.

Source: http://www.budget.gc.ca/2012/themes/theme2-eng.html

Tax Implications of Rounding Guidelines via Canada Revenue Agency

Q1. Do I charge GST/HST before or after rounding?

A1. The GST/HST is calculated on the amount charged for taxable supplies. Rounding should take place after the GST/HST is calculated on the invoice, and only when your customer is paying the total amount of an invoice in cash or paying the balance of an invoice in cash.

Q2. Will the type of payment option (cash, credit, or debit) affect the amount of GST/HST I charge?

A2. No. GST/HST is calculated on the amount charged for taxable supplies. Rounding only occurs after the tax is added to the sub-total. The rounding does not affect the GST/HST required to be collected. You calculate the GST/HST in the same manner as before.

Source: http://www.cra-arc.gc.ca/gncy/lmntnpnny/bsnss-eng.html

Q: What is Arbitrage? A: Riskless Profit.

Website Investopedia.com Wikipedia.com
Definition of Arbitrage “The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time.” “In economics and finance, arbitrage (pron.: /ˈɑrbɨtrɑːʒ/) is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices.”

 

Conditions for arbitrage

Arbitrage is possible when one of three conditions is met:

  1. The same asset does not trade at the same price on all markets (the “law of one price”).
  2. Two assets with identical cash flows do not trade at the same price.
  3. An asset with a known price in the future does not today trade at its future price discounted at the risk-free interest rate (or, the asset does not have negligible costs of storage; as such, for example, this condition holds for grain but not for securities).

Source: http://en.wikipedia.org/wiki/Arbitrage#Conditions_for_arbitrage

 

How the New Rounding Guidelines for the Penny can be exploited for Riskless Profit?

These new Rounding Guidelines create an arbitrage opportunity as condition 1 has occurred; the price of a good in is different depending on the payment method (Cash vs Digital).  To exploit this arbitrage opportunity an individual can alter their payment method to suit the situation:

  • If the transaction price falls into the Round Down case, pay in cash.
  • If the transaction price falls into the Round Up case pay using a Credit Card or Debit Card

If an individual adheres to this method, they have the ability to always be on the “right” side of the Rounding Guidelines.  Either they will pay the correct value via digital transaction, or pay $0.01 to $0.02 less via Round Down case.

Note: For simplicity, this analysis assumes the Credit Card balance is always paid to avoid interest charges, no rewards are giving based on usage of Credit Card, and no charges for the use of Credit or Debit Cards.

Example of transactions under the new Rounding Guidelines

Price Tax HST @ 13% Price +Tax Rounded Price Cash Received After Tax Loss Due to Rounding % Reduction in Original Price

$0.99

$0.13

$1.12

$1.10

$0.97

$0.02

1.89%

$2.49

$0.32

$2.81

$2.80

$2.48

$0.01

0.55%

$4.49

$0.58

$5.07

$5.05

$4.47

$0.02

0.53%

$5.99

$0.78

$6.77

$6.75

$5.97

$0.02

0.31%

$7.49

$0.97

$8.46

$8.45

$7.48

$0.01

0.18%

$9.49

$1.23

$10.72

$10.70

$9.47

$0.02

0.25%

 

Obviously, at the individual level, the savings potential of adhering to this arbitrage strategy is marginal.

The Implication of this Arbitrage Opportunity: Businesses Must Exploit

The individual “reward” was calculated above to demonstrate the potential savings of exploiting the new Rounding Guidelines by paying cash when transaction falls within the Round Down case and paying digitally when transaction falls within the Round Up Case.

Businesses that sell large quantities of products that are relatively low in cost (such as a pack of gum, bottle of water, Tim Hortons coffee, or dollar store items) will be doing their shareholders a disservice if they do not adjust prices such that they always are on the “right” side of the Rounding Guidelines.

 

Transactions adjusted by $0.01 and the impact of the new Rounding Guidelines

Price Tax HST @ 13% Price +Tax Rounded Price Cash Received After Tax Gain Due to Rounding % Gain over Original Price % Gain over Alternative price (-$0.01)

$1.00

$0.13

$1.13

$1.15

$1.02

$0.02

2.00%

5.01%

$2.50

$0.33

$2.83

$2.85

$2.53

$0.02

1.00%

1.97%

$4.50

$0.59

$5.09

$5.10

$4.52

$0.01

0.33%

1.09%

$6.00

$0.78

$6.78

$6.80

$6.02

$0.02

0.33%

0.82%

$7.50

$0.98

$8.48

$8.50

$7.52

$0.02

0.27%

0.58%

$9.50

$1.24

$10.74

$10.75

$9.52

$0.02

0.16%

0.51%

 

The last column demonstrates the potential gain per transaction for a business that is selling goods with the new Rounding Guidelines in mind.  Increasing the price of a good by 1% ($0.99 to $1.00) can result in a 5.01% gain ($0.97 vs $1.02 after tax is paid).  On a single purchased product, this 5% gain likely outweighs any psychological advantage of having the product pricing at $0.99.

Prediction: The Death of Goods Priced at $0.99

Receipt of a 99 cent item

As this receipt demonstrates when a good is priced at $0.99, the after-tax result of $1.12 falls within the Round Down Case in the Rounding Guidelines, which would result in $1.10 being exchanged for the good (if cash is used in transaction).  If the good was $1.00, the after-tax result of $1.13 falls within the Round Up Case in the Rounding Rule, which would result in $1.15 being exchanged for the good (if cash is used in transaction). Therefore, the choice is simple, keep prices at $0.99, and only receive $0.97 after taxes is paid, or raise prices to $1.00 and receive $1.02 after tax is paid.

If businesses are rational and for profit the era of $0.99 products is over. This change is likely to take place over a few years; at that point a noticeable amount of products will be priced at $1.00 rather than the irrational price of $0.99 in Canada (HST provinces @ 13% tax).

Note: Psychological reasons of the 99 cent ending will likely outweigh the additional profit gained when products are more expensive.  This analysis focused on the frequently purchased single item products such as a pack of gum, bottle of water, Tim Hortons coffee, dollar store items, etc.

 

Note: Since the new Rounding Guidelines are voluntary, does that mean companies are permitted to always round up. This would be a more blatant method to always be on the “right” side of the transaction.  Adopting the Rounding Guidelines but changing $0.99 items to $1.00 is much more probable for the vast majority of companies.

Transaction after the Rounding Guidelines implementated 99 cent

 

Made a purchase (the exact item purchased  (Above) on Sunday for $0.99).  The total, as expected, was $1.12.  I promptly  handed over $1.10.  The teller than asked if I had 2 cent, and I said, due to the rounding guidelines I should only have to pay $1.10.  The teller then entered a payment of $1.20 to see what was the correct price was to be paid.  The attached bill demonstrates that the price was $1.10 and change was $0.10.  The additional 10 cents never changed hands.

Shoppers Drugmart deserves credit for placing a line item called “Rounded Change” on the receipt.  What would happen if the teller entered $1.10 for the “Cash” line item? Does the “Change Due” equation equal “Total” – “Cash”?  If so the “Change Due” line would equal -0.02, then “Rounded Change” equal 0.00 as it would be rounded down.  Therefore the same result as the $1.20 case in the receipt above.

Update: an interesting case explained in linked article comments.

Article Title: Coping with change: Shoppers seek savings in the penny-less age

“Someone can make more money by charging.96 cents than.99..99 +.13 = 1.12 = 1.10 – 0.13 = 0.97.96 +.12 = 1.08 = 1.10 -.12 = 0.98 If there are 300 transactions that’s 3 bucks per day * 30 = 90 / month or $1080 per year. Those pennies sure add up.”

Link to Article: http://www.theglobeandmail.com/report-on-business/economy/currencies/coping-with-change-shoppers-seek-savings-in-the-penny-less-age/article8180352/
Link to Comment: http://www.theglobeandmail.com/report-on-business/economy/currencies/coping-with-change-shoppers-seek-savings-in-the-penny-less-age/article8180352/comments/?plckFindCommentKey=CommentKey:ca54de52-aa50-4fec-aa62-2565b99dcbce