I've been wondering about the following scenario. Let's say you invest $10k in stock market. At the end of year 1, your investment has grown to $11k. The government taxes a percentage of that new income, so let's say you're left with $10.8k. At the end of year 2, your stocks has dropped to $9k because they weren't doing well. So the government doesn't tax you anything in year 2. In year 3, your investment goes up to $9.5k. Will the government tax you on the $500 gain from $9k to $9.5k?
I'm thinking the answer is yes, because taxes happen on a yearly basis, and may not look at your financial performance in previous years? But on the other hand, I've heard of people mention things like the government will look back as far as 7 years if you're audited, and I remember a phrase called tax claw-back that let's you use your recent financial history to affect the taxes you have to pay in the future?
As another follow up, I live in Canada and I have USD funds and CAD funds in my business bank accounts. Because the exchange rate is always changing, that means I'm potentially earning or losing value on the USD. And I'm curious if the answer I get to my question above applies to this situation as well.
I'll also ask my accountant, but I have a hard time understanding him because I lack a lot of accounting knowledge.