Flow-through shares are common shares are issued by a company engaged in exploration or development of resources in Canada (oil and gas, mining, renewable energy, and energy conservation). The resource company agrees to “flow through” tax deductions related to resource exploration and/or development equal to the purchase price of the flow-through shares. Tax deductions associated with flow-through shares are a resource exploration incentive program sponsored by the Canadian federal government and clearly set out in the Canadian Income Tax Act. CRA has published information for investors on Flow Through Shares and Limited Partnerships. In addition to the tax deduction, some addition federal or provincial tax credits may apply, depending on the nature of the projects resource companies engage in and the province of residence of the investor.
A Flow-Through Limited Partnership (FTLP) is similar to a mutual fund. The FTLP invests in flow-through shares on behalf of the investors, and the investors claim the tax deductions and credits.
Benefits of Investing in Flow-Through Shares
- Shelter income at highest marginal rate
- Defer taxes until redemption
- Convert income into a capital gain up to sale amount with a tax-deferral until sale
- Tax savings provide downside protection against adverse investment performance
- Typically 100% deductible against income from any Canadian source
- Available capital losses can be used to offset capital gains to provide even better after-tax returns
Additional Benefits of Investing in Flow-Through Shares via a Flow- Through Limited Partnership
- Access to a quality of flow through shares by experienced portfolio managers
- Reduced risk through diversification
- Rolls tax deferred into a mutual fund, so investor can defer any capital gains not yet realized
Some fund companies have corporate class mutual funds which the FTLP rolls into at maturity. The investor can switch to funds with a focus other than resources and defer any unrealized capital gains ￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼Flow-through shares are usually issued at a premium over the current market price. For example, if a share ABC is trading at $10, ABC may issue flow through shares at $11.50. Premiums vary depending on the issue and general market conditions. Flow-through shares have a cost base of $0 for tax purposes, so the entire proceeds of sale would be considered a capital gain. Consider an investor in a 40% tax bracket who buys a flow through share for $10,000 and sells if for $8,000:
|Purchase Amount||Income Deductions||Tax Reduction||Funds at Risk||Proceeds of Sale||Capital Gains Taxes||Net After Tax|
The portfolio manager has realized $5,000 gains by the time the FTLP rolls into a corporate class mutual fund with a value of $8,000. The investor pays tax on the $5,000 capital gains, and their mutual fund units have a $5,000 cost base and an $8,000 value. The investor switches the mutual fund on a tax- deferred basis into a conservative dividend fund to provide tax advantaged income, deferring most of the remaining capital gain until they sell the mutual fund.
Flow-through shares and limited partnerships are normally considered higher risk investments. The tax savings do significantly reduce the amount of investment at risk.
Investment in Flow-Through Limited partnerships is not suitable for all types of investors because of the high risk of this kind of investment. Before considering this investment for tax reasons, consult your accountant or tax professional to assess the impact of such investment on your personal taxation.