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How Flow Through Shares Work!





As it is tax season, it feels appropriate to talk about tax strategies. There are very few tax breaks for Canadians, however, there are still some remaining. One of these tax breaks is to invest in “flow through” shares.

What are Flow Through Shares?

  • These shares are issued by oil and mineral exploration companies who pass the tax breaks for exploration onto investors.

What are the tax advantages?

  • If you were to invest $10,000 in flow through shares, providing that they are eligible for the tax breaks, you can claim the full $10,000 on your tax return. If you are in the 40% tax bracket, that would equate to a $4,000 tax return for that year.

How does it work?

  • As stated above, you get to claim the FULL amount invested against your income. However, when you sell, your adjusted cost base (ACB) is set to $0, ie. whatever you sell for is your PROFIT.
  • If you were to invest $10,000, and sell 2 years later for $10,000, your profit would be considered $10,000. So to calculate your capital gains, with a 40% tax rate, would be $5000 x 40% = $2000 tax payable. Even in the scenario where the shares don’t change in price, you will receive a $2000 gain ($4000 tax return – $2000 tax payable).

Who should buy them?

  • This tax break works best for those in the highest tax bracket, but generally works for anyone. I’ve read from various sources that flow through shares should not exceed 10%-15% of your portfolio.

How do I buy them?

What are the risks/disadvantages?

  • If you are experienced with the Canadian mining/oil sector, you will know that this market can be fairly volatile. Also, when you purchase flow through shares, you typically have to hold onto them for 18-24 months before you can sell them.
  • Flow through shares usually sell at a premium.
  • You can lose up to a certain percentage of your investment, and STILL come out even due to the tax breaks. Below is a table from QIS Capital outlining the loss limits by tax bracket:
    50% tax bracket – 66% of original investment
    40% tax bracket – 75% of original investment
    30% tax bracket – 81% of original investment
    20% tax bracket – 89% of original investment

Can you give some examples?

Summary

  • This is a very superficial description of flow through shares. If this topic interests you, you should continue with your own due diligence.  Here are some discount brokers in Canada that may hold flow through shares, make sure to contact them first to confirm.
  • Personally, I have never purchased flow through shares before, but it’s definitely something I’m going to look into as my tax burden increases.




40 Comments, Comment or Ping

  1. I researched these investments a few years back (before starting the blog) and I think this is a great topic for discussion. I’ll post my thoughts next week.

  2. thanks for the great post!.. I’ll have really consider flow through shares this year ;)

  3. 4. Q Cash

    I had a very positive experience the first time I used flow through shares. I had maxed out my RRSPs and was looking for another deduction.

    I bought into Mavrix Funds flow through shares. I invested $25,000, received $25,000 deduction (althought there is a carry forward of about 10% you have to claim as income the following year). Over the past two years, the fund grew 40% (good timing and all that) and my flow through shares were rolled over into Mavrix’s multiclass series shares this past March 9.

    Now they are quite liquid and when the time comes to sell, I have to treat the entire amount as capital gains. Great savings for me especially now with my reduced income in retirement, my tax savings has been huge.

    WARNING: We hit at the right time. There is the possibility for commodities to fall, but with China and India going gang busters, I think the commodity market has some life in it yet.

    $Q.02

  4. QCash! Thanks for posting your experience. How did you go about finding this fund? What were the fees like?

  5. thanks for the additional info QCash.

    I think i have so much to learn ;)

  6. 7. Q Cash

    FT

    I found this through my “financial advisor”. I had done some research on flow through shares and asked for some more information.

    I liked Mavrix’s approach, because the shares become liquid after 2 years (actually in my case it was 18 months Sep 05 – Mar 07)

    There were no fees (that I saw, I am sure there were at the other end).

    All in all it was a good investment for me at that time. I am considering doing it again to offset some capital gains tax I might have to pay this year, but I am waiting to see what the Tories say in their budget this afternoon about capital gains.

    Q

  7. For the first time I’m actually looking forward to the budget this evening. I’m hoping for a lower capital gains tax or an exemption of some sort.

  8. 10. Chewy

    I too have been doing a lot of research on Flow Through Shares. I made some interesting finds.

    I created a spreadsheet and tried to compare the Management, Preformance, and Expenses of these Limited Partnerships (LP’s). I was able to compare the Prospectus of 10 LP’s that I downloaded from TD’s Webbroker Initial Offerings site.

    The problem I found is that when these LP’s record their preformance they always use after tax dollars. So I compared their Closing Net Asset Value Per Unit at the time of rollover to their Original Unit price. I also looked at the number of years that the LP had Offerings and the number of times that Net Asset Value per Unit was greater than the Original Unit Price.

    What I found is that out of the 10 LP’s I compared, only 3 LP’s had a Net Asset Value per Unit that was greater than the Original Unit Price before the tax deductions on a offering over offering basis. Some of them, like Sentry Select NCE LP’s only had 1 out of 17 offerings that had been positive. Creststreet LP had 2 out of 10 offerings that were positve. 2 LP’s that you might want to think twice about, before giving them your money.

    There were 2 that stood out from the rest. CMP Resource LP and Canada Dominion Resource LP are by far the best when comparing Preformance, Expenses and Management. Both of these LP’s are now owned by DMP Ltd. Both are also managed buy Dynamic Funds which is also owned by DMP Ltd.

    CMP Resource LP has the best preformance record. They had 9 out of 10 offerings that had been positive. Their Offerings are normally $1000 per Unit with a minimum of $5000 buy in. But their Average Asset Value per Unit on those 10 offerings was $1242.74. That works out to be a 24% return on your money before taxes. I calculated their Average After-Tax Rate of Return on Transfer Date ends up being 95%.

    Canada Dominion Resource LP would be my second choice based on their consistancy and management. They had 11 out of 16 offerings that had been positive. They are also owned and managed buy the same companies as CMP. Dynamic Funds is listed as a top preformer on TD’s Webbroker Fund Selector, and they have one a number of Lipper Awards for Consistancy and Preformance.

    My Third Choice would be Mavrix Explorer LP. They had 5 out 9 offerings that were positive. They are in the lower half of the group in Expenses.

    It’s important to realize that if you are investing in one of these LP’s, you are most likey going to lose money. But with the Tax deductions you may come out ahead. If you are not comfortable with the risk, then I would say, just pay your tax bill.

    Never Invest in something just because you are looking for a tax deduction. You should only Invest in something that makes sense to you and that you have a good chance that you are going to make money.

  9. Wow Chewy, thanks for the great information! Very helpful.

  10. 12. Cybrarian

    Excellent research work, Chewy. Thanks very much for posting your findings and analysis. Extremely useful info and helpful advice.

  11. I provide commentary on available flow through shares and limited partnership. Subscribe at http://www.dougransom.com/request.information.html

  12. Full-service advisors have acknowledged that flow-through shares pay advisors at least a 4% commission. Quite whopping compared to the commissions paid out on other investment products. While we would hope not, this could provide ample incentive for an advisor to pursue this investment choice over others.

    Be weary of an investment product of such a high risk. So high, in fact, that the government is willing to write it off fully, as it would a donation to a registered charity. Same write-off…but you’re not donating your money…you’re investing it.

    ‘Z’

  13. 18. Richard Nash

    I really enjoyed Chewy’s contribution and would like to get in contact with him or to buy him (or her) lunch. I have no idea if direct contact through this blog is allowed, but if it is, please pass my contact e-mail on to Chewy – I’d love to hear back.
    Thanks

  14. 19. JR

    Been doing flow throughs for a very longggg time, & dont LP’s anymore.

    I have had good and bad experiences, timing is everything and brokers (who I dislike) flog what is best for them.

    There is a risk to flow throughs in that will you get thetax credits but you ‘MAY’ be a winner after they mature, with the possible rollover to an RRSP for a second tax deduction.

    The only ones (narrow minded me) that I have been doing that provides me with any success for the past several years is the Mineral Fields Super Flow Throughs (SFTS), direct, no fees, no broker charges, minimum $10k lots

    There are huge tax savings depending on which province it is that you live in, for me its Ontario, and from experience I have found that Mineral fields (MF) generally do not to mature theirs in the same tax year.

    For example, if you were to purchase in April this year they would unlikely mature till 12-18 months.

    From experience, the last ones I did that matured, I bought in December 2006, matured in 10-months at 120% of the intial cost, because MF trys to mature them as early as 6-months once they are over the $10k purchase lot price, but not within the same tax year. Once the MF’s mature you have a choice tax free to roll over to their mutual funds, tax free growing till you withdraw.

    I currently have $60k in SFTS that will mature this tax year which I shall simply rollover and buy again.

    For those that go the SFTS, you have to watch the fed’s, since the budget keeps letting then continue just year on year.

    SFTS give me the tax return plus the tax credits, also benefitting from deducting the interest to purchase them.

    There is a recapture on the capital gains and CEE in year two, but generally I net a nice positive ROI on this type of investment strategy when I combine this with a double bang RRSP (50/50 in out in the same tax year) to get as much of the tax back that is taken from my wages at source. This year (just filed 2007)it will be as close to every penny back, since my tax at source was $26K. The goal is to get back as much income tax back that you paid at source, thus the bonus allows you to do whatever with it.

    With the SFTS, this is outside of other passive incomes in a numbered company.

  15. 20. JMul

    Hi there,

    I know that a lot of people will roll over the gains from flow-through into a charity and this gives a little more bang on your buck and is great for a legitimate charity too. But what about rolling the gains into the RRSP?

    What is recommended?

    Thanks

  16. 21. Cannon_fodder

    In this link http://www.investmentexecutive.com/client/en/News/DetailNews.asp?id=38241&IdSection=23&cat=23&BImageCI=1

    they mention that tax credits can be carried back 3 years. Is this for the additional SFTS tax credit or any FTS offering? The reason I ask is that for the first time in many years I have to pay additional tax for 2007 and in 2008 I expect to move into a slightly lower tax bracket. If I can make an investment in 2008 that will allow me to get a bigger refund by applying it 2007 vs. 2008 I’m all for it.

  17. 22. paulette

    This is a good investment to make. Imagine of doubling it just for a matter of 2 years isn’t bad at all.

  18. 23. JR

    Cannon:

    My reason for doing SFTS is the tax benefit (100% write off + the fed & prov tax credit) and any rollovers to RRSP, Mutfunds or reinvestment into another SFTS.

    Mineral Fields is the one that I chose. It generally gives back on maturity not less than 100% of the initial investment, at least the ones that I have done.

    The general idea with SFTS is on maturity of the particular fund you invested in, is that you take you could take the proceeds with further options.

    i) you’d pay captial gain, which is approximately equal to the Prov & fed tax credits) leaving you with a gain of whatever tax you got back.

    ii) Reinvest the money into another SFTS

    iii) Put it into an RRSP and some into a TFSA

    In the case of MF, it has the option on maturity to roll over to their mutual funds with zero tax and capital gains tax. This gives the benefit of further growth. Then should you want to redeem (part or whole) at that point tax is payable. But what you could do I suppose on redemption out of the mutual fund is make that a deposit into an RRSP.

    Past practice is that SFTS keep getting approved in the Governments spring budget, with the current ones approved to March 2009

  19. Flow Through Shares seem to be a great option to boot your tax returns depending on the profits you make.

    After reading your post the idea of purchasing some flow through shares has come to mind. They may not create huge profits but every bit counts especially when you are saving for something big.

    I wonder how well they will go compared to the normal shares. Whether they are relatively secure like long-term shares in businesses.

    Difference between long-term and short-term shares:
    http://www.financiallyenhanced.com/2008/07/01/difference-between-long-term-and-short-term-shares/

  20. 26. Ole

    Just computed some scenarios for a BC resident using FTS or “Super-FTS”
    http://www.flow-throughshares.com/i/flowthroughbrochure.pdf
    I made my own excel sheet and changed the values for marginal rates.
    Afterwards I made another row with “Value on redemption”, then “Less taxes” and net realized value. Take the net realized value – Invested value after tax credits. Divide this by the same Invested value after tax credits and If the FTS were worth the same as when you invested in them and you redeem after 2 years, you get 47.06% return (21.27 per year) regardless of tax bracket.

    Seems to me that you get exactly the same rate of return whether you’re in a high or a low bracket. Exactly to the dot.

  21. 27. Ole

    Oh I realize now… It comes down to the fact that capital gains are taxed at 50%…
    As a BC resident in highest bracket you break even at about 50% in value loss of the shares, 100% ROI if the shares remain at the same value.
    For low income earner I get break even at 40% loss and 65% ROI if the shares remain at the same value.
    This is for super flow through shares.

  22. How many other options are there like flow through shares?

  23. 30. tripleBottomLine

    I have some personal ethical reservations with investing in oil and mining operations. Is anyone aware of renewable energy investments that benefit through flow through shares?

  24. 31. James

    Sorry, I didnt get the part why you would use $5000 times 40% to calculate your payable tax? I thought the entire $10000 is profit, shouldnt you be using $10000 as your taxable income? Thanks

  25. 33. Dwayne

    You have neglected to mention a very important fact about “Flow Through Shares”. They should be called “Business Loss Flow Through Shares” but that name doesn’t look good on marketing material.

    Expoloration companies spend a lot of money looking for oil, gas and minerals. They have huge expenses and no revenue unless they hit the mother load. The “investors” in flow through shares get to write off the losses the company incurs against their own income. Sure you get a $4,000 tax benefit on your $10,000 investment but only because the company has lost $10,000.

    Sure once in a while an investor makes a killing on flow through shares but most people lose everything other than their $4,000 tax benefit. However, the promotors and financial advisors make money every time.

  26. 34. Terry J

    31 James — the reason they used $5,000 instead $10,000 is capital gains tax is only charge on 50% of the profit (at your full marginal rate)

  27. 35. Sushant

    The commission, fees and premium value does not make this a viable option..

  28. 36. Nathan

    One thing that wasn’t discussed on the tax front that I would like some info about is Marginal Tax Rate. How does the income from the shares affect Marginal Tax Rate (ie, how aggressive are you allowed to go into FTS without setting off a marginal tax rate alarm?) Im not sure exactly how marginal tax rate works so any info would be great, thanks!

  29. 37. Carl

    Are you talking about alternative minimum tax?

  30. Is there someone who reviews the flow throughs that are available in Canada as to who has the best ROI

  31. 39. Matt

    Flow through shares are usually a complex subject and I’ve always had trouble understanding them. Your piece on them actually made a ton of sense. Thanks for clarifying what flow through shares are so well. I had a couple junior minor positions on the venture last year and one of them issued a news release talking all about flow through but it went right over my head. Regardless, the stock headed south in a hurry and I got out.

  32. Thanks for another great article! I’m doing some research in flow through shares, and may invest later in the summer when I think stock prices may go down.

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