Flow-Through Shares: more info: I want someFlow Through Investing Basics
Monday, August 6, 2007
By J. David Mason
The story was originally published on StockHouse August 18, 2006.
Resource shares can provide substantial tax savings
If much of Canada's wealth comes from its natural resources, exploration is needed to ensure revenue continues to be generated from the ground. Canada's federal and provincial governments have provided tax incentives so companies will continue drilling. These tax breaks can also be passed down to investors in the form of flow through shares.
Flow through shares are similar to common shares with one difference: the money used for exploration can be deducted from the individual shareholder's personal income from any source. It doesn't matter if that source is dividends, capital gains or any other income. This type of investment can be quite beneficial, especially for individuals in higher tax brackets. You can invest in flow thorough shares or limited partnerships that offer a portfolio of these shares and greatly reduce your taxable income. The limit is the alternate minimum tax of 15% of taxable income that prevents a total deferral of tax through any shelter. Flow through investments, then, offer more flexibility and greater benefits than most deductions, including RRSP's.
With RRSP's, you deduct against income and pay tax at full rates on withdrawals. With flow through, you deduct against any income at full rate and pay tax at half the rate when selling since it's a capital gain.
While these types of investments carry greater risks, the tax savings will often reduce the risk of capital losses. In many cases it cuts the risk in half. Most investors will realize a benefit once they earn back at least half their initial investment. Investors in any tax bracket can purchase flow through shares, although the greatest benefits will flow through to those individuals who pay the highest marginal tax rates.
Flow through shares provide deductions for both federal and provincial income tax. Some provinces allow greater tax savings than do other regions of Canada. The government of Quebec permits its residents to write off up to 190% against provincial income tax depending on the latitude of the project. For example, if you are a Quebec resident and invest $10,000 in flow through shares of a company exploring in northern Quebec, your deduction against Federal income tax would be approximately $5000 and about $9,500 against Provincial income tax. Presuming a 45% tax rate against both taxes, the cost would be $0.35 on each dollar invested.
Most other provinces provide for only 100% write off, federally and provincially, but allow other incentives such as the investment tax credit ("ITC"). Up until the change of Federal government in January, with qualified exploration projects (typically those in early stages) an ITC of 15% could be applied against federal income tax. Being a credit, it has more than double the impact of a write off, and in the example above the cost would be reduced from $0.35 to $0.27 on the dollar.
Provincial ITCs have been available and these, excluding Quebec, range from 5% in Ontario to 20% in British Columbia. However, a Federal Order-in-Council is now needed to reinstate this part of the program, and until this happens, there is uncertainty regarding both levels of ITC. Flow through deductions are part of the statutes (since the 1940's) and are unlikely to be changed in the foreseeable future.
Premiums are also an important factor in deciding whether to invest in flow thorough shares. There is often a premium paid when buying flow thorough investments, so it's important not to overpay.
Investors can purchase these types of shares through a licensed dealer when they are issued by a particular company or through limited partnerships that are offered by a number of providers.
When buying shares from an individual issuer, such as a mining company, it is dependent on when the company needs the money for the program. If, for example, an investor puts money into a company's flow-through shares in 2006, the federal government allows the exploration company to defer the expenditures for about 15 months without penalty to the issuer. Flow through shareholders, however, still get the deduction from their 2006 income.
Buying limited partnerships that hold flow through shares can be a good strategy for investors who want the tax benefits but also want to reduce the risk of investing in a single issuer. Many flow through limited partnerships offer broad diversification by holding shares of several issuers in a single investment vehicle.
J. David Mason is the Chairman and Managing Director of Augen Capital Corp. (TSX: V.AUG) https://www.augencc.com/docs/index.php, a publicly traded merchant bank that offers flow-through limited partnerships.