What is a Flow-Through Share?

Flow-through shares are common shares of a resource company which provide flow-through tax deductions for investors. Resource companies issue flow-through shares to attract capital for exploration and development activities. Resource companies "flow through" eligible Canadian Exploration Expenses (CEE) and Canadian Development Expenses (CDE) to their flow-through shareholders. Investors can deduct these flow-through expenses against their taxable income.

Why does the Government of Canada provide investors with a flow-through tax deduction?

The Government of Canada recognizes the economic benefits of the exploration for, and development of, Canada’s natural resources and encourages investment with a flow-through tax deduction for investors. Originally, flow-through shares were only deductible against resource income, however, in 1983 the federal government changed legislation which allowed qualifying flow-through expenses to be deductible against other income. In recent years, the federal government and some provinces have introduced additional tax incentives for investors purchasing certain flow-through shares issued by Canadian mining companies to provide additional incentive for investment in Canada’s mining industry.

How can investors purchase a flow-through investment?

Flow-through investments can be purchased in one of two ways: 1) Purchase flow-through shares directly from a resource company. The main disadvantages are: limited access to direct flow-through investments and the higher risk associated with a lack of diversification; or 2) Purchase a flow-through limited partnership. The main advantages are: portfolio diversification and a portfolio manager who makes the flow-through portfolio decisions which reduces risk and increases the potential for capital gains.

How does a typical flow-through limited partnership work?

1) Investors invest in a flow-through limited partnership. 2) The limited partnership’s portfolio manager invests in flow-through shares of resource companies. 3) Resource companies use the flow-through capital to incur eligible CEE and CDE expenses. 4) Resource companies “flow-through” expenses to the flow-through limited partnership, i.e. the shareholder. 5) The limited partnership flows through the eligible expenses to its shareholders a tax deductible expense against their taxable income in the year in which they invested. 6) Eighteen to twenty-four months from the close of the limited partnership offering, the flow-through portfolio assets are liquidated, typically by way of a tax deferred rollover of the limited partnership assets to a mutual fund. Shareholders can choose to either hold or sell the mutual fund units.

What should be considered in reviewing a flow-through limited partnership?

There are many aspects of a limited partnership which investors need to consider. They include: a) the portfolio management team’s experience and track record; b) the sector focus of the limited partnership (i.e. mining, oil & gas and alternative energy); c) the amount of capital raised relative to the quantity and quality of the flow-through share investment opportunities; d) management of flow-through share premiums; and e) the limited partnership’s liquidity strategy. These matters can be reviewed in a limited partnership’s offering documents or, investors can ask their Investment Advisor about a flow-through limited partnership offering.

What are some of the risks with flow-through investments?

As with any investment, there are certain risks associated with flow-through investments. Risks can include, but are not limited to: 1) the cyclical nature of the resource industry; 2) commodity price fluctuations; 3) the resource company’s share price volatility; and 4) the resource company’s operational risks. The flow-through tax deduction and the portfolio diversification of a flow-through limited partnership are designed to provide investors with downside risk protection. Investors should review the risk factors for a flow-through share offering or limited partnership investment opportunity by reviewing the offering documents or discussing the risk factors with their Investment Advisor.

What is the flow-through tax deduction in a limited partnership?

Flow-through limited partnerships typically provide investors with a 100% tax deduction based on their original amount of capital invested. The percentage of first year flow-through tax deduction can vary from one flow-through limited partnership to another, and may be in excess of 100% where the limited partnership provides investors with additional mining tax credits. Investors should not make an investment decision solely based on the tax deduction feature of a limited partnership.

When do investors get their flow-through tax slips?

Investors typically receive their flow-through tax slips prior to the end of March of the year following the purchase of their flow-through investment. If the flow-through limited partnership investment is made through an investor’s brokerage Dealer, the Dealer will mail the applicable tax information to the investor.

How does a flow-through limited partnership provide liquidity for investors?

Liquidity for a flow-through limited partnership typically comes in the form of a “tax-deferred” rollover to units of a mutual fund and usually occurs eighteen to twenty-four months from the closing date of the limited partnership offering. When an investor eventually sells their mutual fund units, the value of the units sold are taxable as a capital gain. Although not typical, a Limited Partnerships could also provide liquidity by distributing to investors, on a pro-rata basis, the cash and shares of the resource companies in the flow-through portfolio. The value of the distributed cash and shares would be taxable as a capital gain.

Why is the entire value of the proceeds of selling a flow-through investment taxed as a capital gain?

Flow-through investments typically have an adjusted cost base (ACB) of “zero” because of the flow-through tax deduction. Therefore, for tax purposes the entire value of the proceeds realized from the sale of a flow-through investment is subject to capital gains. If an investor’s flow-through shares roll to a mutual fund, the capital gains tax is deferred until such time as the investor sells their mutual fund units.

Is it to my advantage to re-invest my tax savings in another flow-through offering?

One of the most compelling strategies with flow-through investing is “recycling” the tax savings! With this strategy, an investor sells the flow-through upon maturity (and declares a capital gain), then reinvests the proceeds in another flow-though investment where 100% of that invested amount is fully deductible. An investor now legitimately receives recurring tax savings by simply recycling the investment proceeds. This is a simple, yet extremely effective, tax planning strategy.