One of the more interesting Canadian-specific investment tax strategies available is flow through shares. I’ve written several articles over the years on how flow through shares work, what they are, their associated advantages. As I began to update my knowledge on these unique investment tools, I decided to combine the piecemeal articles that I had written into one catch-all guide to flow through shares.
Overall, I think the most important takeaway when it comes to flow through shares is that they should really only be considered by people who are in high tax brackets and who really understand how risk and investing go together on an advanced level OR people who wish to donate in a very tax efficient manner. Thoroughly understanding just how risky your flow through shares are, as well as your personal risk tolerance, are prerequisites for being successful in this field.
A flow through share (FTS) is a share that has been issued by mining, oil, gas, or energy conservation company in Canada to help finance project development. Essentially, by using flow through shares, the corporation is able to transfer its expenses to the investor.
The reason the government and industry got together to create these unique entities is that both groups wanted to create an incentive to invest in risky resource projects. Many of these projects will fail to produce any returns for their investors; however, the ones that succeed are often very, very successful – and are of great benefit to the broader Canadian economy. So, basically the government wants to incentivize Canadians to risk their money by giving them a significant tax break for doing so.
The main reason why investors in Canada would want to purchase flow through shares is to get a tax break. They can be very beneficial if you are in a higher tax bracket.
For example, 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.
As you can see, this can be quite advantageous to help cut down on your taxes. It’s essentially an automatic 10% return on your investment.
Another way to use flow through shares to your advantage is to make them work for you by maximizing your charitable donations. Financial Planner Carrey Vandenberg helped us out by explaining how this all works:
If you give to charity or church on a regular or substantial basis ($5,000 or more per year) the following is something that you should seriously consider to replace your current mode of giving, namely writing a cheque and only getting the donation tax credit. Using this strategy will still put the same amount of cash in the hands of your designated charity or church, however, it can cost you a lot less.
First, I must state at the outset that the tax savings do depend on your province of residence, your marginal tax rate, your advisor, and what investment that you ultimately use for this purpose. That will be between you and your Financial Advisor.
What I call the “Double Dip Donation Strategy” starts with the investment in a “Super Flow Through Share” offering. This can save you up to $6,180 on a minimum $10,000 investment. In other words, you are only out of pocket approximately $3,800.
Flow through shares are nothing new. They have been a huge part of the Canadian economy for over 50 years, longer than RRSP’s. However, unlike RRSP contributions you must make a flow through share investment before December 31st to have the tax deductions and credits apply to the current tax year.
If you simply want the tax savings and hold the investment for yourself then you can stop there. You will have made a $10,000 investment for a net cost of only $3,820. If you choose to take a second step and use your investment as a charitable donation you will save up to an additional $4,370. The $6,180 tax savings for investing and then $4,370 tax savings for donating.
For the donation part, however, you will have to wait for the flow through shares to convert to a mutual fund. It is at this time you can gift the shares to the charity and they can be simultaneously sold for cash by the charity.
In other words, you have received just over $10,000 back in tax savings and the charity or church you have given to has received $10,000 in cash. This of course assumes that the flow through share offering you have participated in is worth the same amount.
For a regular giver to a charitable cause or church, this is considerably better than simply donating cash which produces a total tax savings of only $4,370.
I use the “Super Flow Through Share Donation Strategy” myself and will continue to do so for years to follow or until the government changes the tax rules. Multiply the tax savings by the number of years you will have breath and we are talking potentially hundreds of thousands of dollars in extra dollars for your (or your kids).
Note: The above tax-saving figures are based on the highest tax bracket in BC ($123,000+ of taxable income). The tax savings are still very compelling at the over $70,000 taxable income level and can still be attractive for taxable incomes over $38,000.
Editor’s Note: Flow through shares are very volatile with a very high probability of decreasing in value.
Disclaimer: Carey Vandenberg is a Financial Planner with Partners In Planning Financial Services Ltd (PIPFS). The views expressed have not been endorsed by PIPFS. The information contained does not constitute an offer or solicitation to buy or sell any investment fund, security or other product or service. This is not intended to provide specific financial, investment, tax, legal or accounting advice for you, and should not be relied upon in that regard. You should not act or rely on the information without seeking the advice of a professional.
Anyone can invest in flow through shares, however, the corporation that issues the flow through shares must be a principal-business corporation (PBC). There needs to be a written flow through share agreement between the corporation selling the shares and the individual (or corporation) who is investing. Once everything is set, the corporation’s eligible expenses will then ‘flow through’ to the original investors.
As stated above, the investor gets to claim the FULL amount invested against their income. After a couple of years, these shares roll over to a mutual fund which you can choose to sell at any time. When you do decide to sell, the adjusted cost base (ACB) is set to $0, ie. whatever you sell it for is your PROFIT.
So, 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).
Technically speaking, anyone can buy flow-through shares. However, as the incentive is to offset your taxes, it works best for individuals who are in the highest tax brackets in Canada.
That being said, from an investing point of view, expert sources have said that flow through shares should not exceed 10%-15% of your portfolio. I personally have dabbled in flow through shares, but have decided that long-term, the juice just isn’t worth the squeeze for me; consequently, I don’t currently possess any flow through shares in my portfolio.
Flow through shares can be purchased directly from companies offering them, through mutual fund firms, and even from your local financial advisor. (Check out our Canadian online stock broker comparison.) They tend to be sold at certain times of the year and are generally sold at a premium.
While flow through shares can absolutely be beneficial for your taxes, there are some risks and disadvantages associated with them as well:
- 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.
- As mentioned above, 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 the original investment
40% tax bracket – 75% of the original investment
30% tax bracket – 81% of the original investment
20% tax bracket – 89% of the original investment
- Flow through shares have a holding period of about 2 years which means it is impossible to get your money out before then.
Editor’s Note: This example is now quite far in the rearview mirror, but I thought it was illustrative of how one might approach the flow through shares market. I should also point out once again, that this is not a strategy that I recommend for the average Canadian investor.
A reader, “Chewy” has left a comment on the research that he has done in the field, and he has come up with a list of his favorite mutual funds that hold flow through investment vehicles.
To briefly summarize, here are the top 3 picks based on “Chewy’s” research:
- CMP Resource LP
- Canada Dominion Resource LP
- Mavrix Explorer LP
Below is his comment:
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, performance, and expenses of these limited partnerships (LP’s). I was able to compare the prospects 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 performance 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 an 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 positive. 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 performance, expenses and management. Both of these LP’s are now owned by DMP Ltd. Both are also managed by Dynamic Funds which is also owned by DMP Ltd.
CMP Resource LP has the best performance record. They had 9 out of 10 offerings that had been positive. Their offerings are normally $1,000 per unit with a minimum of $5,000 buy in, but their average asset value per unit on those 10 offerings was $1,242.74. 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 to be 95%.
Canada Dominion Resource LP would be my second choice based on their consistency and management. They had 11 out of 16 offerings that had been positive. They are also owned and managed by the same companies as CMP. Dynamic Funds is listed as a top performer on TD’s Webbroker Fund Selector, and they have one a number of Lipper Awards for Consistency and Performance.
My Third Choice would be Mavrix Explorer LP. They had 5 out of 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 likely 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.
I’m no flow through share expert, and while this article explains the basics there is a lot more to learn on the subject before making any investments, so please continue with due diligence. If you do decide to pursue this option, you can take a look at these discount brokers in Canada that may hold flow through shares. Just make sure to contact them first to confirm.