Are Flow-Through Share Investments Right for You?

Our tax regime includes an interesting opportunity for taxpayers who acquire newly issued Flow-Through Shares (“FTS”) from Canadian resource companies. Based on meeting specific requirements, the investor is allowed to deduct the cost of the investment against taxable income, provided that the underlying company spends the funds on exploration and development expenses, and agrees to forgo the expense deduction. Stated another way, the company is passing the expense deduction on to investors. In addition to the tax deduction, an investor will generally get a 15% federal tax credit (some investments also qualify for a provincial tax credit).

Here is an example:

  • An FTS is purchased by an individual for $50,000 in 2020 – this leads to a $50,000 deduction on the individual’s 2020 personal tax return
  • The individual also gets a tax credit of $7,500 ($50,000 x 15%) – this is a dollar for dollar reduction to tax payable in 2020
  • The individual will report income on $7,500, the value of the tax credit, in 2021 and will pay tax on such amount

Based on the preceding details and an outline of the investor’s taxable income, we can determine the amount of tax savings from the strategy. However, the overall return is then dependent on the value of the FTS investment – the overall return will be very positive if the value of the investment stays constant or appreciates, whereas we may have a negative return if the FTS investment declines materially. There is an opportunity to mitigate the investment risk if an investor can immediately sell the investment – this is acceptable from a tax perspective because our tax regime does not impose an FTS holding period. Based on a set selling price we can then confirm the net benefit from the FTS strategy.

There are several groups that can assist with this FTS planning – they generally facilitate the purchase of the FTS and the sale of same to mutual fund or institutional investors – the buyer is generally an entity that would not benefit from the tax incentives such that they do not need to purchase the original FTS from the issuing company. The proceeds on the sale of an FTS are a capital gain for the investor – an FTS has a zero cost which is sensible because the investor gets a deduction for the FTS. A capital gain is only ½ taxable – for example, if the FTS described above was sold for $40,000, then the taxable capital gain would be $20,000 and this is fully offset by the deduction of $50,000. The opportunity gets even more attractive for a taxpayer with capital losses available – eliminating the tax on some or all of the capital gain can materially improve the benefits of the strategy.

An FTS strategy can also be used in connection with charitable giving – in the example above, the FTS would be purchased for $50,000 and the investor would get the applicable tax benefits. The investor could then donate the FTS to charity and if the FMV was $40,000 would get a charitable donation receipt for this amount. The preceding means that a donor can donate to charity at a lower effective out-of-pocket cost.

In our experience, FTS are an attractive strategy for individuals who have regular income subject to the top personal tax rate, i.e. taxable income in excess of $220,000. Further, the strategy is most appropriate where the bulk of the income is regular income (employment, self-employment, interest or rental income) – the strategy may not be a fit if an individual’s income includes material dividends or capital gains. The rate of return from an FTS strategy is dependent on the specific variable on an FTS deal, however, can be in the 20% range.

Please contact us if you would like to learn more about FTS investing and the potential fit in your circumstances.

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