Flow-Through Shares Explained
Flow-Through Shares are a tax-advantaged investment in the Canadian natural resource sector. Taxpayers in the highest marginal tax rate can reduce their taxable income and receive refundable or non-refundable tax-credits depending on their province of residency.
Essentially, exploration or mining companies who issue flow-through shares renounce the deductions that would normally be available to the company and provide the deduction to the investor. In order for the investor to benefit from the flow-through shares the company must spend the flow-through dollars on exploration in Canada. This includes most non-development stages of mining including ground sampling, geophysics, drilling, etc.
Flow-through shares are available through some funds or directly in a specific company through an investment advisor. Although the majority of flow-through shares are available towards the end of each year, we attempt to complete flow-through financings throughout the year. This often gives us access to what we consider to be the better flow-through offerings in the companies most likely to provide substantial upside potential. There is also a rush towards the end of each year for flow-through shares resulting in what some may consider less quality issues. Just because an issue is flow-through does not mean it is a suitable investment as the fundamentals of the company should be considered first.
Tax Deductions & Tax Credits
Income tax benefits to individual investors will vary, depending on the taxpayer’s jurisdiction of residence for income tax purposes and marginal tax rate. At present, Quebec offers the largest potential tax savings for flow-through share investments followed by British Columbia, Manitoba, Saskatchewan and Ontario.
In October 2000, the Canadian federal government introduced a 15% non-refundable tax credit. The credit is in addition to the existing 100% deduction of eligible exploration expenditures and is deductible from the federal portion of one’s taxes. To distinguish it from the fully deductible regular flow-through, investors are calling this new credit-enhanced version "super" flow-through.
For taxpayers at the highest marginal tax rate the federal 15% non-refundable tax credit, when added to the regular 100% deduction, is equivalent to a 137% exploration expense deduction for federal tax purposes.
Several provincial flow-through initiatives have been announced that apply to the provincial portion of income tax relating to eligible expenses in relevant jurisdictions. Ontario (5%), Saskatchewan (10%), Manitoba (10%) and British Columbia (20%) offer harmonizing tax credits. The Ontario tax credit is refundable; the other tax credits are non-refundable.
Under tax legislation governing flow-through shares, eligible exploration expenditures have been 100% deductible for at least two decades. These deductions effectively reduce or shelter before-tax income. Tax credits apply directly to reduce taxes payable.
- A non-refundable tax credit reduces taxes to the extent of taxes payable.
- A refundable tax credit reduces taxes payable and then, if there is an excess, results in a cash refund.
The federal tax credit is non-refundable (the taxpayer has to pay taxes in order to use the claim). However, it can be carried back and applied against taxes paid in the previous three years. Unused tax credits may also be carried forward for a period of ten years.
