Flow-Through Shares

Flow-Through Shares

Flow-through shares are stocks that can only be purchased directly from Canadian oil and mineral exploration companies, usually at a slight premium. This article will address only the acquisition of these shares by an individual and not by a corporation. In addition, this article assumes that the company issuing the flow-through shares will use the invested money on the exploration for resources, and receive tax deductions for this work called Canadian Exploration Expenses (CEE). There are flow-through shares purchases that qualify for Canadian Development Expenses (CDE) which are deductible over a number of years and are not considered in this article.

The CEE deductions, in turn, flow through the company to you (the purchaser), and are deductible against any source of income typically in the year of acquisition.

You may also qualify for special tax credits called Investment Tax Credits (ITC) dependant on where the exploration takes place and where you reside.

An Ontario resident purchaser may be eligible for a federal ITC of 15 per cent, plus a provincial ITC of 5 per cent if the exploration is done in Ontario. These ITCs are a direct reduction of your tax liability. When claimed, these ITCs are reported as income on your tax returns.

Companies that issue flow-through shares must spend all the money on exploration in Canada within 24 months of the time of purchase.

Flow-through shares are beneficial mainly to people in a high income tax bracket.

How do they work?

When you purchase flow-through shares, you will receive a tax slip from the company allowing you to claim the full purchase price as a deduction on your year-end taxes.

For example, assuming you are in the top tax bracket in Ontario (53.53%), if you bought $10,000 in flow-through shares, you would have a tax savings of $5,353. However, you need to be aware that the cost base of the shares is reduced by the deduction you have claimed. In this example your new adjusted cost base of the shares is $0 ($10,000 purchase price less $10,000 deduction claimed); therefore, whatever price you sell the shares for in the future is considered a capital gain in its entirety.

Assuming your investment has neither risen nor decreased in value, and you sell for the same $10,000 you purchased for, your capital gain would be $10,000. Since capital gains are only 50 per cent taxable, you would pay 53.53 per cent on $5,000 which is $2,676.50.

Subtracted from your original savings of $5,353 means your eventual tax savings in this example would come to $2,676.50, excluding any tax savings or costs arising from potential ITCs.

Are there risks?

Once you purchase the flow-through shares and have taken the CEE deduction, you are relying on the company to spend the money correctly. If the total sum of the investment is not spent on exploration within the 24 months, you may be retroactively denied the CEE deduction. The funds cannot be spent by the corporation on overhead or administrative expenses.

It is extremely important to do your due diligence before purchasing flow-through shares to ensure the company has enough capital to cover its operating costs for the next 24 months without using your investment.

In addition, it is common that the flow-through shares acquired may not be traded for an extended period, generally for 24 months, and you are subject to market risks related to the value of the shares. Even if there is no holding period, the shares will still be subject to market volatility.

In order for you to, at a minimum, break-even on the transaction, the market value of the shares when you sell them cannot be less than 63.45% of the original purchase price.

You should also be aware that flow-through shares acquired after March 22, 2011 are not eligible for the tax exemption on securities donated to a charity, although they do qualify for a donation receipt.

Purchasing flow-through shares can be very beneficial but, like any other venture into the stock market, does not come without risks. Speak with your advisor before deciding to purchase any flow-through shares to determine if this is a wise investment for you.

This article was originally published in February, 2015. It was updated in October 2019.


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