SprottWealth Insights

Introduction to Flow-Through Shares

Friday, June 30, 2017

Flow-through shares were established in order to incentivize the resource sector to explore for oil, natural gas, and minerals. The Federal Government allows Canadian resource companies that invest in the oil and gas, mining and renewable energy sectors to renounce and “flow through” certain eligible exploration expenses, known as Canadian Exploration Expenses (CEE) or certain eligible development expenses, known as Canadian Development Expenses (CDE).

  • Canadian Exploration Expenses

    • Includes certain expenses incurred to determine the existence, location, extent or quality of a mineral resource or of an accumulation of petroleum or natural gas in Canada. Certain expenses incurred to bring into production a natural accumulation of petroleum or natural gas in Canada, or a new mine in a mineral resource in Canada may also qualify as CEE.

  • Canadian Development Expenses

    • Includes certain expenses for the development of an oil or gas well in Canada, or of a mine in a mineral resource in Canada.[i] 

In issuing flow-through shares and passing along these eligible expenses to shareholders, the shareholders are then able to deduct those eligible expenses against their own taxable income as if the expenses were incurred directly by the shareholder. Canadian Exploration Expenses (CEE) are 100% tax deductible in year one, while Canadian Development Expenses (CDE) are 30% deductible on a declining balance basis starting the year of the flow through investment. Certain mining CEEs provide individual investors with an added federal tax credit of 15% and a provincial tax credit, the value of which varies province to province.

Flow-through shares can be purchased directly on an issuer-by-issuer basis, or can be accessed by investing in a flow-through limited partnership, which is a vehicle that is professionally managed, offers diversification and a broad range of flow through issues.

 

 

Tax considerations of investing in flow-through shares

  • Deductions from taxable income, through renounced expenses
    • When the shares are disposed of, the proceeds are taxable as a capital gain
    • The adjusted cost base of the shares is deemed to be nil. As such, the entire proceeds from the sale is considered a capital gain, with a 50% inclusion rate
  • Mineral Exploration Federal Tax Credit: Individuals (excluding trusts) can claim a further 15% non-refundable tax credit for certain mining CEEs renounced on investments in flow-through shares of mineral exploration companies. Qualifying expenses are limited to exploration drilling from surface.
  • Mineral Exploration Provincial Tax Credit: Can only be claimed by a resident paying provincial taxes in the province in which the exploration is incurred. The value of credit varies from province to province. Qualifying expenses are limited to exploration drilling from surface.

Additional Information/Risks

  • Investments in flow-through shares can involve a higher degree of risk, as some junior to mid-size resource companies typically issue flow-through shares
  • Stock prices of resource companies can be volatile and tied closely to the ups and downs of energy and mineral prices
  • There is usually a resale restriction for a period of time after purchase, due to the offering typically being conducted on a private placement basis
  • These shares may be issued at a higher price than the company’s regular common shares to reflect the taxable benefits
  • If a company that has raised capital through flow-through financing was unable to spend it on eligible expenses, investors who participated in the financing will be subject to a reassessment of taxes in that particular year.

Is Flow-Through Investing For You?

Flow-through purchases are best suited for those investors in the highest marginal tax bracket who are in a position to accept the heightened risk associated with purchasing shares of junior to mid-sized resource companies and obtain the highest tax deduction.

To learn more about flow-through investing and how it may be beneficial to you, contact your SprottWealth Investment Advisor today or book an appointment at 416-943-4383.

1 [i] http://www.cra-arc.gc.ca/tx/bsnss/tpcs/fts-paa/nvstr/hw-eng.html