Do you have carry-forward capital losses that you haven’t been able to use? Will you be moving to a lower marginal tax bracket in the next 3 to 7 years? Do you have a long-term investment time horizon (15+ years)?
If your answer is ‘yes’ to any of these questions, you may want to explore an interesting, but little understood tax strategy made available to you, courtesy of the Federal government.
To help encourage investment in Canadian resource companies in the oil and gas, mining, and renewable energy sectors, the companies in these sectors are able to issue something called flow-through shares.
While flow-through shares are similar to regular common shares, where they differ is that qualifying exploration expenses incurred by the issuing company may be “flowed-through” to investors holding the shares. The result: the Tax Act allows flow-through investors to deduct as much as 100% of their investment in the year they invested.
Exploration expenses incurred by junior resource companies on a yearly basis are typically “wasted” in that they are not offsetting any taxable income. In addition, exploration is very expensive and these companies constantly require capital to fund their exploration activities.
Flow-through shares meet these companies’ needs. The junior companies issue flow-through shares to raise capital and then “renounce” their exploration expenses to individual investors, monetizing the resource company’s income tax deductions.
On a personal income tax basis, flow-through exploration expenses can be deducted against all sources of income on your tax return.
Sprott Private Wealth Smart Money Portfolios are a smart way to take advantage of institutional quality asset allocation. The Vertex Value Fund is one of the funds we’ve selected for inclusion in the Smart Money Portfolios. What follows is an extract from their December 2014 Fact Sheet.
“The fundamental investment objective of the Vertex Value Fund is to provide long term capital growth by investing primarily in the equity securities of Canadian and United States companies.
“Our investment process involves seeking out primarily equity securities of companies that we determine to be priced at attractive levels relative to the market, their competitors and their growth rates. That often means buying solid companies at 50%-80% below their previous highs, which in our view removes a lot of risk from investing. Companies with annuity like cash flows, strong balance sheets and high dividend yields will be given the greatest weighting.
“You could sum it up by saying our mission is to build a position at a very good average entry price… then wait.”
An investor buys shares in a Flow-Through Limited Partnership (LP) and deducts 100% of Canadian Exploration Expenses (CEE) in the year of investment. In approximately two years, the partnership terminates and the investment is rolled into a mutual fund corporation, at which point the investor may sell the fund. The proceeds of the disposition are taxable as capital gains, at a tax rate of only 50% of regular income.
The same investor who buys shares in a Flow-Through (LP) decides to defer their taxes further and does not sell their shares of the mutual fund corporation. Instead, they switch to a mutual fund “class” (i.e. a “Corporate Class Fund” is a corporation that holds a collection of different mutual funds, allowing you to switch between funds without triggering a taxable event), and no capital gains are triggered. When they retire and are in a lower marginal tax bracket, they sell the fund and trigger capital gains taxes, at a rate of 50% of regular income.
Investing in Flow-Through LPs effectively converts income into capital gains, so investors can take advantage of any capital loss carry-forwards in the year in which they sell their shares of the mutual fund corporation.
Investors who are controlling shareholders of private Canadian corporations can use flow-through investments to shelter the corporation’s income. The tax benefits would be similar to the tax saving and tax deferral benefits available to individual investors. However, the effectiveness of any of those strategies depends on corporation and should be carefully reviewed by a professional tax advisor.
Investors can access the flow-through market by purchasing shares directly from the junior resource companies or by investing in a Flow-Through Limited Partnership. Flow-Through Limited Partnerships are investment vehicles that add three important benefits to the tax advantages of flow-through investing: