Flow through shares are Canadian investments used by mining, oil, gas and renewable energy companies to raise capital for exploration purposes.
How does it work?
When a resource company has to spend money in order to explore a specific piece of land, this creates tax deductions. Generally, the companies are early-stage and not profitable enough to make use of these deductions. Therefore, the company uses the share to “flow through” – or transfer – its exploration tax deductions/credits to the investor.
What the investor gets
- Canadian resource companies renounce Canadian Exploration Expenses (CEE) to the investor allowing them to deduct 100 per cent, or Canadian Development Expenses (CDE) which can be deducted to the maximum of 30 per cent
- Investors can receive additional non-refundable or refundable tax credits
- Investors in high-tax brackets can reduce their overall tax burden
Possible risks
- Investors are basically buying a tax deduction, so these flow-through shares are issued at a premium compared to their regular shares. That premium can range from 20 to 30 per per cent on CEE credits or eight to 15 per cent on CDE credits.
- Exploration is unknown. If a company is unable to find resources, the share value will tank, ultimately leaving investors with a loss.
- Since the investment generates a huge tax write-off, the adjusted cost base of the share for tax purposes is zero. When selling shares, the entire price is subject to capital gains.
- The shares often require a mandatory holding period, and can trigger the Alternative Minimum Tax for higher earners.
Where it works
Flow through shares are exclusive to Canada. These were specifically designed as a feature of the Income Tax Act to promote private investment into the high-risk natural resource and exploration industries, with a goal to keep capital moving toward early-stage mining, petroleum and energy companies.
The Canadian government also subsidizes those industries with direct incentives such as the federal Mineral Exploration Tax Credit (a 15 per cent federal tax credit designed to help junior mining companies raise equity), the 30 per cent federal Critical Mineral Exploration Tax Credit (CMETC), as well as provincial tax credits depending where the exploration is taking place.
Are flow through shares a good investment?
Flow through shares can be highly rewarding as a tax-planning tool when used by high-income investors that have high risk tolerance.
This investment offers significant up-front tax savings, but there’s risk involved in that the investment is into an early-stage exploration company.
There is the option to access the benefits of flow through shares through a Flow Through Limited Partnership (FTLP) instead of investing in individual shares. This provides a pool of resource companies, mitigating the risk of a single company collapsing.
The main selling factor is the ability to write off 100 per cent of your investment against your taxable income.
Could it work anywhere else to encourage investment
This model is highly adaptable. The base of the model is to transfer unused tax deductions to investors, bridging the funding gap for risky, early ventures.
In the time of AI, technology and innovation, the need for funding has risen in this sector. The federal government has proposed using this model for high-tech companies’ R&D expenditures, specifically for those early-stage startups. This would allow these companies to pass through the “Valley of Death”
This concept inspired the United Kingdom’s Seed Enterprise Investment Scheme and the Enterprise Investment Scheme.
These programs use tax incentives to promote investment in early-stage companies and risky business ventures, and have raised tens of billions of dollars and created thousands of jobs – prompting some experts to question where else such a structure could be considered to spur investment.
