Flow Through and Super Flow Through Shares
Let’s discuss flow-throughs and super flow-throughs, and how they can impact your tax situation.
A lot of noise that's been made in the past 5 - 15 years about flow through shares. Let’s go back to the basics and examine the actual facts.
What is a flow through share?
A flow through share is a share of a common stock or common security that trades on either the venture exchange or the Toronto Stock Exchange.
In exchange for giving them money, they will flow through the tax credit that they receive from the government for either development or exploration.
They will flow that tax credit over to you, the shareholder, so you invest in them.
Generally, they are not profitable. These companies are usually junior companies, smaller companies that are either just starting out, or exploring their options.
They're typically going to be what's called penny stocks, junior small cap stocks, or micro-cap stocks. These are usually volatile companies – highly speculative, and highly risky.
Flow Through Shares
Now, who are these investments for and what do they actually do?
Let's start about what they actually do.
You invest in a company, and the company trades on Toronto Stock Exchange. Let’s say you put a dollar into this company. There are two types of credits.
Let's start with the CEE, the Canadian Exploration Credit.
The CEE is a 100% tax deduction in the year that you've purchased these flow through shares.
You buy a share for a dollar, you get the full tax deduction right away, and you can then offset that against your income.
There are a couple of things you need to factor in.
Because of the taxable nature of the shares, when you do sell them they will be treated as a zero-cost base for the shares.
Leaving that aside to stick to the basics of this deal, you buy a share and get the full tax credit in year one.
You need to hold onto the shares for a period of time so when you do sell them, hopefully the shares are either at the same price that you bought them at, or maybe even higher so you make a little bit of money on top of the full tax credit you receive.
Ideally you made a ton of money on the shares, but even if you don't make money on the shares, flow throughs can be a very good investment because of the tax credit.
These work really well for people who are in the top tax bracket. If you're making above $200,000 a year annually of T4 income, flow throughs can be very efficient because you’ve likely maxed out your RRSP room, leaving you with no other avenue to invest or reduce your tax bill.
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The other credit that we talked about earlier is the CDE credit, the Canadian Development Credit. For this one, you generally write off the tax deduction over three years.
If you're going to be doing a flow through with that credit, you need to make sure that you will be in a top tax bracket for those years, otherwise you're missing out on the deduction.
Flow throughs really only work for people who are in the top tax bracket or near the top tax bracket.
What price will you have to pay for your shares of your flow through?
Generally, there is what's called a premium to a buying flow through shares.
If the common shares are trading at a dollar, you'll typically see anywhere from 20% to 30% premium on the CEE exploration credits, with anywhere from 8% to 15% on the CDE credits.
Now you're paying a premium, you're paying more for these shares, than you could buy them in the market. And the reason you're paying a premium is because you are getting that tax deduction.
They're giving you the tax deduction in exchange for more cash than they normally would raise.
These are typically done through an issuance – a share-raise as we would call it – or an equity-raise. Typically, companies will issue these throughout the year.
Historically these were done more as one-offs, but in in the last five or ten years, there's been way less appetite for flow through shares.
What happened is that the market has conglomerated itself and we are now seeing these larger groups, these mutual funds if you will, of flow through shares coming together.
Then you end up owning a mutual fund of flow through shares.
That's been more or less the strategy in the last five years. From time to time we still see the flow through issuance, which is a one off you could participate in if you deal with an investment’s brokerage house.
Let's get one thing very clear. With respect to flow throughs, they are extremely risky. They are extremely speculative, and these do not form part of a well-balanced portfolio.
They're usually either exploratory mining companies or exploratory oil and gas companies. When we say exploratory, it means that they haven't struck anything yet.
These are often very risky junior companies so just make sure you know what you're getting into.
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If you're going to do a flow through, make sure you talk to your advisor about it and make sure you are fully aware of the tax consequences involved in buying these flow through shares.
Also make sure you're aware of the length of time that you need to hold these flow through shares before you qualify for the credit.
They can work ridiculously well because imagine you buy a share, and the share goes up with you also receiving the full tax credit.
That would be a huge win for your portfolio but be aware that it could also go the other way.
The shares could also go to zero, so you have a complete loss on the value of your shares, and all you get is a tax deduction.
Essentially, you should never be buying a flow through simply for the tax deduction.
You should buy it because you like the company, you like the sector and you think the tax deduction combined with the company is going to be a beneficial portion of your assets.
Super Flow Through Shares
Finally, there are certain provinces that will have even another tax deduction, known as super flow throughs.
Manitoba is one, Quebec and B.C. are others, where you will be allowed a super flow through deduction if you live in the province where the development or the exploration is happening.
If there's a company in northern Manitoba that's exploring for a mine for example, they will give you a super flow through tax credit, which can bring your cost of investment down to about 25 or 30 cents.
It's really dramatic and in those situations, the tax savings are phenomenal.
Again, these are risky companies, but they might work out for your portfolio, and can be used to plan and also mitigate some tax impact above the RRSP.
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