Flow Through Shares – Are they a good idea?

In all the years that I have been doing taxes there has been a common theme.  Everyone hates paying taxes, think they pay too much, and are always looking for a way to pay less.  Now I have written about how paying tax is good because it means you are making money, and paying lots of tax means you are making lots of money.  No one listens, most think I am an idiot, and other keep looking for schemes to reduce their taxes.  C’est la vie (that's life).

In light of this I have chosen to try and use math and reason to explain why flow through shares may not be all they are cracked up to be.  For those of you who don’t know, flow through shares are commonly found in mining, and Oil and Gas.  These industries typically need lots of money for exploration and development and attract investors by offering legal tax deductions for investing in their businesses.

Flow through shares work by transferring certain types of corporate expenses to individual investors.  These expenses are then deductible by individuals because the corporation has the legal right to flow them through to the shareholders.  This is done because the corporation has so many expenses it does not need them all, or is willing to trade them for the influx of working capital that is required.

Flow through share have the following tax consequences.  You can receive up to the value of your investment in flowed through tax deductions, and the adjusted cost base (ACB) of the shares you own afterwards is zero.  In addition, when you sell your shares any  value received in excess of zero is treated as a capital gain which means only ½ is taxed, while the other ½ is tax free.

Now lets look at the Math.  The best type of flow through expense is called CEE.  It is a type of depreciation expense that is deductible 100% in the year the funds are expended.  So let’s assume that you “invest” $20,000 and let’s assume that your personal tax rate is 40%.  In addition let’s assume that you manage to sell your shares for $2,000 (1/2 of which is taxable).  Keep in mind this is not guaranteed.  In fact most times flow through shares are worthless unless the company makes a big find on the project for which the shares were issued.

Investment                        $20,000

Tax Savings                       (  8,000)

Sale of Shares                    (2,000)

Tax on Sale                            400

TOTAL LOSS                   10,400

In this example, even with the favorable sales price you still end up $10,400 in the hole.  Sometimes these investments pay off, but most times they do not.  Keep this in mind the next time you think paying taxes sucks.  Giving your money away or investing it unwisely will cost you far more.  In this case if you had just paid the $8,000 in tax you would still have the other $12,000 as opposed to being out of pocket $10,400.   Seems pretty simple to me, but I am just a dumb accountant with 6 years advanced education (post secondary) and more tax knowledge than 99% of all Canadians.  What would I know?