How Flow Through Shares Work!
by FrugalTrader on March 15, 2009
As it is tax season, it feels appropriate to talk about tax strategies. There are very few tax breaks for Canadians, however, there are still some remaining. One of these tax breaks is to invest in “flow through” shares.
What are Flow Through Shares?
- These shares are issued by oil and mineral exploration companies who pass the tax breaks for exploration onto investors.
What are the tax advantages?
- If you were to invest $10,000 in flow through shares, providing that they are eligible for the tax breaks, you can claim the full $10,000 on your tax return. If you are in the 40% tax bracket, that would equate to a $4,000 tax return for that year.
How does it work?
- As stated above, you get to claim the FULL amount invested against your income. However, when you sell, your adjusted cost base (ACB) is set to $0, ie. whatever you sell for is your PROFIT.
- If you were to invest $10,000, and sell 2 years later for $10,000, your profit would be considered $10,000. So to calculate your capital gains . with a 40% tax rate, would be $5000 x 40% = $2000 tax payable. Even in the scenario where the shares don’t change in price, you will receive a $2000 gain ($4000 tax return – $2000 tax payable).
Who should buy them?
- This tax break works best for those in the highest tax bracket, but generally works for anyone. I’ve read from various sources that flow through shares should not exceed 10%-15% of your portfolio.
How do I buy them?
- You can purchase them directly from companies offering them or through mutual fund firms like Front Street Capital and Middlefield Resource Funds (source: Canadian Business Magazine).
- Check out our Canadian online stock broker comparison .
What are the risks/disadvantages?
- If you are experienced with the Canadian mining/oil sector, you will know that this market can be fairly volatile. Also, when you purchase flow through shares, you typically have to hold onto them for 18-24 months before you can sell them.
- Flow through shares usually sell at a premium .
- You can lose up to a certain percentage of your investment, and STILL come out even due to the tax breaks. Below is a table from QIS Capital outlining the loss limits by tax bracket:
- 50% tax bracket – 66% of original investment
40% tax bracket – 75% of original investment
30% tax bracket – 81% of original investment
20% tax bracket – 89% of original investment
Can you give some examples?
- This is a very superficial description of flow through shares. If this topic interests you, you should continue with your own due diligence. Here are some discount brokers in Canada that may hold flow through shares, make sure to contact them first to confirm.
- Personally, I have never purchased flow through shares before, but it’s definitely something I’m going to look into as my tax burden increases.