Are Flow-through Shares a Good Investment?

Yes, flow-through shares are a good investment. In Canada, many small resource companies issue flow-through shares (FTSs) whenever there’s a need to raise capital to cover expenses related to early-stage exploration and development endeavours. You can invest in these products and enjoy multiple juicy perks, starting with significant tax deductions.

But don’t go and invest in FTSs yet; read through this article first. It will introduce you to the fundamentals, everything from the meaning of flow through shares and how they work to their risks and advantages. 

What are Flow-through Shares?

Flow-through shares are investment tools offered by Canadian resource companies in sectors like mining, gas, and energy conservation. Most budding corporations with limited capital use these shares to facilitate the financing of project development and exploration activities.

Flow-through shares are very popular in Canada, and rightly so. These financial instruments come with numerous tax incentives. For starters, they allow investors to claim deductions for resource expenses often renounced by eligible corporations, like costs associated with geological surveys and drilling, which are. Moreover, flow-through shares allow investors to enjoy tax credits on expenses that experts consider as flow-through mining expenditures.

To give you a better grasp of this concept, here’s a flow-through shares example. Suppose a junior mining company with limited resources needs to raise money to fund an oil exploration project in Ontario. In that case, it can issue flow-through shares. You, an investor, can buy $10,000 worth of the company’s FTSs, which will allow you to claim a $10,000 deduction from the same year’s taxable income.

How Do Flow-through Shares Work?

Flow through shares come in their varieties. As an investor, you have access to traditional FTSs that allow you to enjoy tax deductions transferred to you by the involved flow through investments Canada companies. You can also invest in super flow-through shares or charitable flow-through shares, which come with additional perks like enhanced tax benefits and charitable donation structure, respectively.

Having said all that, how do flow through shares work? Here’s a breakdown of the entire process:

Step 1: A junior corporation issues flow-through shares

First, a company considered a principal business corporation must issue flow-through shares. To qualify as a principal business corporation, a company’s principal operations must be rooted in mining and exploring minerals and other resources. Companies that primarily process minerals and metals aren’t considered as PBCs.

Step 2: Investors buy flow-through shares

You, an investor, buy the flow-through shares issued by a qualified resource company, making you a corporation shareholder. Before taking this significant step, we encourage you to research and learn the essentials of FTSs, including their risks and potential perks.

Step 3: The corporation incurs exploration and project development expenses

The involved resource company uses funds from FTSs to cover qualified expenditures. These range from expenses associated with geophysical, geochemical, and geological survey endeavours to costs arising from drilling and trenching.

Step 4: The corporation renounces tax deductions

After incurring qualifying expenses, the corporation renounces the associated tax deductions. In other words, it hands over its right to claim tax deductions to investors like yourself who’ve bought the company’s flow-through shares.

Step 5: Investors claim tax deductions

The company involved will send a tax slip with relevant information upon renouncing tax deductions. Investors can use this document to claim tax deductions on their returns. As an investor in flow-through shares, you have ample opportunity to reduce taxable income and earn juicy capital gains in the future.

Advantages of Investing in Flow-through Shares

The benefits of investing in flow-through shares are many and varied, especially for high-income individuals. That is because these investment vehicles give affluent investors the opportunity to enjoy immense tax deductions and leverage unique opportunities in sectors like mining, gas, oil, etc.

Let’s explore some of the perks that people who invest in flow-through shares stand to enjoy:

Risks and Disadvantages

Before putting your hard-earned money in flow-through shares, familiarize yourself with the risks and downsides you may encounter. We’ve explored some of them below.

1. The investment’s high-risk nature

More often than not, FTSs are issued by small companies that are still grappling with initial-stage exploration and development projects. Sadly, not all budding corporations get a breakthrough. According to recent findings, approximately 21.5% of small companies fail within their first year. In other words, there’s a slight chance that you may buy flow-through shares issued by a business that will fold prematurely, causing a significant dent in your finances.

2. Zero cost basis for capital gains

If you sell your flow-through shares today, your cost basis for tax purposes will be zero. Simply put, the government will consider the entire amount you get as a capital gain and tax 50% of it. If, for instance, you sell your FTSs for $1,000, half of this fortune, which is $500, will be subject to taxation. The more you get, the higher your taxes.

3. Limited liquidity

Since flow-through shares are sold by early-stage, high-risk entities with limited market presence, they often have less demand and don’t trade frequently. That causes limited liquidity and makes it harder for investors to sell their FTSs quickly, especially when things start going downhill, courtesy of issues like declining prices.

4. Sector-specific risks

As you already know, FTSs are linked to players in the natural resource sector. This aspect comes with one major issue: sector-specific risks. What does that mean? When investing in flow-through shares, you will be exposed to uncertainties and challenges that often plague the natural resource sector, like the possibility that your company won’t discover commercially viable minerals or will come up with low-price commodities.

5. Complex tax mandates

The taxation rules and mandates regarding flow-through shares can be complicated, especially for green investors. If you are new to this, expect to spend a significant amount of time learning the nuances. Newbies are also at a greater risk of misunderstanding relevant rules and attracting penalties from the CRA.

6. FTSs are unique to Canadian resource companies

Flow-through shares are offered exclusively by Canadian resource companies. Consequently, you can invest in FTSs from any other company that isn’t Canada or a corporation that isn’t involved in resource exploration and development projects.

7. Ill-suited for low-income investors

FTSs are ideal for high-income investors who are in a better position to enjoy ginormous tax deductions. If you are in a lower bracket, the chances are high that you are already paying an insignificant amount of tax or none at all. Therefore, tax deductions won’t improve your situation by a significant margin. Plus, you may lose whatever you have when FTSs tank and end up in a financial catastrophe.

Who Should Consider Investing in Flow-through Shares?

Flow-through shares aren’t for everyone. We highly encourage the following types of investors to consider buying them:

• High-income individuals: If you frequently earn an enormous annual income, we urge you to consider investing in FTSs. They will put you in a better position to cut your taxable income and enjoy significant tax deductions.
• High-net-worth investors: If you are a high-net individual with sizable wealth, invest in flow-through taxes today. That is advisable since your financial situation allows you to tolerate high risk. And, if you invest a considerable amount of money and the company becomes a roaring success, you’ll rake in enormous returns from your investment.
• Investors interested in the resource sector: FTSs are ideal starter assets for investors looking to diversify their portfolios with instruments from the natural resource sector. You can get in on the ground floor of an early-stage company today and reap handsomely in the long run.
• Companies seeking tax relief: Are you running a corporation with substantial income? Investing in flow-through shares will enable you to enjoy reduced corporate tax liability. The higher your income, the more you get to enjoy tax relief and offset future profits.
• Resource sector gurus: If you have an extensive understanding of the natural resources sector, start investing in flow-through shares. Your knowledge base will enable you to make informed investments decisions and avoid crippling pitfalls.

Conclusion

FTSs are issued by small companies that may either attain enormous success or go down in flames. Before buying these products, make peace with the fact that you may incur significant losses if things don’t go your way. And if you are a green investor and have yet to gain experience, educate yourself before pouring money into any FTS. Our article has flow through shares explained in detail and many other aspects, but we haven’t covered everything. Please visit other reputable sources and learn more.