The Tax Benefits of Flow-Through Shares
Flow-Through Shares (FTSs) are specific to the mining, oil and gas, renewable energy, and energy conservation sectors. FTSs are primarily used to help corporations raise funds for projects that require a significant amount of capital, and which will likely not return a profit for a long time.
What are Flow-Through Shares?
The basic premise of FTSs is that in order to issue them, the corporation must agree to renounce certain tax benefits. Investors then purchase FTSs at a higher price than normal shares, and in return, claim the tax benefits that the corporation has renounced. The increased price of FTSs is therefore mitigated by the tax benefits they provide investors. The corporation then benefits by using the monetary difference between FTSs and their normal shares to fund the overhead for upcoming projects.
What are the Tax Benefits of Flow-Through Shares, and How do they Work?
A corporation must be a principal-business corporation (PBC) to issue FTSs. The PBC then enters into a flow-through share agreement with the investor. All FTS agreements in Canada are regulated by the Canadian Revenue Agency (CRA) and can be subject to audit at any time. Once the agreement is formed, the PBC can renounce its expenses/tax benefits to the investor. Since FTSs are unique to the energy and resource sectors, only certain expenses/tax benefits can be renounced. These benefits include Canadian exploration expenses (CEEs) and Canadian development expenses (CDEs). It should be noted that some overhead expenses do not fall under CEE and CDE. For example, expenses such as administrative, management, or financing costs; equipment and materials not used exclusively for exploration and development; and employees whose duties extend beyond exploration and development activities do not qualify.
Although FTSs are regulated federally, some provinces also provide their own FTS income tax benefit. These provinces include British Columbia, Manitoba, Ontario, Saskatchewan, and Quebec. Investors may qualify for an additional investment tax credit (ITC). More information on ITCs can be found here.
How to Ensure you Receive the Tax Benefits of Flow-Through Shares
When entering into an FTS agreement, there are some important things to consider. First, the investor’s return on their investment is dependent on the corporation complying with its obligations under the FTS framework. This includes the corporation knowing which expenses qualify as FTS deductions and upholding their reporting obligations. Additionally, the investor should ensure the corporation is a PBC and the FTS agreement is registered. The CRA will not allow the investor to claim the FTS or ITC tax benefits if the FTS agreement is not registered with the CRA. A summary of the relevant FTS forms can be found here. FTSs also tend to have a designated minimum amount of time before they can be traded. For this reason, they are rarely used as a short-term investment. Investors should keep this in mind while weighing different investment options. Overall, investors should ensure they are entering into an FTS agreement with a trusted corporation that thoroughly understands its FTS obligations.
If you own flow-through shares, or are considering purchasing them, and want to know more about the tax benefits of these flow-through shares, contact us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.