I know it’s early to be talking about Canadian tax saving strategies, but I thought I would talk about my experience with flow through shares since it doesn’t seem like there’s much information out there on this topic.
Besides, it’s never too early to be talking about taxes!
So your big question might be, “what the heck are flow through shares? How do they “flow through”? Who gave them that name anyways?”
I can’t answer who came up with the name Flow Through shares, but I’ll try and answer the former two questions.
Flow Through Shares
- Basically an investment that has intense tax advantages (which means you get a big refund come tax refund time)
- Primarily involves investments in the Oil and Gas Industry, the Mining Industry, and the Wind Power Industry
- The investment is 100% tax deductible against your income
- After a certain period (usually 1-2 years) your shares will roll over into a mutual fund which you can sell at any time
- It turns fully taxable income into future tax advantaged capital gains
- You have to look at the Marginal Tax Bracket you’re in to see how much money you will get back come refund time
- The higher your pay (the more taxes you pay), the more you’ll get out of this
Here’s how it works:
Let’s pretend you bought $10K worth of flow through shares. Let’s pretend you make the big bucks, and your Marginal Tax Bracket is 43.7%.
When you get your tax refund- if you work as an employee, you will get $4370 back, meaning you will have tax savings of $4370.
This works by multiplying $10,000 x 43.7%= $4370.
(It’s just like an RRSP- whatever you contribute, you get a tax savings of your marginal tax bracket)
However, there’s a catch.
When you sell your flow through shares- let’s assume for simplicity’s sake that you neither make nor lose money on the $10,000 you invested, the adjusted cost base is $0- so the capital gain is considered $10,000.
So that tax you would have to pay when you sell is:
$10,000/2=$5000x 43.7%=$2185.
So you got $4370 back from the government, but when you sell, you have to pay a capital gains tax of $2185. Therefore, the net income advantage is $2185.
Again, since I haven’t done a PROS and CONS list in a long time, I’ll do one now:
PROS:
- It’s a nice tax shelter from the government (as we know, there are few tax shelters!)
- If you’re in a high tax bracket, it’s one way to not have to be gauged in paying taxes
- You help stimulate the Canadian economy, eh?
CONS:
- When you sell, the adjusted cost base is $0, so whatever you have is considered a capital gain
- They can be super risky
- They are often sold at a premium
- It would be supportive of the oil and gas industry, mining.. I guess that’s what Canada is all about, but if you have issues with it in terms of the environmental consequences of supporting exploration companies, then it might not be for you
- Doing the taxes for flow through shares is complicated. You’ll probably need to get an accountant involved (which might incur extra costs)
My own experience:
Check out my post on my “other” investments. As you know, initially in my personal finance journey, I was tax savings hungry and all I cared about was getting nice fat tax refund. One shouldn’t just jump into an investment for the tax refund (as I have now learned, lol). I had bought $5000 worth of flow through shares in 2005. I received approximately $1500 in a tax refund which I later reinvested into something else. However, the current value of my flow through shares is $1800 (note that I had invested $3500 initially). So if I were to sell it (which I plan to do soon), I would have to pay about $270 in capital gains tax. So I had actually received $1230 in a tax refund, were I to sell it at its current pricing. So I am down a net of $1930.
So as you can see, flow through shares have not been good to me (hey that rhymed!).
Tips on buying flow through shares:
- It is recommended that Flow Through shares are not to exceed 5-10% of your portfolio since they’re so risky
- They can be bought buy your local financial adviser (mine kind of pushed them on me)
- They are usually sold at certain times of the year (“offerings”) and are often sold at a premium
- Try and time your flow through shares purchase well
- Make sure you understand that your money won’t be accessible for at least a year or two- so don’t buy it if you’re planning to save up for a large purchase
- Don’t be like me and just get it for the tax advantages (though very tempting, I know)
I hope that helps clarify the confusion! Any readers out there have flow through shares in their portfolio?
I like your post about FLOW THROUGH SHARES PROS.
I’ve owned flow-through shares in 2007, 2008 and 2009. It’s more important than ever to understand what you own. Small-cap energy and mining companies are very volatile, and flow through shares performed very poorly in 2006 and 2007. Since 2008, they’ve performed much better, and I’ve actually made some good money.
Having said that, I’m not sure you couldn’t do better by buying a small cap energy and materials fund. Also, if you’re getting big tax deductions, watch out for alternative minimum tax (AMT).
@Robert- Thanks for your input. Glad to hear that you have been successful holding flow through shares!
Wow, you managed to scare me and intrigue me all at the same time right there!
I’ll think I’ll stick to my ETF index investing strategy for now, but it’s definitely good to know of another tax sheltered investing strategy that is out there. This is the first I had heard of it.
@SavingMentor- lol sorry! Yeah, I personally am going to stay away from flow throughs for a while. Maybe until I get into the top tax bracket and I don’t have any write offs or something. =)
I know enough about flow through shares to stay away from them.
This instrument is so risky the government is willing to let you write off your entire investment.
@DividendLover- Yeah, They are certainly risky. I should have had a second thought when she classified the my risk profile as 100% risk. =(
Invested in fts $5000 in an oil and gas company in 2009. Let’s see how this one will end up, bad I suppose as most of my investments
@the cynical investor- Well, at least you got some money back this year =) Things will still be rosy in 2010 because you probably got a beautiful tax refund. Then you just have to wait another year and cross your fingers. =P
This is company if anyone wonders
WCSB Royalty Income Investments
I’m not sure if supporting the Canadian mining industry is a con. Energy must come from somewhere, and it’s better to get it from nearby democracies. I think that anything which encourages exploraration and drives down prices helps the overall world economy. Flow through shares definitely do this; though since they focus on exploration the biggest effects won’t go online for a number of years.
There’s a big reason that people buy flow-through shares that wasn’t addressed here: charitable donations. Once you write off the donation, you are basically giving a charity a donation that you’ve only payed approximately 10% for (assuming you’re in the highest bracket)!
@Jake- Thanks for mentioning that aspect of Flow Through shares. That’s another strategy to minimize the taxes you pay.
[...] that are losing money big time. In order to receive a tax credit, I got persuaded into buying some flow through shares, Venture investments that gave out a tax credit, and some more mutual funds about four or five [...]
Be careful with the strategy of donating the Flow Through Shares. The last budget presented by the Conservative party before the election reduced the benefit of donating flow through shares. It is likely to be part of the new budget and may be retroactive to when it was first presented.
@Dwight- Thanks! I noticed that in the new Conservative Party platform too. They stopped that loophole.
Where do you get the factor of 2 to divide your 10000 and get 5000 in order to calculate the tax one pays when they sells the flow through shares:
“So that tax you would have to pay when you sell is:
$10,000/2=$5000x 43.7%=$2185.”
Can somebody get back to me on this? Thanks!
As mentioned in the article, you must pay capital gains tax on the full value of the investment when you redeem the shares. As capital gains tax is half that of regular income, the gain is divided by 2 then multiplied by your marginal tax rate. .