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Flow Through Shares and what the pros and cons of them are with an example of youngandthrifty's experience with flow through shares.

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!  To be honest, after spending hours of research on how to use flow-through shares to invest, I came to the conclusion that the average Canadian investor is way better sticking to something simple like a robo advisor, or a discount brokerage like Questrade, where they can invest in a basic couch potato portfolio of vanilla index ETFs.  If you are fortunate enough to have maxed out both your TFSA and RRSP, then you might consider flow through shares simply because the tax advantages would then start to become a little more pertinent.

So your big question might be, “What the heck are flow through shares? How do they “flow through”? … and 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 $1,230 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!).  I’ve had much better results using basic index funds and recently switching over to a “hands off” index investing service called Wealthsimple.

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?

Article comments

29 comments
John Monroe says:

This article does not talk about flow through shares but flow through share mutual funds. The funds come with a high fee, usually over 10%, but invest in a portfolio of flow through shares so are less risky.
You usually need to be an accredited investor to invest directly in flow through shares, but the minimum hold period is usually only 4 months. Riskier, but a higher expected return since you don’t pay the mutual fund fees and can sell sooner.

Savvy Investor says:

Flow-throughs have great returns on average but you must do them every year to get that average. I use short duration flow-throughs that are generally 10-12 months and roll over into a mutual fund trust that is far more tax favourable. This flow-through has averaged 18.59% since 2004. Remember this is the average. Some years could have an 8% loss and other years a 40% gain. I max out my RRSP contribution room every year so I turn to flow-throughs that don’t have a limit. I can write off any capital losses in my flow-through (Not in RRSP) I am taxed far more favorably in the flow-through compared to the RRSP. I don’t have to worry about clawbacks with flow-throughs as I do with RRSP’s. Would you rather have 1 million in accumulated RRSP or the same amount the mutual fund trust from the flow-through roll over. I believe too many investors focus on what they earn and not what they. More money in my jeans at the end of the day only makes good investment sense. Be a savvy investor and look at the bottom line. Someone mentioned Exchange Traded Funds and robo advisors. CAUTION is all I will say. Not all ETFs are created equal. Many use leverage which will accelerate losses in a market downturn. Happy investing all!!

david says:

Okay, I am answering my own question for the benefit of others. The ACB is NOT zero when you sell. The ACB starts at zero (or close if not all the CEE is used). It then increases if the portfolio manager sells and passes on the capital gains, dividends, and interest to the partner (you). The fund company publishes the ACB at rollover. See http://qwestfunds.com/pdf/flow_through_educational_pdfs/ft_taxation_cycle.pdf

david says:

If the flow through share manager sold shares in the partnership and passed the capital gains to the partner (as indicated on the T5013 box 151), does the ACB get adjusted? If not, doesn’t this result in double taxation?

David says:

Really wish you didn’t need an expert tax accountant for these come time to cash them out. Supposedly, the ACB is nil correct? Well, what if the FT partnership sells shares and passes the capital gain onto you (box 151 of T5013)? Does the ACB increase to account for the fact that you paid the tax on the capital gain?

jcw says:

I wonder if this would work. Buy certain FTS, say at the premium of 25% Claim your tax credit and immediately short the same number of shares in the market. After one or two years, use your FTS to cover your short position by placing the FTS into the account with shorted shared. If those positions cannot be in the place into the same account to cancel out one another, buy the shorted shares back and sell the FTS at the same time. Will this strategy work?

Kyle says:

Gotta be honest jcw, you’re in over my head at this point. Best to contact the CRA on that one.

Rickerbucks says:

I myself do $10,000 every year and roll them over as they “mature” every two years. I have a few good years and I have a few bad years but overall, when rolling over and “topping up” to $10,000 every year seems to get me a LOT of tax breaks. Affectively I am almost using the same capital repeatedly to get the tax break. Note: I do have to declare capital gains when I sell so I have to watch out about managing my losses on other investments as well

Subrata Debnath says:

Just trying to understand how the net amount of $1930 was arrived at. If I understand correctly, it should be $1530 (current value of $1800 minus $270 being 50% of the tax at the same rate). Would appreciate if someone can explain what I am missing.

Thanks !

Kyle says:

Hey Subrata, “Young” doesn’t usually comment on articles any longer and I’m not as familar with the situation. Send us a comment on the comment form and we’ll forward it on.

Mikey says:

After tax ROI on flow through shares is approx 22%, which leaves a great deal of latitude for loss of your original input. The mistake is thinking of it as an investment (which it’s not) instead of a tax shelter (which it is) Yes, there are bad years, but there are also bad companies – a google search on “flow through shares Canada” will bring up discussions on which are which. My 10k last year is deflated by 60%, but I’m still clearing 1500 profit after taxes etc. Personally I’m doing 15k this year. Those people I know who do flow through do them every year. Ultimately depends on your risk comfort I suppose.

Only beneficial to those making more than 55k a year though.

Of note, If you borrow money for the share, the interest on that loan is tax deductible (I use my LOC)

Narayan Rathi says:

Can u please explain me why have we divided 10000$ with 2 in the example when we are selling the shares we invested in .

Martin says:

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!

Dwight says:

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. .

Dwight says:

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.

young says:

@Dwight- Thanks! I noticed that in the new Conservative Party platform too. They stopped that loophole.

Jake says:

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)!

young says:

@Jake- Thanks for mentioning that aspect of Flow Through shares. That’s another strategy to minimize the taxes you pay. 🙂

Jeffery Cloyd says:

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.

the cynical investor says:

This is company if anyone wonders

WCSB Royalty Income Investments

the cynical investor says:

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 🙂

young says:

@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

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.

young says:

@DividendLover- Yeah, They are certainly risky. I should have had a second thought when she classified the my risk profile as 100% risk. =(

SavingMentor says:

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.

young says:

@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. =)

Robert says:

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).

young says:

@Robert- Thanks for your input. Glad to hear that you have been successful holding flow through shares!

I like your post about FLOW THROUGH SHARES PROS.