Flow-through shares: an overlooked tax tool for high earners

How to deduct 100% or more of your invested capital from your taxable income — and why it is especially relevant at year-end.

How do flow-through shares work?

Flow-through shares are a mechanism unique to the Canadian tax system. Companies in the resource sectors — mineral exploration, oil and gas, certain renewable energies — issue shares and “flow through” to the investor exploration or development expenses they agree to renounce. The investor can then deduct those expenses from their own taxable income, generally up to the amount of capital invested, and sometimes more when federal or provincial tax credits are added.

That is what explains their popularity at year-end: the deduction applies to the relevant tax year, right when many taxpayers are looking for ways to soften a large tax bill.

Who might this suit?

This is a tool generally reserved for high-income taxpayers facing a high marginal rate: the higher your tax rate, the more meaningful the deduction can be. Typical candidates include professionals, business owners who pay themselves substantial compensation, or individuals with an exceptional income year.

The investment still has to fit within a coherent plan: a high risk tolerance, a flexible time horizon and an already well-diversified portfolio are prerequisites. Where appropriate, flow-through shares should represent only a limited slice of a portfolio.

Very real risks

Let’s be clear: the tax advantage does not make the investment risk-free, and it is never a guaranteed tax saving. Before investing, you should understand in particular:

• the speculative nature of the resource sector — many exploration companies have neither revenue nor production;
• the volatility of these securities, whose value can fall enough to wipe out the tax benefit obtained;
• limited liquidity: hold periods to respect and a sometimes thin market at resale;
• distinct tax treatment on exit, since the adjusted cost base is deemed to be nil, which usually triggers a taxable capital gain on sale.

The overall outcome therefore depends on the deduction obtained, the performance of the shares and your tax situation — three elements that vary from one person to the next.

A strategy that calls for careful guidance

As with any tax strategy, every situation is unique: your income, your other deductions and your goals all influence whether this tool is relevant. A joint review with your tax specialist and your wealth management advisor will help determine whether flow-through shares belong in your plan — and in what proportion.

Would you like to explore the question before year-end? The Pérennité Wealth Management team can discuss it with you, for information purposes and based on your profile. Contact us to talk it over.