A guide to how flow-through fund limited partnerships can mightily aid your tax planning!
The end of the year will raise concerns among many professionals, self-employed persons, business owners and even regular wage earners about the amount of tax they will owe the Canadian Revenue Agency (CRA).
Tax demands can come as a nasty shock and place the unfortunate recipient in a quandary. What assets can be sold, income diverted or spending deferred are the questions that typically come to mind when a tax bill comes due.
Help is at hand with the flow-through fund limited partnership, one of the few tax shelters still available in Canada and one that will not only give investors a deduction against their taxes, but will potentially qualify for a British Columbia provincial tax credit. Oh yes, and they can also feel good about helping the Canadian economy. How come? And what’s the reason behind this official largesse?
In 1986, the Canadian government decided to encourage investment into small and medium oil & gas and mining companies by allowing them to transfer expenses (Canadian Exploration Expenses) directly related to exploration to investors. The government did this by instituting the Flow-Through Tax Credit under the Income Tax Act which allowed these companies to “flow through” these costs to investors via the purchase of flow-through shares. Broadly, this allowed for exploration and pre-production expenses to be generally 100-percent tax deductible against any source of income in the year the investment is made. Sounds great, eh?
A flow-through partnership is a professionally managed portfolio of junior resource stocks that exists for a defined period of time, usually one to three years. At the end of that period, a “disposition” must occur in which the shares are sold or rolled over into another security, usually a mutual fund. On disposition, proceeds would be treated as a capital gain.
The flow-through concept has been enormously successful in raising money for resource exploration. According to the Department of Finance, approximately $1.4 billion per year was raised by flow-through shares from 2007 to 2012 alone.
You’re probably wondering by now how a potential investor can take advantage of this uniquely Canadian tax innovation to their best advantage. Well, below is a hypothetical example of a flow-through share fund, assuming the top tax bracket of 43.7 percent for a B.C. investor. For the sake of simplicity, the fund is also assumed to be invested entirely in B.C. resource companies, though in actual fact a fund manager is more likely to spread risk across the country.
Investment amount $1,000
Combined Fed & Prov Tax rebate (43.7 tax rate) $ 437
Federal Tax Credit $ 120
B.C Tax Credit $ 200 +
Total tax savings $757
Less income tax on inclusion of federal & provincial income tax $139 –
$618
So, an investment of $1,000 garnered a cash return from tax savings of $618; however, an investor can still make a profit even if the fund is redeemed at a lower value than $1,000.
“What?” I hear you saying. “I lost money on the fund but can still realize a gain? How so??”
Let’s assume the fund is redeemed at a modest 60 percent of the investment value, bearing in mind the proceeds are fully taxable as a capital gain.
Now let’s do the math!
Proceeds of the sale $600
Less capital gains at 43.7% tax bracket $109 –
Net proceeds $491
In the end, money can be made since the investment also garnered some handsome tax savings, making the total return to the investor of:
Tax savings $ 618
Net proceeds $ 491 +
$1,109
Therefore, the final cash benefit to the investor is $1,109 on an investment of $1,000. Certainly better than handing the same grand to the tax man and the investor’s money would be locked up for a little less than one year.
As you can see from the previous example, if the fund was redeemed for anything more than 60 percent, the investor would begin to realize a profit.
Who can benefit from investing in a Flow-Through Fund? Just about anyone. It includes individuals and corporations interested in reducing or deferring taxes; individuals wanting to reduce Old Age Security claw backs; or recipients of lump-sum payments.
Interested? Then you’d better hurry. The last date to invest in this last, great Canadian tax shelter to achieve tax savings for earnings in 2014 is December 15th.
This article is for information purposes only and does not constitute an offer to sell or a solicitation to buy the securities referred to herein. The information contained in this article is not intended to provide any tax, legal, or financial advice. We recommend that you consult an investment professional before investing in this or any investment product. Please consider a fund's objectives, risks, and charges and expenses, and read the Offering Memorandum carefully before investing.
Chuck Duerden is a dealing representative for Pangaea Asset Management in Kelowna. He may be reached at 250.575.3798 or at [email protected]. Follow Chuck as Charles Duerden on Facebook and LinkedIn.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.