## Flow Through Shares, article courtesy of Marilyn Kerfoot

### Flow Through Shares: A Basic Summary

by Marilyn Kerfoot

Ever since the federal government eliminated the tax on capital gains for gifts of public securities, the financial media have touted the advantage of using flow through shares to make charitable gifts.

Although some flow through share gifts have been completed, I have yet to see anyone from a charity write about the experience.

This article is intended to give you easy to understand information on gifts of flow through shares so that you can decide whether they are suitable for your charity.

#### What are Flow Through Shares?

Flow through shares are a special class of public securities issued by Canadian mining and oil and gas companies. They were introduced by the federal government in the early 1990s to encourage exploration and development in Canada's resource sector. In exchange for receiving flow through shares in a company, an investor provides funds to pay for the company's exploration and development expenses.

The tax benefits related to these corporate expenses are flowed through to the investors/shareholders. This is where the term "flow through" comes from.

An investor can deduct up to 100% of the flow through shares' purchase price against income for the year in which the shares were purchased.

This results in a significant tax saving for the investor.

Some flow through shares qualify for an additional tax credit from the federal government and some (but not all) provinces. These are referred to as "super flow through shares" because they increase the investor?s tax benefit even more.

After a hold period of at least several months (and possibly up to one year or more), an investor can exchange the flow through shares for "normal" shares of the company on a tax deferred basis.

However, as a result of the deduction taken in the year of purchase, the adjusted cost base of these shares is typically zero. Thus, when the "normal" shares are sold, the sale creates a capital gain equal to the market value of the shares, and 50% of that gain is taxable.

#### The Charitable Gift Component

If the investor gives the "normal" shares to charity rather than selling them, no capital gains are taxed.

(Remember: The May 2006 federal budget eliminated the tax on capital gains for public securities that are gifted in-kind to charities.)

This means that the cost of making the charitable gift is very low because the tax savings to the investor/donor have essentially been doubled.

The investor gets a tax deduction when purchasing the flow through shares andreceives a tax credit when the "normal" shares are subsequently gifted to a charity.

Consider the following example in which the investor is taxed at the highest marginal rate (assume 45%), and the fair market value of the shares neither rises nor falls between the time the investor purchases the shares and then gives them to charity.

 A Value of shares when purchased $100,000 B Tax deduction in year of purchase$100,000 C Tax savings in year of purchase $45,000 D Value of shares when gifted$100,000 E Capital gain realized on gift $0 F Value of tax credit on gift$ 45,000 H Total tax savings to investor (C + F) $90,000 I Total cost of gift to investor (D ? H)$ 10,000

#### Donor Profile for Flow Through Shares

Flow through shares are not for everyone.

The typical donor will be wealthy, have access to sophisticated tax advice, and have a high risk tolerance when it comes to investing.

Although the resource sector has provided positive investment returns over the past few years, flow through shares are a relatively high risk investment.

Only those individuals with a high marginal tax rate, business savvy, and a taste for more creative investments will be drawn to flow through shares.

#### Considerations for Charities Receiving Flow Through Shares

Flow through shares are very different from other public securities. A charity needs to know what it is getting into before agreeing to accept them as gifts. Here are a few considerations to keep in mind.

• Make sure that you and your donor are dealing with a financial firm that has experience with both flow through shares generally and making gifts of those shares to charity. Some firms provide turn key programs with established processes that help make the donor's initial investment and subsequent gift to charity go more smoothly.
• Be very cautious if a donor asks you to accept a gift within the hold period. During this phase, the shares are not liquid. This creates two problems for the charity: (1) It is difficult, if not impossible, to arrive at a fair market valuation of an illiquid asset. If you can't arrive at a proper value you aren't allowed to issue a tax receipt. (2) Illiquid assets are of little value to a charity. Your charity needs to be able to sell the shares to realize any real benefit from the gift.
• Find out how long it will take to sell the shares after they have been gifted to your charity. It may take longer than usual to sell these shares (10 to 20 days or more).
• Remember: the value of the shares might drop pending sale which means your charity could be issuing a tax receipt for a value that is greater than the sale proceeds it receives. Make sure your charitys disbursement quota can absorb any difference between the tax receipt value and the value of the sale proceeds.
• Insist that your donor get independent tax advice. Flow through shares are complex investments that are not suitable for everyone. Stay away from providing any advice, including making comments on the quality of the firm promoting the flow through share "product". Each donor needs to take responsibility for carrying out his/her own due diligence.

The above article is provided courtesy of Marilyn Kerfoot.

Last modified: Tuesday, 13 November 2018, 2:48 PM