FP Answers: Should I follow my broker’s advice and invest in flow-through shares

Article content

By Julie Cazzin and Allan Norman

Article content

Q: I made about $300,000 last year and expect to earn more this year. I maximize my contributions to my registered retirement savings plan (RRSP) every year, but I’m still paying a lot of tax. My broker says I should invest in flow-through shares, but they seem risky to me. Do you think I should invest in flow-through shares? — Scott in Brockville, Ont.

FP Answers: Scott, you may be the perfect candidate for flow-through shares because of the tax benefits they bring. They are generally only available to accredited investors, meaning someone with a minimum annual income of $150,000 or a minimum investment portfolio of $1 million.

Your broker is likely suggesting flow-through shares because you’ll get a tax deduction for the full amount you invest, plus a federal and possible provincial tax credit you can use to reduce your taxes. The total amount when you eventually sell your flow-through shares will be taxed as a capital gain. 

Article content

But you are right to be concerned about the investment risk. In most cases, flow-through shares are issued by junior mining companies. Indeed, only Canadian companies engaged in the exploration of natural resources or renewable energy can issue flow-through shares.

In addition to the investment risk, the fees are high, which will cut into your overall gains. You’re also often locked in for 18 to 24 months, and you don’t always know what you are buying when you make the purchase.

Some investors deal with the investment risk by purchasing flow-through shares each and every year. The expectation is that they will purchase more winners than losers over time. 

Another strategy to eliminate the investment risk is to sell your shares almost right away and capitalize only on the tax benefits. There are flow-through providers that will facilitate this for you.

Article content

These providers will present you with an offer before you make a purchase. In the offer, you will see the purchase and selling price of the shares, the associated fees and your estimated return upon completion of the transaction. Then you decide what you want to do. This approach significantly reduces the risk normally associated with flow-through shares.

You may be wondering who (the liquidator) would purchase your flow-through shares? Well, a liquidator is going to offer you less than what you paid for the shares, which means an immediate loss for you on your shares, but the tax benefits will remain with you, and they will overcome the stock loss. 

Article content

The liquidator may also be able to purchase the shares from you for less than what the common shares are currently trading for on the market. This allows them to maintain or grow their ownership concentration in the company.

Scott, there’s more to flow-through shares than what I have shared here, but this should be enough for you to get the sense of whether you should continue to investigate them or not.

Just one other note. A flow-through share is a common share (a stock), but you can’t buy and sell them like stocks. You will have to find a flow-through share provider, which is easy enough to do with a quick Google search.

Allan Norman, M.Sc., CFP, CIM, RWM, is both a fee-only financial planner with Atlantis Financial Inc. and a fully licensed investment adviser with Aligned Capital Partners Inc. He can be reached at www.atlantisfinancial.ca or alnorman@atlantisfinancial.ca. This commentary is provided as a general source of information and is intended for Canadian residents only.

_____________________________________________________________

 For more stories like this one, sign up for the FP Investor newsletter.

_____________________________________________________________