Investors should exercise caution when Canadian resource companies in the mining, oil and gas industries seek to raise capital by offering Flow Through Shares (FTS). Typically, these companies have high upfront exploration costs and limited or no revenue, so they issue shares and allow tax deductions to “flow through” to investors as long as the companies qualify for the Canadian Exploration Expense (CEE). You can find more information about the CEE in the report “Guidelines for Determining the Tax Treatment of Certain Exploration Expenses“, which you can access by clicking the provided link.
CEE includes expenses incurred to determine the existence, location, extent or quality of a mineral resource of a mineral resource or petroleum or natural gas accumulation in Canada. Certain expenses incurred to bring these projects into production may also qualify as CEE. The definition of CEE also includes Canadian Renewable and Conservation Expenses (CRCE). It’s worth noting that the money raised through FTS may not be used for day-to-day activities, such as paying salaries.
To learn more about FTS and the CEE, visit the websites of the Prospectors and Developers Association of Canada (PDAC), Natural Resource Canada (NRC) and the Canada Revenue Agency (CRA).
Investors who participate in FTS offerings benefit from a lower Break-Even-Sell-Price than the price paid at the time of issuance because the tax deduction from exploration costs flows through to them. The Break-Even-Sell-Price varies by investor, depending on their tax bracket. For more information about FTS offerings, read the QIS Capital article “Flow-Through Shares Offerings Explained“, which explains the consequences for Canadian investors who want to participate in FTS offerings. However, investors should participate in FTS offerings only if they are willing to invest in the company regardless.
The table below, taken from the QIS Capital article, shows the real worth of shares to investors who participate in FTS offerings:
What Are Flow-Through Shares Really Worth? |
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|
Tax Bracket |
Break-Even-Point to FTS Price |
Example FTS Price |
Break-Even Sell Price |
|
50% |
66% |
C$ 0.50 |
C$ 0.33 |
|
40% |
75% |
C$ 0.50 |
C$ 0.38 |
|
30% |
81% |
C$ 0.50 |
C$ 0.41 |
|
20% |
89% |
C$ 0.50 |
C$ 0.45 |
Assume investors in FTS offerings are in the highest tax bracket of 50%. As FTS offerings often require a holding period, calculate the Break-Even-Sell-Price by multiplying the FTS price by 0.66. Be aware that the stock price may decline to the Break-Even-Sell-Price level shortly after the holding period expires. Moreover, the Break-Even-Sell-Price can be lower, varying by Canadian province.
