Amplify charitable giving with flow-through shares. Here's how they work

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What if I told you there is a way you could donate $100,000 to a charity at an after-tax cost of only $10,000, rather than the $50,000 after-tax cost of a cash donation? Would you consider a strategy that would offer you the opportunity to multiply the impact of your donations by 10 times?

This is exactly what happens when you use a flow-through share donation (FTSD) gifting arrangement.

Flow-through shares have been around since the 1970s. However, it is important to note that investing in flow-through shares is different from using an FTSD gifting arrangement. Investing in flow-through shares is a high-risk strategy, as it entails investing in junior mining, resource and renewable energy companies. However, the FTSD gifting arrangement eliminates this risk for the donors and charities by the way that it is structured, as neither the donors nor the charities will be holding on to the shares they purchase.

What is a flow-through share?

Certain corporations in the mining, oil and gas, renewable energy and energy conservation sectors may issue flow-through shares to help finance their exploration and project development activities. These must be newly issued shares that have the attributes generally attached to common shares.

Junior resource corporations often have difficulty raising capital to finance their exploration and development activities. In addition, many junior resource companies are in a non-taxable position and do not need to deduct their resource expenses. The flow-through share mechanism allows the issuer corporation to transfer the resource expenses to the investor.

Impact of the federal budget of 2022 on flow-through shares

The government of Canada’s Budget 2022 proposed to eliminate the flow-through share regime for activities in the fossil fuel sector. This will be done by no longer allowing expenditures related to oil, gas and coal exploration and development to be renounced to flow-through share investors for flow-through share agreements entered into after March 31, 2023.

While this will make offering flow-through shares by companies in these sectors no longer viable, there are plenty of opportunities still available in the mining and resource sectors as well as renewable energy sector. In order to qualify for renunciation in the renewable energy context, expenses must qualify as “Canadian renewable and conservation expenses” (CRCE). CRCE are certain expenses payable to an arm’s length person in respect of certain qualifying projects. Sectors that would qualify for CRCE include active solar heating equipment, hydroelectric installations and wind energy conversion systems.

Budget 2022 included a new Critical Mineral Exploration Tax Credit (CMETC), doubling the existing 15-per-cent Federal Investment Tax Credit for mineral exploration to 30 per cent, for those minerals critical to electrification and batteries. This has proven to be very positive, generating a significant increase in capital raised by way of flow-through shares for exploration for lithium, among other critical minerals. With the political and strategic importance of these minerals on the rise, this bodes well for continued robust exploration for these minerals in Canada.

Advantages for investors

Canada’s Income Tax Act allows issuers to agree that they will transfer or “renounce” their exploration expenses to individual investors. Companies that have revenue may not wish to do this, since they would want to apply those expenses against their income to reduce or eliminate their own tax liabilities. But junior exploration and mining companies, which usually have no significant revenue, won’t need those expenses because it is likely that their exploration expenses exceed their income and they won’t be paying any income tax.

It therefore makes sense for this type of company to renounce its resource expenses and pass them on to individual investors, who will happily apply them against their personal incomes. The higher the income tax bracket of the investor, the higher the tax benefits of investing in flow-through shares would be.

Investors can also benefit from investment tax credits for individuals (excluding trusts) on resource expenses in the mining sector that qualify as flow-through mining expenditures.

If you purchase flow-through shares of qualifying companies, you can deduct up to 100 per cent of the cost of the shares from your personal income. Flow-through shares, however, are deemed to have a cost base of zero. Therefore, if you purchased the share for $1 and sold it for $1, you would have a capital gain of $1. Due to the fact that you will have an income tax deduction of $1 as a result of the purchase of the flow-through share, and because only 50 per cent of capital gains are included in your taxable income, you would still have a net after-tax benefit from purchasing flow-through shares.

Flow-through share donation strategy

Major donors to Canadian charities have been using the FTSD gifting format to significantly reduce the after-tax cost of their charitable gifts while ensuring that the charities of their choice receive the full pledge amount immediately on closing, net of all fees and expenses.

The first structured FTSD gifting arrangement took place in 2007 and received Advanced Tax Rulings from Canada Revenue Agency (CRA) and Revenu Quebec. Since then, billions of dollars have been raised by natural resource companies using the arrangement, funding exploration and development while also enabling various Canadian charities to help donors achieve their philanthropic intentions at a fraction of the after-tax cost of a cash donation.

This strategy is available to accredited investors who intend to make major gifts to Canadian charities. Each gifting arrangement is registered as a tax shelter with the CRA and involves a series of simultaneous transactions. The investment banking arm of the FTSD provider first negotiates a bought deal financing with a natural resource company. Using this strategy, the issuer raises equity capital in the least dilutive manner possible, because the subscriber pays a premium to market price to access the tax benefits.

These transactions typically close within four weeks from announcement. In the meantime, the FTSD provider contacts charities, advisors and investors requesting participation in the deal. The donors who are interested in participating in the deal must have their documentation and financing in place before the deal closes. The donor subscribes to flow-through shares thus accessing the Canadian Exploration Expense (CEE) and associated federal and provincial investment tax credit benefits and can write off the entire purchase amount against income. The donor then immediately donates the shares to the charity of their choice.

Upon receipt of the shares, the charity immediately sells them to pre-arranged institutional investors and the donor receives a charitable donation tax receipt for the full value of the shares donated equal to the net intended gift plus the closing costs. All transaction costs are funded by the donor and paid by the charity, resulting in receipt of the intended gift amount in full.

It is important to note that in a FTSD format, the donation arrangement provider arranges for the sale to an institutional or strategic end buyer. Newly issued flow-through shares are subject to a 120-day trading restriction. However, because all parties to the sale in an FTSD arrangement are “accredited investors,” a securities law exemption permits a private sale, off the stock exchange, in which the 120-day trading restriction is assumed by the end buyer. The format enables the donor to also simultaneously sell some of the shares to the same end buyer that will purchase the shares from the charity at the same price that the shares are sold by the charity according to a deal pre-arranged by the FTSD provider. The donor and the charity receive the proceeds of sale of their shares simultaneously.

What is critically important is that you deal with a reputable FTSD provider who has undertaken extensive due diligence on the quality of the issuer, to obtain a comfort level that the funds will be properly deployed in accordance with the flow-through share rules, within the required time frame. Quality of management, familiarity with the flow-through regime, sufficient liquidity to fund overheads during the exploration program, and credibility of the exploration plan are all important diligence areas. Typically, the issuer must also provide a letter of indemnity obligating it to make all participants in the transaction “whole” on an after-tax basis, if it fails to spend the funds properly.

Benefits of the flow-through strategy

This strategy can multiply major gift donations. In all Canadian jurisdictions, a $100,000 gift will cost between $10,000 and $25,000 (10 per cent to 25 per cent) after tax depending on the province. In Ontario the net cost of a personal donation is about $9,950 for a donor in the highest marginal tax bracket, and is approximately $10,000 for a holding company.

This donation strategy can be as powerful for Canadian Controlled Private Corporations. Corporations have a notional account called the Capital Dividend Account (CDA). The non-taxable portion of capital gains can be credited to the CDA and flowed out of the company to the shareholder on a tax-free basis. As a result of income tax changes that were implemented in 2012, capital gains tax is payable on donation of flow-through shares to charities. This generates CDA creation of almost $2 per each $1 of donation, with the amount varying by province.

FTSD structures use tax incentives available to all Canadians, but the market risk normally associated with a flow-through share purchase is mitigated by arranging for the immediate sale of the shares, on date of issuance, to an end buyer, at an agreed price, negotiated at arm’s length by the FTSD provider. The Advance Tax Rulings by CRA and Revenu Quebec have also confirmed that this strategy works from a tax perspective, so long as the format set out in the rulings is strictly adhered to.

Currently there are few providers of the FTSD gifting arrangement in Canada, including PearTree Canada, Oberon Capital, Sprott Capital Partners, WCPD Group and Ber Tov Capital. It is important for you and your tax advisor to perform due diligence on the providers and ensure that their strategy complies with CRA Advance Tax Rulings and that proper risk management protocols are in place.

A properly structured FTSD gifting arrangement can not only benefit Canada’s economy and Northern and Aboriginal communities by increasing investments in mining, oil and gas, renewable energy and energy conservation industries, but can also benefit the charitable sector and help Canadian philanthropists multiply the impact of their donations while maintaining or reducing their after-tax cost of giving.

Tina Tehranchian, MA, CFP®, CLU®, CHFC®, CIM®, MFA-P(TM) (Philanthropy) is a FP Canada(TM) Fellow and a Senior Wealth Advisor at Assante Capital Management Ltd. in Richmond Hill, Ont. She can be reached at (905) 707-5220 or through her website at www.tinatehranchian.com. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. Before acting on any of the above, please make sure to see a professional advisor for individual financial advice based on your personal circumstances. The opinions expressed are those of the author and not necessarily those of Assante Capital Management Ltd. Insurance products and services are provided through Assante Estate and Insurance Services Inc.

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