Use of flow-through shares for giving can benefit all, but watch the pitfalls

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When it comes to philanthropy, high- and ultra-high-net-worth donors might wonder whether they should go with the flow.

Flow-through shares are often used in charitable giving programs. But experts say it’s important for donors, their family offices and advisors to understand how they work, and their pros and cons.

“Several organizations in Canada market flow-through shares as a giving tool,” says Shane Onufrechuk, Vancouver-based tax partner for KPMG in Canada. They offer advantages, but there may also be risks and costs, he says.

Flow-throughs are shares issued by resource exploration companies that allow the initial buyer of the shares to claim a tax deduction equal to the amount they invested.

This enables companies that issued the shares to raise the capital they need for resource exploration and development. In many cases these companies are not profitable yet and therefore are not paying taxes, so they don’t need the deduction, while the share buyer can benefit from the tax break.

“Donors get the deduction and give the shares to a charity, which then sells them on the open market and gives the donor a charitable donation receipt. The charity then has the money from the sale to use for their good causes,” Onufrechuk explains.

WCPD Foundation is one of the organizations that offers a philanthropic flow-through program for investors in Canada. Programs like the one it operates “can typically triple donations, and triple your impact, at no additional cost [to the donor],” the foundation says.

“We have facilitated significantly more flow-through transactions than any firm in Canada and assisted in over $175 million in donations to charities across the country,” the foundation adds.

One point of contact

PearTree Financial, which also runs philanthropic flow-through programs, says that donors who use this type of giving “can achieve an after-tax cost of giving of less than 20 per cent, often less than a personal donation, when you give through your holding or operating company.”

Another firm, Oberon Capital Corp., says that, with the benefit of the tax breaks, “in all Canadian jurisdictions, a $100,000 gift will cost [the donor] between $5,000 and $15,000 (5 per cent to 15 per cent) after-tax. Thus, for the same after-tax cost of a traditional cash gift, donors may increase their gifts by over 200 per cent.”

These types of shares are notorious for being high-risk, which is why they have the tax advantages in the first place.

Darren Coleman, Coleman Wealth

Flow-through program providers also say they offer donors the advantages of having one point of contact with professionals who can identify good exploration resource companies to invest in, as well as the ability to disburse funds to charities though a donor-advised fund (DAF) — a fund to which the donors dedicate their giving automatically.

A DAF “offers seamless disbursements to your confirmed charity,” which simplifies the giving process, according to Sprott Inc., another firm that provides flow-through philanthropic services.

Risks posed by the investments

While investors who seek to organize their giving through flow-through shares and programs might understand the tax advantages to this kind of philanthropy, they still should be aware of the risks posed by the investments themselves, says Darren Coleman, senior vice president and portfolio manager at Coleman Wealth, a division of Raymond James Ltd. in Toronto.

“It’s one thing to buy these shares for the tax incentives, but you also have to look at the underlying quality of the investment. These types of shares are notorious for being high-risk, which is why they have the tax advantages in the first place,” Coleman says.

While it’s unlikely that a recipient charity or foundation will hold on to the flow-through shares they receive for long, the share price could go down quickly, leaving the charity with less.

One way to mitigate the potential for big losses in resource exploration companies is to look for those in resource areas where demand is rising.

“For example, with renewable energy becoming more important, the need for finding resources that go into batteries is also growing,” Coleman says. Depending on the details, it may make sense to look at flow-through shares exploring for these kinds of materials rather than those exploring for more traditional resources such as oil or coal.

“In any case, the candidate who would be interested in flow-through shares would be someone who has really high taxable income, at the top marginal rates,” Coleman adds. Even with the tax deduction benefits, “they should have a high risk tolerance and recognize that flow-through shares are high-risk investments.”

Everything happens quickly

Onufrechuk agrees that these resource-based shares can be risky, but adds that the risk can be mitigated because typically donated flow-through shares are bought by the donor, donated and then sold by the charity over a short time.

Nevertheless, even in that short time, there’s potential for a high-risk share to tank. “You should understand and be sure of what you’re buying and donating,” he adds.

“Another issue to be aware of is that the rules for doing these donations properly can be complicated,” Onufrechuk says.

“You want to work with a sophisticated tax advisor who can look at the program carefully,” he says.

Firms that specialize in flow-through donation programs will likely have good, detailed information about the options they offer and how they work. “But these companies can take healthy fees. Donors should be aware that this is money that would otherwise be going to philanthropy,” Onufrechuk adds.

Ultimately, while a flow-through share philanthropy program can be beneficial for high-net-worth investors, he says, “you should also make sure the program is looked at carefully by your family office and the advisors your family office uses.”