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Flow-Through Shares in Canada

Release date : 2020/07/05

Executive Summary

  • Flow-through shares are a financing tool available to a Canadian resource company that allows it to issue new equity (shares) to investors at a higher price than it would receive for “normal” shares, thereby assisting it in raising money for exploration and development.
  • Investors are willing to pay more for flow-through shares, because the investors are permitted to claim deductions for the issuing corporation’s CEE (and in some cases CDE). This reduces the investor’s Canadian taxes.
  • Essentially, the investors and the corporation agree that the investors will purchase flow-through shares from the corporation, the corporation will incur certain expenditures on CEE within a certain time period, and the corporation will renounce that CEE in favour of the investors. CEE renounced by the corporation cannot be deducted by it.
  • In the mining business, it is quite common for mining companies (especially smaller ones) to have no net income for tax purposes. Since generally expenditures on exploration and development can only reduce taxes owing down to zero, such mining companies may find themselves with deductions for tax purposes that they will not be in a position to use for many years (if ever) because they are not generating enough income. Companies in such circumstances may also need to raise financing in order to fund ongoing operations. Flow-through shares (“FTS”) can provide mining companies with reduced-cost access to financing in this situation.The basic principle behind flow-through shares, which are unique to the resource sector in Canada, is that a mining corporation willing to forego the tax benefit of certain CEE and CDE amounts that it incurs can “renounce” these expenditures to investors buying shares in the corporation in certain circumstances. The investors purchasing the FTS from the corporation are permitted to deduct the amount of CEE or CDE the corporation has incurred and renounced to them: in effect, they are treated as if they had incurred the CEE or CDE, instead of the corporation. The corporation benefits because it can issue the shares to the shareholders for a higher price than they would otherwise be willing to pay, due to the tax benefit associated with being able to deduct the CEE or CDE. The investors benefit by being able to reduce their incomes for tax purposes (and pay less income tax) by virtue of claiming deductions for the renounced CEE and CDE. While the corporation loses the ability to deduct the CEE or CDE renounced to the FTS investors, the net present value of those deductions may be quite small if the corporation is unlikely to have enough taxable income to utilize these deductions in the near future. In this way, FTS represent one of very few ways in which one taxpayer is permitted to monetize or sell the benefit of its tax deductions in favour of an arm’s-length person.
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