David,
Do you have any knowledge of and can you comment on the efficacy
of the capital gains tax minimization system promoted by Vanessa Stenner
on her "Your Money, Your Wealth" radio show?
When I heard the show the system was being actively promoted as a way
to substantially offset the capital gains on sale of rental property,
provided the investor took steps prior to the sale.
EXXXXXXXXXX
===========================
david ingram replies:
Vanessa's method is to sell flow -through shares. the flow through expenses
offset the capital gain and there is no tax.
However, it has nothing to do with Capital gains because the flow through
share expenses can be used to offset tax on RRSP withdrawals, wages,
interest, rents or any other form of taxable income.
I wrote a decent article on Flow Through Shares for Resource World Magazine
that I am reproducing here.
--------------------
Flow Through Shares
A flow through share is available to mining, petroleum and some renewable
energy companies to help finance exploration and project development
activities.
Eligible companies issue the shares to new investors who receive ownership
in the company and “flow through” income tax deductions from NEW
expenditures incurred by the companies on exploration and development.
Any company can issue a flow through share but they are of the most value to
junior companies that are not paying income tax and cannot or chose not to
use the deductions themselves.
By passing the exploration or development expenses on to “you” the investor,
you are encouraged to provide capital to fund that exploration and
development because you get to use the income tax refund immediately.
It used to be that all the exploration money had to be spent in the calendar
year. This created immense problems because people were looking for their
tax shelter at the end of the year and the company did not always have the
money to spend until the investors had paid up. However, that was changed
and the company now has until Dec 31st of the “next” year to make the
expenditure.
A June 6 2002 proposal by the PDAC (Prospectors and Developers Association
of Canada) to Finance Minister John Manley also makes sense. In this
suggestion, the PDAC made the point that the investor should be able to make
his or her investment up to the same day that we can make our RRSP
contributions, February 29th or March 1st of the following year (60 days
after Dec 31st). This has not come into effect yet but would be a welcome
addition to financial planning and would likely result in more money into
the system.
You, the investor should (have to) do your own due diligence to make sure
that the company you are investing in has not only a plan but will still
have the free cash to be “capable of making the expenditure” ON TIME. If
they can’t make the expenditure or make it late, and do not succeed, you
lose your tax refund and could also have no or little value for your
investment.
ADVANTAGES of BUYING A FLOW THROUGH SHARE
1. There is an immediate tax refund. When you do get your tax loss amount,
you get to use it right now. You can carry any excess back THREE years and
forward TEN years. Therefore, if you had a high income in 1999, and are
going to be low this year but have lots of cash, an investment in flow
through shares today, can be used to get back a chunk of the high tax
dollars you paid in 1999 or 2000.
2. A gain in value (you hit a gusher or a real gold mine) is treated as a
capital gain. i.e. If you bought it for $1,000 and wrote off the $1,000 the
Adjusted Cost Base is now zero. If you then sold it for $1,000, the $1,000
would be a capital gain and only $500.00 would be taxable. At a 50% tax
bracket (easier to calculate), you would have saved $500 in tax and only pay
$250 back and would have made a clear $250 profit on the tax break alone.
3. The share prices are linked to mineral or petroleum commodities and this
should result in a hedge against inflation.
4. Your investment is given the tax deduction or credit for a specific
exploration program but your shares own all aspects of the company.
DISADVANTAGES OF FLOW THROUGH SHARES
1. The stock prices of resource companies are highly volatile.
2. You are / could be dealing with a junior company with no taxable income
and no or little strength behind it. If they had strength or profits, the
company would not be giving up their deductions.
3. There will likely not be a specific prospectus issued and the flow
through shares will have to be sold in large blocks of $25,000 to $150,000
depending upon your provincial regulations.
4. Without the flow through deduction, you may find it hard or impossible to
sell the shares.
POSSIBLE SOLUTIONS TO THE ABOVE DISADVANTAGES
There are limited partnerships available like the NCE Flow-Through (2002-1)
Limited Partnership, which is raising $75,000,000 to invest in flow through
shares. This offering will go ahead with a minimum sale of $10,000,000. The
minimum subscription is 100 units at $25.00 for a total of $2,500.
An example of the diversification can be shown by the TOP 10 holdings of the
MRF 2001 Limited partnership. The 25.38 million is made up by 15.30% of
Ketch Energy Ltd, 13.60% of Canadian Superior Energy Inc, 12.70% of Compton
Petroleum Corp, 6.90% of Oiltec Resources Ltd, 6.70% of Olympia Energy Inc,
6.20% of Belair Energy Corp, 5% of Keywest Energy Corp, 4.1% of Crescent
Point Energy Ltd Cl A, 3.70% of Cougar Hydrocarbons Inc, and 3.10% River
Gold Mines Ltd.
SUPER FLOW THROUGH SHARES
FEDERAL 15% NON-REFUNDABLE INVESTMENT TAX CREDIT FOR EXPLORATION IN CANADA
(ITCE)
This program applies to mining companies only for above ground preliminary
mineral exploration. It does NOT apply to underground exploration or the
expenses to bring a mine into production. A slight disadvantage is that
because it is a direct refund of 15%, the amount must be deducted from your
CEE (Canadian Exploration Expense) Account. However, actual cash in your
pocket is always better than tax deduction of the same amount. To be
eligible, the expenditure must have been made AFTER Oct 17, 2000 and BEFORE
Jan 1, 2004.
Shares which qualify for both the flow through amount above AND the ITCE are
generally referred to as “SUPER FLOW THROUGH SHARES.”
A company could chose to issue ordinary flow through shares AND super flow
through shares at the same time. Their accounting will need to be extremely
accurate to document the relevant expenditures.
In addition to the Federal ITCE, Ontario, British Columbia, Quebec and the
Yukon have different rates of refundable and non-refundable tax credits with
different start and stop dates and different rates.
At the time of this writing (Aug 15, 2002), the following rates apply:
Yukon:
The Yukon Mineral Exploration Tax Credit (YMETC) is a refundable corporate
and personal income tax credit of 25% of eligible mineral exploration
expenditures incurred by eligible individuals and corporations conducting
off-mine site exploration in the Yukon between April 1, 2001 and March 31,
2003. For eligible mineral exploration expenditures incurred between April
1, 1999 and March 31, 2001, the YMETC was 22%.
QUEBEC Flow through Shares. There is a 125 or 175% deduction for qualifying
exploration expenses in Quebec. This was extended to Dec 31, 2003 on Sept
14, 2001. On Jan 1, 2004, the Quebec deduction is expected to be replaced
with a refundable tax credit.
ONTARIO has harmonized its system with the federal government by providing a
5% refundable tax credit.
BRITISH COLUMBIA has a 20% refundable Mining Exploration Tax Credit which
can be passed through to flow through share investors retroactive to Aug 1,
1998. If passed on, the amounts received will be taxable to the investor.
TAX CREDITS
REFUNDABLE TAX CREDIT
A refundable tax credit is actual cash. Even if you do not have a tax
liability, you get a tax refund.
NON-REFUNDABLE TAX CREDIT
A non-refundable tax credit is one that disappears if you have no tax
liability as it can only be used as a credit against tax owed.
The biggest and only disadvantage of the tax credits is that they must be
added in as taxable income for the year that you received them.
Tax Flow of the “cash”
For those who are interested in details, there is a wonderful
Pricewaterhouse Coopers spreadsheet showing the cash flows for all provinces
and territories. Could not have done it better myself. See it at:
http://www.pdac.ca/pdac/misc/super_flow_through_shares.pdf
david ingram for Resource World Magazine
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