Canadians who invest in flow-through shares and have an interest in charitable giving can reap multiple tax benefits by combining these two activities. They can support their favourite charities at a minimal after-tax cost — a good thing for both donors and receivers.

“Many clients have more assets and income than they can reasonably use, and are looking to build philanthropy into their wealth planning,” says John Horwood, first vice president and investment advisor at Richardson Partners Financial Ltd. in Toronto. “Giving while living is something that many people enjoy, and when clients see how their actual out-of-pocket expenses can be reduced by legitimate tax strategies, they realize they can afford to be generous.”

The advantages of donating flow-through shares to charity, as an “in-kind” donation in lieu of cash, expanded dramatically with last May’s federal budget measures. The budget enriched the tax benefits of donating qualified publicly traded securities, such as shares and mutual fund units, to registered charities other than private foundations by eliminating any capital gains taxes on the appreciation of donated securities. In addition, donors receive a tax credit based on the fair market value of the securities. When combined with the generous tax incentives already offered to investors purchasing flow-through shares, the resulting multi-layered strategy is a huge boost to philanthropic activity, says Sandy Cardy, senior vice president of tax and estate planning at Mackenzie Financial Corp. in Toronto.

“If investors are looking to be philanthropic, rather than donate cash to charity, they can donate qualified securities and eliminate the capital gains,” says Cardy.

Flow-through shares are common shares issued by Canadian companies in the oil and gas, mining or renewable energy businesses. The difference between flow-throughs and regular shares is that the proceeds raised by the issuing company must be spent specifically on exploration, and the tax deductions thus generated are transferred or “flowed through” from the company to the purchasers of the shares.

Flow-through shares offer the dual benefits of a tax advantage and the potential upside that could come from new resources discoveries. The acquisition cost of flow-through shares is fully deductible from any kind of taxable income earned by the investor, and the resultant tax savings reduce the amount of money that investors are out of pocket. Typically, the exploration expense deductions associated with flow-through shares reduce the investor’s adjusted cost base to nil, or close to it, for tax purposes.

Normally, the profits realized from the eventual sale of the shares — based on the difference between market value and the zero cost base — are taxed as capital gains. But investors can avoid such taxes entirely and help a charity at the same time by donating these shares. If clients have flow-through shares in their portfolios, those securities can be ideal to donate to charity because the shares would normally incur larger capital gains than other types of securities when sold, even if the investor merely breaks even on the original price.

“Here’s the scoop: when it comes to charitable giving, investors get the best result by donating whatever eligible security has the largest accrued gain,” says Gena Katz, executive director at Ernst & Young LLP in Toronto. “With flow-throughs, investors have taken tax deductions up front, and these deductions grind the cost base down to nothing.”

Here’s how the strategy, called “triple-dipping” by some tax experts, works. Assume an investor in the top tax bracket in Ontario invests $10,000 in flow-through shares. First, he or she will save $4,600 in taxes as a result of the $10,000 deduction from his or her taxable income based on the cost of the flow-throughs. Most of the deduction is allowed in the year the investment is made; the rest is claimed in the second and third year following. (The tax saving in this example is based on the top marginal tax rate of 46% in Ontario, but this varies slightly from province to province.) Second, if the shares are donated to a charity after two or three years, when the company’s exploration and development program has run its course, assuming the shares are worth a minimum of $10,000, there will be no taxes on the $10,000 capital gain on the sale of the flow-throughs (based on a cost base of zero). Third, when the shares are donated to charity, the investor is entitled to a $4,600 donation tax credit, based on the $10,000 market value of the sold shares and 46% top marginal tax rate. With the investor receiving two $4,600 tax reductions, the net after-tax cost of a $10,000 flow-through share charitable donation is a mere $800.

@page_break@Because flow-through share price gains are tied to the success of exploration programs, such shares are speculative and should be sold only to investors whose risk tolerance levels are suitable. If the company drills its holes and comes up empty-handed, the value of the shares might fall so low that the tax advantages are eroded. The shares are most appropriate for Canadians in the top income tax bracket, who can benefit fully from the tax write-offs and also can withstand exposure to speculative resources stocks without throwing their overall risk/reward balance out of whack.

“Flow-through shares must fit with the investor’s risk profile, and it is a mistake to put tax incentives ahead of the quality of the investment,” says Jo-Anne Ryan, vice president of philanthropic advisory services for Toronto-based TD Waterhouse Canada Inc. “The reason why the shares offer the tax incentives in the first place is that they tend to be aggressive, speculative investments, and some of them have blown up. The caution is that they must be suitable for the investor. And, typically, that means someone who is taxed at the highest marginal tax rate and can tolerate the risk of investing in junior resources companies.”

One of the caveats with flow-through shares is that investors must wait until the shares lose their flow-through status before they can be sold or donated, which typically happens two or three years after the shares are purchased and the various tax credits have been used up. Often flow-through shares are contained within a limited partnership holding a diversified portfolio of flow-through offerings, and investors are given units in the partnership.

To make the investments eligible for charitable donation, the partnership must offer investors the opportunity of converting their units into a publicly traded security, such as units in a related mutual fund trust, while maintaining the zero cost base.

Limited partnership units are not eligible for the charitable donation tax advantages. IE