The Plan Nord, the Quebec government's ambitious project to develop the natural resource opportunities in the northern part of the province, is likely to benefit a knowledgeable and risk tolerant group of investors cum-tax-savers.
These are the investors in so-called "flow-through" shares. These investors already know that their investment can result in substantial tax deductions but are also aware the overall investment risk can be high. The Plan Nord may inspire other investors to explore these tax advantaged investments.
The flow-through investment can be made by purchasing flow-through shares of participating resource exploration companies. More commonly, however, they are offered in flow-through limited partnerships such as those managed by Matrix Asset Management, Front Street Capital or Pathway Asset Management, and available through most investment dealers. These limited partnerships consist of professionally managed portfolios of several different companies offering flow-through shares.
How does this work?
The federal and provincial governments encourage investment in the resource sector through resource exploration and development tax deductions offered to the exploration companies themselves. Often these resource companies are so junior in their own corporate development that they have no sizable income with which to use these tax deductions when trying to offset their corporate income. Therefore, the governments effectively allow these companies to pass on or flow-through these tax deductions to individual investors through the issuance of flow-through shares.
The federal government offers tax deductions of up to 100 per cent of the investment made while the Quebec government offers Quebec taxpayers a deduction of up to 150 per cent on the Quebec exploration expenses.
By virtue of investing in these flow-through shares or Quebec-concentrated limited partnerships, the individual investor can claim these resource-exploration tax deductions for him or herself.
Have a look at this example: a Quebec taxpayer at the highest marginal tax rate of 48.22 per cent and with an individual income of $300,000 who does not invest in a flow-through strategy would typically pay an estimated $129,322 in taxes this year.
That same person who decides to invest $50,000 in one Quebec-based flow limited partnership we reviewed recently, would benefit from a federal tax refund of $12,100, a provincial tax refund of $17,400 plus a net investment tax credit of $3,850 for a total tax refund of $33,350, thereby reducing their total taxes payable to an estimated $95,972.
Results may vary according to one's own tax situation.
While all taxpayers or investors can choose to invest in flow-though shares, they appeal primarily to those in the highest tax bracket and/or those who have had a sudden influx of income in any given year such as those who have sold a business or have large severance payments due to retirement. These latter investors should be cautious about triggering the Alternate Minimum Tax (a calculation designed to make sure everyone pays at least some tax), which is why a call to your accountant before proceeding is de rigueur.
It should be noted that an investment in flow-through limited partnerships is usually subject to a minimum hold period of 24 months, during which time the investment is illiquid.
After this hold period, the limited partnership flow through units are normally converted to a resource-based mutual fund (at a very low adjusted cost base) at which point they can be sold.
When sold, these units will be subject to capital gains taxes but Quebec often exempts this on Quebec flow through investments if certain conditions are met. Federal capital gains taxes will apply but at a 50-per-cent inclusion rate only (which is the same for all capital gains).
Now, while it is nice to save taxes, one should not lose sight that this is an investment to begin with and the objective is to make a return on one's investment. After considering the tax refunds in the example above, the net money at risk to a Quebec investor would be typically reduced to 40 cents on the dollar, meaning that the $50,000 invested really becomes a $20,000 investment (after taking into consideration the future federal capital gains taxes).
Therefore, for this $50,000 investment, the flow-through share or limited partnership would have to lose 60 per cent (or $30,000) for this to have been a bad investment. Well, don't kid yourself.
Losses are rampant in the junior exploration sector, particularly when global commodity markets are in turmoil.
However, by diversifying your risk through a managed portfolio of flow-through limited partnerships, and enjoying the infrastructure push of Quebec's great Plan Nord, one has improved hope that this investment risk may be duly rewarded.
John Archer is an investment adviser with RBC Dominion Securities in Montreal. email: john.archer@rbc.com
Montreal Gazette
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