Flow-through share(s) (“FTS”) are a long-standing feature of Canada’s tax and resource landscape. Designed to stimulate investment in industries like mining and renewable energy, the federal FTS regime allows eligible companies to flow certain resource expenses through to investor shareholders, who may then deduct amounts from their taxable income.

While FTSs can provide tax benefits and support early-stage exploration and development projects, they also raise important legal considerations. This guide explains how the FTS program works and outlines key eligibility requirements.

All legislative references in this article are to the Income Tax Act (Canada) (the “Act”) unless otherwise specified.

Who can issue FTSs?

To issue flow-through shares, the issuing corporation must be a “principal business corporation” (a “PBC”). A PBC is a corporation whose principal business, as determined factually,[1] involves specified activities in the resource sector.[2] In addition, a holding corporation whose assets are 90% comprised of shares or indebtedness in one or more PBCs that are related to the holding corporation may qualify as a PBC.[3]

What qualifies as a FTS?

A PBC can issue shares which will qualify as a FTS, provided certain conditions are met. To qualify as a FTS, the share must be:

  • a share of the capital stock of a PBC (or a right to acquire such share);[4]
  • issued to a person[5] under a written agreement between the person and the PBC for consideration that does not include property to be exchanged or transferred by the person under any of sections 51, 85, 85.1, 86 or 87;
  • issued under an agreement pursuant to which the PBC agrees to incur Canadian exploration expenses (“CEE”) or Canadian development expenses (“CDE”) in an amount not less than the consideration received for the share in the period that commences on the day the agreement was entered into and ends 24 months after the end of the month in which the agreement was entered into; and
  • issued under an agreement pursuant to which the PBC agrees to renounce the expenses before March of the first calendar year beginning after the above-mentioned period in the prescribed form in an amount not exceeding consideration received for the share.

In addition, a FTS cannot be a “prescribed share” or “prescribed right”. Generally, a share will be a “prescribed share” if the economics of the share are in any way fixed, returned, enhanced with a form of assistance or a transfer of property, or indemnified or guaranteed.[6]

The FTS rules allow PBCs to renounce two categories of expenses: Canadian exploration expenses[7] and Canadian development expenses.[8]

How does the expense renunciation process work?

Investors can participate in the FTS program as an individual, or through a trust, corporation or partnership. However, only the original purchaser is entitled to the tax deductions provided by the FTSs.

A PBC can renounce qualifying expenses that it incurs to a holder of a FTS where certain conditions are met[9]:

  • the investor must have paid consideration in money to a corporation for the issue of the FTS;
  • the issuing PBC must incur CEE or CDC during the period commencing on the day the agreement was entered into and ending 24 months after the end of the month in which the agreement was reached (the “Period”);[10]
  • before March of the first calendar year that begins after the Period, the PBC renounces effective on the day on which the renunciation is made or on an earlier day, the expenses incurred on or before the effective date of the renunciation; and
  • the PBC complies with filing requirements under the Act.[11]

Renunciations are subject to further restrictions and limitations.[12] The relationship between the issuing PBC and the FTS holder is subject to parameters: a corporation cannot renounce expenses that have been renounced to it by another corporation with which it is not related.[13]

In addition, a renunciation cannot be made to a person with which the PBC has a “prohibited relationship.”[14] In high-level terms, a prohibited relationship exists where the PBC and the entity in question are not sufficiently independent.  

Additional restrictions:

  • ensure the renounced expenses are otherwise deductible under Part I of the Act;[15]
  • govern the amount renounced[16]; and
  • ensure the expenses cannot have been incurred prior to the time when the investor and the PBC entered into the relevant FTS agreement.[17]

Providing the filing requirements under the Act have been met, the holder of the FTS is deemed to have incurred the expenses in the amount renounced on the effective date. On the other hand, the issuing PBC is deemed to never have incurred the expenses as of the effective date and thereafter. [18]

CEEs are fully deductible in the year they are incurred; the investor can deduct up to the amount of consideration paid to acquire the FTS against their other sources of income in the year of subscription.[19] CDEs are deductible on a declining balance basis over a number of years, and are generally limited to 30% of the investor’s cumulative CDE per year.[20]

When to renounce: Understanding the FTS “look back rule”

Generally, a PBC can only renounce expenses incurred after the subscription, and to the extent that the expenses are actually incurred. However, a “look back rule” allows an investor to fully deduct expenses in the year of the subscription of the FTS where all or part of the expenses are incurred during the subsequent calendar year, so long as prescribed criteria are met.[21]

Where to find additional benefits: Provincial tax credits

While the FTS program is an initiative of the federal government, some provinces provide credits which can amplify the tax benefits of FTSs:

  • British Columbia provides a mining flow through share tax credit, which allows qualifying individuals who invest in FTSs to claim a non-refundable credit of 20% of their BC-based flow-through mining expenditures.[22]
  • Manitoba provides a 30% credit to individuals who invest in FTSs of qualifying mineral exploration companies where the expenses were for activities in Manitoba.[23]
  • Ontario provides a tax credit in an amount equal to 5% of eligible Ontario-based exploration expenses to individuals for expenses incurred by a corporation that has a permanent establishment in Ontario.

Conclusion

FTSs present a powerful investment vehicle that combine the potential for equity growth with substantial tax benefits. However, due diligence is critical. Investors must be mindful of the eligibility criteria surrounding deductions and credits. A subsequent article will explore additional considerations, including the applicability of alternative minimum tax, mineral exploration credits, and charitable donations.

Our Corporate Tax group is available to discuss the structure, compliance issues, and strategic implications of FTS arrangements.

[1] See American Metal Co of Canada Ltd v MNR, [1952] CTC 302, at para 17.

[2] Subsection 66(15).

[3] The CRA’s position is that a corporate general partner can qualify as a principal-business corporation due to the activities carried on through the partnership where certain conditions are met . See also, CRA Views, Interpretation—external, 2004-0105951E5 — Principal—business corporation, February 1, 2005. See also, Folio S3-F8-C1: Principal-business Corporations in the Resource Industries, February 1, 2017.

[4] The inclusion in the FTS definition of rights to acquire a share has existed in the definition since its introduction in 1986 – see Technical Notes to Notice of Ways and Means Motion Relating to Income Tax, October 1986, p 16. Online at <https://publications.gc.ca/site/archivee-archived.html?url=https://publications.gc.ca/collections/collection_2016/fin/F34-27-1986-eng.pdf >

See also CRA Views, Interpretation—external, 2014-0534941E5 — Flow-through share subsec. 66(15), September 5, 2014, in which the CRA confirms that a right to acquire a share of a PBC will be a FTS even where the underlying shares to be acquired does not itself qualify as a FTS.

[5] Deemed to include a partnership by subsection 66(16).

[6] Regulations 6202 and 6201.1. Regulation 6202 does not apply to new shares.

[7] Subsection 66(12.6) – (12.61).

[8] Subsection 66(12.62).

[9] CEE can be renounced pursuant to Subsection 66(12.6) and CDE can be renounced pursuant to subsection 66(12.62).

[10] Certain expenses reclassified CDE are not renounceable pursuant to subsection 66(12.6) and subsection 66.1(9).

[11] Subsection 66(12.68) and subsection 66(12.7).

[12] Subsections 66(12.67) to 66(12.71).

[13] Subsection 66(12.67).

[14] Subsection 66(12.67) and 66(12.71).

[15] Subsection 66(12.71).

[16] Subsection 66(12.6).

[17] Subsection 66(19). See Technical Notes, 66(19).

[18] The effect of the renunciation is set out in subsections 66(12.61), (12.63). The filing requirements are set out I subsection 66(12.68) and subsection 66(12.7).

[19] Subsection 66(12.63). Subsection 66.3(3) deems an investor’s cost of a FTS to be zero.

[20] Subsection 66.2(2).

[21] Subsection 66(12.66); A PBC that renounces expenses under the look-back rule is subject to Part XII.6 tax on CEE and CDE expenses. The tax is calculated monthly beginning in February of the year following the effective date of the renunciation (i.e. December 31 of the preceding year). The tax decreases as the expenses are incurred by the PBC. Part XII.6 tax is deductible by the PBC under paragraphs 18(1)(t(i) and 20(1)(nn).

[22] BC Income Tax Act, subsection 4.721(1).

[23] The Income Tax Act (Manitoba) Subsection 11.7(1).