Flow throughs are a deal between Canadian resource companies and the Canadian government. Various institutions act as middle agencies between Canadian buyers of flow throughs and the companies that use the money.
When we buy a flow through, the money usually is used to buy shares in various companies. Companies use the money for research or to develop projects. Because of the special deal with the government, we as buyers are allowed to deduct the full cost of the flow through on line 224 of our personal tax return.
Flow throughs have a start date and a maturity date, which is usually 14 to 18 months later. The agencies that manage the flow throughs have for years been able to buy cheap shares of many small cap stocks and let us claim the cost. As the small cap companies developed and the market value of their shares went up, most flow throughs matured at a value that was higher than the after tax cost of the flow through — and often higher than the original purchase price.
In my own experience flow throughs that cost $5,000 matured at $2,700 to $7,000. For tax purposes the matured value was called capital gain, which was half taxable. So this was a great deal. We claimed the $5,000 cost as a deduction and in Manitoba saved about $2,700 of taxes. When the flow through matured at say $5,000, only $2,500 was taxable as capital gain. It was a great system for years.
In 2008 the whole system crashed. Small cap stocks usually run on shoestring budgets and often sell more shares to raise cash. And some borrow as they get closer to production. Well, credit dried up for many and especially small speculative businesses. And as the stocks dropped it got harder and harder to raise more money by selling more shares. And if they could raise money by selling shares they had to sell a lot of shares, which dilutes any kind of future earnings.
So small cap stocks fell off a cliff. And so did the payout or maturity value of our flow throughs.
Here is the list of flow throughs I own at this time, what they cost and what they were worth on December 31, 2008.
The San Gold ($15,000) was a four-month flow through, which normally is quite risky but I know that company and this is my second four-month flow through. So on the $25,000 those two have cost me, I have saved something over $12,000 worth of income tax. Plus, the flow throughs above are all from 2007 or 2008 but the money for them came from flow through I had cashed out from years past.
So over all, I’m OK. I don’t like the low pay out and I am $18,000 down on this list of flow throughs. But I likely saved $35,000 worth of income tax over the years so this doesn’t hurt too much. But my plan was to use the payouts each year to buy the next flow throughs for the next year and as you can see the low payouts will really cut into the dollars I have to buy the next flow throughs for 2009.
However anyone who started to buy flow throughs in late 2007 or 2008 likely has suffered quite a meltdown in value.
IS THIS A GOOD TIME TO BUY?
I’m not sure this is a good time to buy flow throughs for mining companies, especially small cap mining companies. It might be a decent time to buy flow throughs for oil and gas companies. But the risk sure is a lot higher than it used to be.
MORE ON TFSA
Editor Jay asked me to keep writing about the Tax Free Savings Account (TFSA), so here goes. This is where any Canadian over 18 can deposit $5,000 for 2009 and on and any money that money makes will be tax free. For us older folks this could be a way to make some money that will NOT cut into our Old Age Pension (OAS). For young folks, done right the TFSA could take you on a path to being a millionaire.
What does done right mean? Well, first I don’t think investing money at two to three per cent per year will make you much. In my travels and in our newsletter StocksTalk I merged two strategies together that are working well for readers. I merged the TFSA and selling covered calls. Here is an example:
First, buy 200 shares of Fortis (FTS). FTS is what we call a comfort stock. It pays a dividend of just over $1 per year, which is four per cent on the $24 stock. We would set up our TFSA to let us sell covered calls and these past few months we’d collect a fairly easy 30 to 50 cents per month per share. Over a year that’s $3 to $6 plus the dividend makes it $4 to $7 per year or $800 to $1,400 per year for the 200 shares. Both are good returns.
Folks who attended the meetings at Lloydminster and Delia got a detailed discussion on how to merge the TFSA and selling covered calls strategies. I have to congratulate the ag committees of those areas for bringing that information to their communities. Most other Canadians have to read this stuff in print or may never hear it.
Which brings to mind that Mike Jubinville and I will be at Lougheed, Alta., on March 24 at the community hall on Main Street. This is an open meeting set up by the Ag Society Special Events Committee. The fee will be somewhere around $20 for the day and includes lunch. Call Brenda at 1-780-386-3849 to reserve a spot. Mike will cover the outlook for crops. I will discuss the five-legged stool, merging two-generation farms, the TFSA, selling covered calls and more if time permits.
Andy Sirski manages his own investments, has a small income tax business and publishes an investment newsletter called StocksTalk. For a free one month subscription send an email to [email protected]