Flow Through Shares Strategies Part 1

A strategy often implemented by Flow Through Share investors is to keep rolling over their investments to gain a perpetual annual tax credit.  I’ll give you an example of a client who understands the risks and is engaging in this strategy:

Mining_Equipment.jpgBob Mackenzie (not his real name!) earns $300,000 per year and maximizes his RRSP every year.  Since he is in the top marginal tax rate of 46.41% (Ontario) he is basically getting half his contribution amount back in the form of a tax refund.  Well Bob likes that, but doesn’t like how he is still paying 50 cents on the dollar for most of his earned income – in other words he is always looking at ways to save on tax! (aren’t we all?)

Now, because Bob is a more aggressive investor and likes to play the game a little he warmed to the idea of investing in Flow Through Shares Limited Partnerships since the savings in tax helped offset the riskiness of the investment. (If you need a refresher on Limited Partnership Flow Though Shares, please click here.) But we also decided to create a strategy around this type of tax planning / investment planning strategy…

Most investors take their money out of a FTS-LP (abbreviation for Flow Through Shares Limited Partnership) at the 2 year mark (i.e. as soon as they can!) since they can roll that money into another FTS-LP and get the tax deductions all over again. Normally I don’t recommend more than 5% of a person’s overall portfolio be exposed to any one FTS-LP and no more than 10% exposure to multiple FTS-LPs so in this case with Bob (who had a total portfolio of $1 million) he put in $50,000 his first year (giving him just under $25,000 back come tax time) and made a second contribution of $50,000 the following year in a different FTS-LP.

Now when one FTS-LP "matures" after 2 years, he rolls it into another offering so in effect, he has a constant $50,000 deduction from his income every year since you could say he has a 2 year FTS-LP ladder. (Same concept as a laddered bond portfolio in that there is a security "maturing" every year available for rollover…).

Let’s look at Bob’s annual tax situation before and after implementing a FTS-LP 2 year ladder:

               Income       RRSP Contribution    FTS-LP Investment   Tax Refund

Before    $300,000           $20,000                         $0                  $10,000

After      $300,000           $20,000                     $50,000              $35,000

Remember, his total portfolio exposure is only 10% to the FTS-LP investments starting in year 2 (in year 1 it is only 5%).

Also remember FTS-LPs are very volatile – some lose 30% after two years (or perform even worse!) and some double in value - in this case Bob is happy knowing that over time some will pop and some will tank and he is comfortable with the volatility – just so long as he is getting his big fat tax refunds every year.  In his mind, even if the long term performance of the underlying investments in the FTS-LP ladder are COMPLETELY FLAT he still makes 20% per year after factoring tax effects. And of course the expectations are that you pick the more decent ones by proven managers with strong track records in the space and you would expect for a long term ROR of 8-10%.

Finally, don’t go out and buy a FTS-LP after reading this post alone – you really need to understand them and hopefully view these investments as you should any other – based on the investment merits first and tax advantages second. 

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Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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  • Albert Leung

    I like what is in the article but don’t understand about the rollover to another LP and get deductions. Don’t you have to report capital gain when dispose of the 1st LP?

  • Preet

    Hi Albert – there are two ways of structuring the ladder.

    Also it should be pointed out that the ACB of the flow through is 0 – so whatever amount you sell is a capital gain (if you sell it).

    The flow through will normally roll-over into a mutual fund with no deemed disposition (A section 85 rollover I believe?), if the company has a wide shelf of funds you could keep it in there without triggering the gain. In this case you could switch funds (if in a class structure) around to make sure you stick to your long term asset allocation.

    The other option is to sell those rolled-over funds to purchase the new flow through – in which case you will have to pay tax of roughly 1/4 the value of the rolled-over amount. You would have to top that up yourself to keep the ladder going.

    I’ll have to amend this post in the future to accurately reflect the options – so thanks for the question!