Flow-through share: Explained
BY TIO Staff
|July 12, 2024In the world of trading, there are numerous financial instruments and investment options available for traders. One such instrument is the 'Flow-through share'. This article aims to provide a comprehensive understanding of what a flow-through share is, how it operates, the benefits and risks associated with it, and its relevance in the trading market.
Flow-through shares are a unique form of investment that are primarily used in the natural resource sector. They offer a way for companies to transfer tax deductions to their investors. This glossary entry will delve into the intricacies of this fascinating financial instrument.
Understanding Flow-through Shares
Flow-through shares are a type of share issued by companies to finance their exploration and development activities. They are most commonly used in the mining, oil and gas, and renewable energy sectors. The unique aspect of these shares is that they allow the issuing company to 'flow through' tax deductions related to their exploration and development expenses to the shareholders.
This means that investors in flow-through shares can deduct the cost of the company's exploration and development activities from their own taxable income. This can provide significant tax benefits, particularly for high-income individuals or corporations.
Origins of Flow-through Shares
The concept of flow-through shares originated in Canada in the 1950s as a way to stimulate investment in the mining sector. The Canadian government allowed mining companies to transfer their exploration expenses to investors, who could then deduct these expenses from their taxable income.
Over time, the use of flow-through shares has expanded to other sectors, such as oil and gas and renewable energy, and other countries, including the United States and Australia, have introduced similar schemes.
How Flow-through Shares Work
When a company issues flow-through shares, it agrees to spend the proceeds from the share issue on qualifying exploration and development activities. These activities must be carried out in the country where the shares are issued.
The company then renounces or 'flows through' the tax deductions associated with these expenses to the shareholders. The shareholders can claim these deductions on their tax return, reducing their taxable income.
Benefits of Investing in Flow-through Shares
Flow-through shares offer several benefits to investors. The most significant benefit is the tax deduction. By investing in flow-through shares, investors can reduce their taxable income, potentially saving them a significant amount in taxes.
Another benefit is the potential for high returns. If the company's exploration and development activities are successful, the value of the shares can increase significantly. However, this also comes with a high level of risk, as the success of these activities is uncertain.
Tax Benefits
The tax benefits of investing in flow-through shares can be substantial. The exact amount of the deduction depends on the company's exploration and development expenses and the investor's tax rate. In some cases, the tax savings can exceed the cost of the shares.
It's important to note that the tax benefits are only available to residents of the country where the shares are issued. For example, only Canadian residents can claim the tax benefits of Canadian flow-through shares.
Potential for High Returns
Investing in flow-through shares can offer the potential for high returns. If the company's exploration and development activities are successful, the value of the shares can increase significantly. This can provide a substantial return on investment for the shareholders.
However, the potential for high returns comes with a high level of risk. The success of the company's exploration and development activities is uncertain, and there is a risk that the value of the shares could decrease.
Risks of Investing in Flow-through Shares
While flow-through shares offer potential benefits, they also come with significant risks. These include the risk of the company's exploration and development activities being unsuccessful, the risk of changes in tax laws, and the risk of a decline in the price of the shares.
It's important for investors to fully understand these risks before investing in flow-through shares. This section will provide a detailed overview of the main risks associated with this type of investment.
Risk of Unsuccessful Exploration and Development Activities
The main risk of investing in flow-through shares is that the company's exploration and development activities may be unsuccessful. This could result in a decline in the value of the shares, potentially leading to a loss for the investor.
Investors should carefully evaluate the company's exploration and development plans and the potential for success before investing in flow-through shares.
Risk of Changes in Tax Laws
Another risk of investing in flow-through shares is that tax laws could change. If the government decides to eliminate or reduce the tax benefits associated with flow-through shares, this could decrease the value of the shares.
Investors should be aware of this risk and consider the potential impact of changes in tax laws on their investment.
Risk of Decline in Share Price
Like any investment in shares, there is a risk that the price of the flow-through shares could decline. This could be due to a variety of factors, including poor company performance, changes in market conditions, or a decline in the price of the natural resources the company is exploring for.
Investors should consider this risk and the potential impact on their investment before investing in flow-through shares.
Conclusion
Flow-through shares are a unique form of investment that offer potential tax benefits and the potential for high returns. However, they also come with significant risks, including the risk of unsuccessful exploration and development activities, changes in tax laws, and a decline in the share price.
Investors should carefully consider these risks and benefits before investing in flow-through shares. As with any investment, it's important to do your own research and consider seeking advice from a financial advisor.
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