Introducing Investors to
private placement
opportunities in some of
Canada's fastest growing
public companies.
* Private Placements
* Discounts from Market Price
* Flow-Through Shares
* Warrants
What are Flow-Through Shares?
Reducing Investment Risk with Flow-Through Shares
To stimulate domestic exploration and development in resource-based companies, Canadian income
tax regulations have been designed to provide favorable tax treatment to individuals and corporations
who invest in the mining as well as oil & gas industries. Flow-through shares permit certain
exploration and development expenses incurred by the issuing corporation to "flow-through" to
individual investors. Typically, flow-through shares are offered by mining and oil & gas companies
that are unable to fully utilize their exploration and development expenses. The tax deduction
renounced by the company and transferred to the investor serves as an additional incentive for
investors to purchase the shares, thus benefiting the corporation by increasing its ability to raise
financing for its exploration and development activities. The individual investor can in turn utilize the
expenses to offset other sources of income, thereby reducing the taxpayer's income tax liability or
increasing his tax refund. While some recent studies suggest that flow-through shares have created
only limited additional exploration in Canada, they are certainly one of the most popular tax shelters
among Canadian investors. More importantly, flow-through shares significantly reduce the risk of
investing in resource stocks by allowing investors to recover a substantial portion of their original
investment through income tax savings. In other words, the tax savings associated with the
flow-through share investment significantly reduces the investor's "at risk" amount invested.
Investors who have participated in a flow-through share offering during a given year will receive a
statement and/or information slip from the company at tax time to assist them in the preparation of
their income tax return. The statement itemizes the particular deductions that may be claimed. The
extent of these deductions is dependent upon the actual usage of the capital raised by the share issue.
A portion of the proceeds received by the corporation in exchange for the shares is often used to
offset general and administrative expenses as well as the costs associated with the issuance of the
shares. This portion may not be transferred to individual shareholders and remains an expense of the
company. A forecast of the expected use of the proceeds is generally provided by the company so
that investors may estimate their tax benefit and evaluate the flow-through share offering prior to
purchasing shares. Big Blackfoot Resources Ltd. intends to utilize all of the gross proceeds of the
financing to conduct eligible Canadian Exploration Expenditures. Management has indicated that it
plans to complete these expenditures during 1997, which will enable participants in the financing to
claim a Canadian Exploration Expense equal to 100% of their investment on their 1997 tax return. It
is important to emphasize that both individuals and corporations can participate in flow-through share
offerings. Deductions that result from flow-through shares may be claimed at the discretion of the
investor. If the investor does not have sufficient taxable income in a given year, flow-through share
deductions may be accumulated until such time as the investor can fully utilize them. As a result of the
tax savings, the exact extent of which depends on the participant's marginal tax rate, the downside
risk associated with the investment is reduced.
There are several important factors that investors should take into account prior to participating in a
flow-through share offering. The following is a list of some of the more important considerations:
1. For income tax purposes, the cost of a 100% flow-through share is always nil. The full proceeds
upon disposition of the shares (after brokerage commissions), are subject to income tax as a capital
gain (currently 3/4 of capital gains are taxable). However, investors in flow-through shares benefit
from the different tax treatment of the tax deduction and the ultimate capital gain. The tax deduction
associated with the flow-through shares is used to offset income that is fully taxable, while only 75%
of the subsequent capital gain is taxable. In effect, this differential significantly reduces the investor's
"break-even" price as you will see in the examples on the following page.
2. A timing benefit is generally realized by investors who subscribe to a flow-through share issue
since in most cases the resulting tax deduction can be claimed in the taxation year in which the
investment is made, while capital gains only arise and become taxable when the shares are sold. This
can occur years later, or at the very least, during a subsequent taxation year. The tax savings can be
reinvested thereby compounding the investor's rate of return.
3.Since deductions generated by flow-through shares can potentially trigger Alternate Minimum Tax
(AMT), it may be prudent to contact a qualified tax practitioner before finalizing any significant
investment in flow-through shares.
4.Like other types of private placement investment opportunities, flow-through share offerings
provide investors with the opportunity to purchase significant equity positions in companies with
thinly traded shares at a set price and without having to pay brokerage commissions. As with most
private placement financings, the issuing company pays the costs associated with the sale of the
shares, not the individual investors. These savings can be very significant for investors who are
looking to accumulate larger positions in a particular company.
CASE EXAMPLE:
Mr. Subscriber is considering the purchase of flow-through shares of Big Blackfoot Resources
pursuant to the private placement at $0.45 per share. The company's common shares are currently
trading on the Alberta Stock Exchange at roughly the same price. 100% of the proceeds from the
issuance of the flow-through shares will be used by the company to pay for various Canadian
Exploration Expenses during the current year. For illustration purposes, assume Mr. Subscriber's
marginal tax rate is 45% and that he sells his shares a year later when the required hold period ends.
Mr. Subscriber decides to purchases 40,000 flow-through shares at $0.45 per share ($18,000
investment). At the end of the taxation year in which he purchased the shares, Mr. Subscriber will
receive an information statement from the corporation documenting his eligibility to claim an $18,000
(100% x $18,000 investment) Canadian Exploration Expense deduction on his personal income tax
return. As a result of this deduction, his personal income taxes are reduced by $8,100 (45% x
$18,000) and his "at risk" investment is correspondingly reduced to only $9,900 ($18,000-$8,100).
Example #1
Stock Price
Appreciates to
$1.00
Example #2
Stock Price
Remains at
$0.45
Example #3
Stock Price
Declines to nil
($0.00)
Flow-Through Common Shares
Gross proceeds on sale of shares
$ 40,000
$ 18,000
nil
Tax savings associated with flow-through tax
deduction
$ 8,100
$ 8,100
$ 8,100
Tax on capital gain (3/4 taxable)
Original purchase cost
Net after-tax profit
$ (13,500)
$ (18,000)
$ 16,600
$ (6,075)
$ (18,000)
$ 2,025
nil
$ (18,000)
$ (9,900)
Regular Common Shares
Gross proceeds on sale of shares
Tax on capital gain (3/4 taxable)
Original purchase cost
Net after-tax profit
$ 40,000
$ (7,425)
$ (18,000)
$ 14,575
$ 18,000
nil
$ (18,000)
nil
nil
nil
$ (18,000)
$ (18,000)
Benefit of Investing in Flow-Through Shares VS
Regular Common Shares
$ 2,025
$ 2,025
$ 8,100
Example # 1 illustrates the benefit derived from the differing tax treatment of the flow-through
deduction and the ultimate capital gain when the shares are sold. The investor also received a timing
or deferral benefit by receiving the full deduction in the year of his investment and not paying tax on
his capital gain until the following year when he sold the shares. The investor could have also
reinvested his tax savings to compound his overall rate of return during this deferral period. Mr.
Subscriber was also able to acquire the shares without paying brokerage commissions which likely
would have amounted to several hundred dollars if the shares had been acquired on the open
market. These later benefits are in addition to the $2,025 benefit which was derived solely from the
tax rate differential between the deduction and capital gain.
Example #2 illustrates that the investor will still receive a positive cash flow from the investment
(11.25% gain) even if the price of the shares remain at his purchase price. The benefits are the same
as in the first example. Effectively, the break-even price on the investment was reduced from $0.45
to less than $0.375 (excluding commissions).
Example #3 attests to the ability of flow-through shares to substantially reduce the downside risk of
an investment.
These examples are intended only to illustrate the advantages of flow-through shares. Your exact
level of benefit will depend upon your marginal tax rate.
Equity-Link Investment Services
Corp.
Suite 36 - 750 Fortune Drive
Kamloops, British Columbia,
Canada V2B 2L2
Phone: (250) 376-2690
Fax: (250) 554-3128
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