My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Thursday, September 23, 2010

Are you a flow-through junkie?


This is the time of year when many of our clients are approached by their financial advisors to consider the purchase of a flow-through limited partnership investment as a means of reducing their personal income tax liability. Many of these limited partnerships invest in shares issued by a variety of junior oil, gas and metal exploration companies. The essence of this type of investment is that these partnerships allow exploration deductions to “flow-through” to individual investors.
In simple terms, if you pay $10,000 for a unit of an oil and gas limited partnership, you will receive approximately $10,000 in income tax deductions that can be utilized in your personal income tax return. Assuming the highest marginal income tax rate, you would save approximately $4,600 in taxes making your out-of-pocket cost $5,400 after claiming these “Flow-Through” deductions.
Most limited partnerships are subsequently rolled into a mutual fund that is saleable within two years. Carrying on with our example, let’s say that in two years the limited partnership is rolled into ABC Mutual Fund and you immediately sell your unit for $10,000. The cost base of the investment has been reduced to zero because of the deductions noted above, so you would owe capital gains tax of approximately $2,300 and net out $7,700. Your after-tax return would be $2,300 on the $10,000 investment ($7,700 on sale of mutual funds net of tax + $4,600 tax savings$10,000 cost). You would break even if you could sell your mutual fund units for approximately $7,000.
The use of flow-through investments can also be very effective when you have capital losses you cannot use otherwise. If you have $10,000 in capital losses to utilize, in the example above, you could apply those losses against the gain and now you would realize $14,600 on the $10,000 investment since you would not owe any income taxes.   
There is an intriguing alternative to selling your mutual fund units.  If you donated your mutual fund units instead of selling them on the open market (assuming a $10,000 value) you would have no income tax liability and you would receive a tax refund of $4,600 on the donation. Therefore, in the scenario where your investment has a value of $10,000 at the time of donation, the charity would receive a $10,000 donation and your out-of-pocket cost would only be $800!
Even though a flow-through is a tax advantaged investment, it must be considered part of your resource investment portfolio. I know a couple of “tax shelter junkies” who purchase several shelters a year. These investments should always be discussed with your investment advisor because of the risks involved in investing in young resource companies and to ensure the risk allocation fits with your asset allocation.
Some advisors suggest you buy a shelter for two straight years then sell in the third year when it becomes a mutual fund and use the proceeds to buy a new flow-through in year 3 and repeat the process each year. The idea is to have a consistent tax shelter flow without adding significant additional funds. The downside to this strategy is that the tax advantage is partially negated as you will owe approximately $2,300 in capital gains tax on the sale of the mutual fund and save $4,600 in tax due to the purchase of the new flow-through.
Another timing strategy I have seen clients use is buying flow-through investments in years where oil or gold is in a downturn figuring that the downside investment risk is reduced. This strategy, while probably flawed technically, has worked fairly well for some, but of course in a rising resource market, this strategy prevents investors from buying shelters.
To summarize, the tax dog’s tail should not be wagging the investment. You should talk to your advisor about whether flow-through shares purchases should be considered in the context of your overall portfolio.
For You Couch Potatoes

This week is the beginning of the fall TV season. Two of my favorite shows, Dexter and Criminal Minds, had very disturbing endings last year and, notwithstanding their disturbing nature, they were two of the best finales I have ever seen.

In Dexter, Trinity murders Dexter’s wife Rita and Dexter finds his young son in the blood of his murdered mother mirroring Dexter’s past when he was found in his mother’s blood by Harry, the policeman who became his adoptive father. One can only imagine how Rita’s death will impact Dexter’s behaviour.

In Criminal Minds, the Reaper kills Agent Hotchner’s wife in a dramatic conclusion to the 100th episode.

It is unusual for significant characters to suffer such dramatic deaths (especially Rita) and for me, the surprise and drama adds to the quality of these series .

Just so you don’t think I am a sadist watching both these series, my two favorite comedies also start this week.

Two and a Half Men, one of my favourites, is a well known series that may be on its last legs. A new favourite is the Big Bang Theory. Jim Parsons, who plays Sheldon Cooper, is one of the funniest characters on TV. He just won the Emmy for best Comedy Lead Actor. If you have never seen the show, I highly recommend it. This is what Wikipedia says about the show, but the description does not do it justice.


The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

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