Subscription and sale, settled moments apart.
This page is for the person who wants to verify the claims rather than take my word for it.
The transaction
A Canadian resource company raises capital by issuing flow-through shares from treasury. Under the flow-through regime, it can renounce eligible Canadian Exploration Expenses to the subscriber, who can then deduct the cost against income in the current tax year.
In a structured “bought deal”, an institutional buyer agrees in advance to buy the shares from the subscriber at a fixed price, which is known before one commits to the transaction. The subscription and the subsequent sale are documented together and settle together. There’s no window in which the subscriber holds an unhedged position, so there’s no exposure to share price volatility. The net result is, the subscriber gets the expense deduction and net proceeds of sale. The transaction is structured within CRA guidelines.
The comparison, expanded.
The tax treatment is identical in all three. What differs is certainty of the outcome.
The shares are held. A 120-day resale restriction is typical, and where the share price lands at the end of that window decides whether you finish ahead after tax.
These LPs typically invest in multiple flow-through offerings which provides a degree of diversification. On average, units are held 10 to 24 months, sometimes longer, before rolling over into a liquid mutual fund. It’s hit and miss as to whether drawdowns inside that window will end up negating the tax benefits. On occasion it can work out well when there is share appreciation during the illiquid period but the outcome is always uncertain.
Issuer due diligence
I don’t perform issuer due diligence myself. It's carried out by the firm(s) I work with before any transaction is put in front of a client. They review the issuer’s financial position and its ability to complete the exploration program paying for eligible expenses and on the prescribed timetable.
Alongside that, the state of the treasury, the program budget, the operator’s track record of finishing what it starts, and whether the size of the raise is proportionate to what the company can realistically spend.
The indemnity agreement
The subscription documents include an indemnity agreement saying that if the issuer’s own conduct causes any tax benefits to be disallowed, the issuer indemnifies subscribers. No waiting for final adjudication which could take months or even years. Meaning, the issuer will reimburse any reversed deductions on or before 20 business days following receipt of any notice of reassessment (NOA). This puts the cost of any relevant issuer’s failure back on the issuer itself.
Start with the Primer.
A guide to the tax benefits and mechanics of flow-through shares. One transaction, completely outlined, start to finish. It answers much of what people ask me at the start of their investigation.
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