Tax Angles, Flow- through shares and your RRSP

A number of 1986 mining flow- through share vehicles were structured so that the shares will be listed on a Canadian exchange and the actual shares delivered to the investors in January or February, 1987.

The selling documents make much of the fact that the investors will be able to transfer the shares to their self-administered registered retirement savings plans (RRSPs), by March 1.

It is suggested that investors may thereby obtain a “double deduction” for Canadian Exploration Expense, or CEE, (and mining exploration deple tion) and the deduction for an RRSP contribution within 60 days of the year-end. Let’s be serious

The “double deduction” argument is of course purely a sales pitch with no logical basis.

In our view the investor who transfers the flow-through shares to his RRSP is likely serving the interests of the issuing company and its other shareholders more than his own interests. 006No double deduction

You have a 1986 contribution limit with respect to your RRSP that is neither increased nor decreased by virtue of a mining exploration flow-through share investment. If you are a member of a registered pension plan to which an employer makes a contribution for the year or a member of a deferred profit-sharing plan to which you or your employer make a contribution for the year then your 1986 RRSP contribution limit is the lesser of $3,500 and 20% of your earned income, minus in each case your registered pension plan contribution for the year.

Otherwise your 1986 RRSP contribution limit is the lesser of $7,500 and 20% of your earned income. The contribution may be either cash or qualified property.

If the contribution is qualified property, the contribution is treated as a disposition at fair market value for tax purposes.

Since a flow-through share has a NIL cost base, the contribution will give rise to a capital gain that either has a tax cost or utilizes available capital gains exemption.

That is, except for brokerage costs, the result is exactly the same as selling the flow-through share and using the cash proceeds to make a contribution to your RRSP.

So much for the “double deduction” pitch. The real questions

The real questions to be addressed are:

(1) should you sell the flow- through share when received or continue to carry the investment, and

(2) if you decide to carry the investment should it be held personally or through your RRSP?

The first question is the normal investment decision. If you expect the share to perform better than alternative investments you would continue to carry it. Otherwise it should be sold.

One of the major drawbacks of flow-through share issues is that they have a dilutive effect, and many investors dispose of their shares shortly after receiving them, depressing the market.

Obviously the issuing company and other shareholders would prefer that you transfer the shares to your RRSP rather than participate in any sell-off, but you should make your own investment decision in this respect.

If you decide to carry the investment, there are two factors to consider in deciding whether to hold it personally or through your RRSP. First, any gains realized in an RRSP are ultimately subject to full taxation since all withdrawals are included in ordinary income.

If you are holding an investment in the expectation of capital appreciation and you do not anticipate having used the full amount of your capital gains exemption by the time of disposition, it is likely that you should hold the investment personally and not through your RRSP.

Even if you do not expect to have the capital gains exemption available, you will have to consider whether the income earned on the gain in the RRSP will compensate for the difference between tax at capital gains rates if realized personally and the tax at ordinary income rates on the ultimat e withdrawal from the RRSP.

Second, remember that the purpose of the RRSP rules is to allow you to provide income for your retirement years. Whether an investment in shares of a particular mining or exploration company is appropriate for this purpose is a question you will have to address.

You should answer these questions before contributing flow- through shares to your RRSP. Mr Playfair and Mr Dent are tax partners at Clarkson Gordon, Toronto.