Flow-Through Shares Explained

What are flow-through shares in Canada?

Start with the problem the mechanism solves. A junior exploration company spends money on geologists, drills, assays and helicopters, and earns nothing. Every dollar it spends on exploration is a legitimate business expense that Canada's tax code lets it deduct, but a deduction is only worth something to a taxpayer with income to shelter. A company with no revenue simply accumulates tax pools it may never use. Meanwhile the people funding that company, its shareholders, often do have income they would like to shelter.

A flow-through share moves the deduction from the party that cannot use it to the party that can. Under the Income Tax Act, a "principal business corporation" engaged in mining, oil and gas, or certain renewable projects can sell shares under a flow-through share agreement. The company agrees to spend the money on eligible exploration and then to renounce those expenses to the subscriber. Renouncing means the company gives up its right to deduct the expense, and the investor acquires that right instead, as if they had drilled the holes themselves.

So what is a flow-through share, mechanically? It is an ordinary common share. There is no separate class, no different voting right, no preference on liquidation. The only thing that distinguishes it from the share trading on the exchange is the contract under which it was sold and the tax consequences that contract triggers. Once the renunciation is filed and the resale restriction expires, a flow-through share is indistinguishable from any other share in the float.

The policy goal is straightforward. Canada wants grassroots exploration to happen on Canadian ground, exploration is the riskiest and least fundable stage of the mining cycle, and the government is willing to forgo tax revenue to keep drills turning. The mechanism has existed in one form or another since the 1950s and, together with the credits described below, is the reason a large share of the exploration dollars raised on the TSX Venture Exchange every year are flow-through dollars.

How flow-through shares work in Canada, step by step

The sequence runs the same way for a $500,000 raise by a two-person explorer and a $20 million raise by a well-followed developer.

1. The company announces a placement. It may be entirely flow-through or, more often, a mix of flow-through shares and "hard-dollar" units. The announcement states the price of each, how many are being sold, and what the flow-through proceeds will be spent on.
2. You sign a flow-through subscription agreement. This is a longer document than a standard one because it contains the company's covenant to incur and renounce eligible expenses by a set date, and usually an indemnity if it fails. Our subscription agreements guide walks through the clauses.
3. The company spends the money on eligible exploration. The rules allow a "look-back": under the general rule the company can renounce expenses effective December 31 of the year the agreement was signed as long as the money is spent by the end of the following calendar year. That is why so many flow-through raises close in the fourth quarter. Investors want the deduction in the current tax year; the company gets a year to do the work.
4. The company renounces the expenses and files with CRA. You receive a T101 slip (or, for a limited partnership, a T5013) showing the amount of Canadian Exploration Expense renounced to you and the portion eligible for the federal credit.
5. You claim the deduction and the credits on your return. The CEE is deducted from income. The credit, if the work qualifies, reduces tax payable. Your adjusted cost base in the shares is deemed to be nil.
6. You hold four months, then decide. The shares carry a resale legend for four months and a day. After that they are free trading and, if you sell, the whole proceeds are a capital gain because your cost base is zero.

Two details deserve emphasis. First, the deduction is only as good as the company's compliance. If it fails to spend the money on eligible work, or spends it late, CRA can deny or reduce the renunciation, and the company faces penalty tax under Part XII.6 of the Act. The indemnity in the subscription agreement exists for that reason, though an indemnity from a company that ran out of money is of limited comfort. Second, the look-back rule means you deduct in one year money that is spent in the next. It is the timing feature, more than the deduction itself, that makes December flow-through financings a fixture of the junior calendar.

CEE vs CDE in plain terms

The Act sorts resource spending into pools, and two of them matter here.

Canadian Exploration Expense (CEE) is money spent to find out whether a mineral resource exists: prospecting, geological and geophysical surveys, geochemical sampling, trenching, and drilling before a decision to build a mine. CEE is deductible at 100% in the year incurred. This is the pool that flow-through shares are built around, and it is the only pool that can earn the federal exploration credits.

Canadian Development Expense (CDE) is money spent to bring a known resource toward production: sinking a shaft, driving a decline, acquiring a mineral property, and, since the rules were tightened in the last decade, most pre-production mine development that used to be treated as CEE. CDE is deductible on a declining-balance basis, 30% a year, rather than all at once. CDE can also be renounced through flow-through shares, but it cannot earn the exploration credits, and because the deduction is spread over years it is worth considerably less to an investor.

The practical point for a reader of financing announcements: a flow-through raise by a grassroots explorer is almost always CEE and is often eligible for a credit. A flow-through raise by a company that is building a mine may be renouncing CDE, with a slower deduction and no credit. The announcement should say which, and the difference changes the after-tax math materially. Where the announcement is vague, the expense type is the first question to ask the company.

The 15% METC, the 30% CMETC, and provincial stacking

The deduction alone would make flow-through attractive. The credits layered on top are what make it the most tax-efficient equity purchase available to a Canadian individual.

The federal Mineral Exploration Tax Credit (15%)

The METC is a non-refundable federal credit equal to 15% of eligible "flow-through mining expenditures" renounced to an individual. Eligible spending is, broadly, grassroots surface exploration in Canada: work to determine the existence, location, extent or quality of a mineral resource, as opposed to work on an existing mine. It is available to individuals and to individuals investing through partnerships, not to corporations. Introduced as a temporary measure in 2000, it has been extended repeatedly, usually a year or two at a time, and each extension comes with a new expiry date for the agreements that qualify.

The Critical Mineral Exploration Tax Credit (30%)

Introduced in the 2022 federal budget, the CMETC doubles the rate to 30% for exploration that primarily targets minerals on Canada's specified list, a list that includes copper, nickel, lithium, cobalt, graphite, rare earth elements, uranium and others, and which Ottawa has expanded since. To qualify, a qualified person under NI 43-101 must certify that the project is reasonably expected to be primarily a critical minerals project. An investor cannot claim both the METC and the CMETC on the same dollar of expense. The credit has its own legislated end date for qualifying agreements, which has also been pushed out at least once. If you want to see which explorers are positioned for the higher credit, our critical minerals company list is the place to start.

Provincial credits stack on top

Several provinces add their own incentive for exploration carried out within their borders. Quebec offers additional deductions beyond the federal ones for eligible exploration in the province. British Columbia, Saskatchewan and Manitoba each run a provincial mining flow-through or exploration tax credit that applies alongside the federal credit. Ontario has a smaller focused flow-through credit for eligible Ontario exploration. The rates differ widely between provinces, some are permanent and some are renewed periodically, and the definition of eligible spending is not always identical to the federal one.

Because the federal and provincial credits are combined with a deduction at a high marginal rate, the after-tax cost of a flow-through subscription to a top-bracket investor in a generous province can fall well below half of the cash invested, and in the best combinations lower still. Precisely how far depends on the province, the mineral, the year and the investor's own bracket, and every one of those inputs moves. Check the current federal rules on the CRA website and the relevant provincial ministry before assuming any rate, and keep in mind that a credit received reduces the cost base of the shares to nil and that alternative minimum tax can claw some of the benefit back in the year of the claim.

The premium and the four-month hold

Nothing in the tax code requires flow-through shares to be priced above market. The market does that on its own. Because the buyer receives a deduction the company does not value and a credit the company cannot use, the buyer is willing to pay more per share than a hard-dollar buyer would, and the company captures part of that willingness as a higher issue price. The gap is the premium.

Premiums vary with the tax environment and the company. A junior with a hot drill program and critical minerals eligibility can command a premium of 30% or more over the market price, sometimes with no warrant attached. A junior raising in a weak tape may sell flow-through at a premium of 10% or less and still have to include a half warrant. The same raise will often price the hard-dollar units at a discount to market. The distance between the two prices is a direct read on how much of the tax benefit the company was able to capture for itself, and it is one of the more useful signals in a financing announcement.

The second cost is time. Securities sold by private placement in Canada are subject to a restricted period under National Instrument 45-102 of four months plus one day from the closing date, during which the shares cannot be resold on the exchange. That is the same hold that applies to a hard-dollar private placement, but it matters more for flow-through because the buyer has already paid up and often has no warrant to soften a decline. Four months is long enough for a junior to release two sets of assays, run out of money, or both. The premium you paid in October can look very different by the time the legend comes off in February.

The liquidity discount: why flow-through paper sells off after the hold

If you have watched a junior drift lower for no visible reason in the fourth or fifth month after a large financing, you have seen the liquidity discount at work. It is the least understood part of flow-through and the one that most often costs new investors money.

Consider who buys flow-through. A meaningful share of the money comes from flow-through limited partnerships whose business model is to deliver the tax deduction to their unitholders, collect a fee, and convert the portfolio to cash or to a mutual fund on a fixed schedule. Another share comes from individuals who wanted the deduction more than they wanted the stock. Both groups have a cost base of zero, both have already banked most of their return through the tax system, and both are free to sell the day the four-month legend expires. A partnership that bought at a 25% premium and can sell at a 25% discount to that price has still done well for its investors on an after-tax basis. The stock price is almost incidental to it.

The result is a predictable overhang. Shares that were issued at a premium reach the market en masse with holders who are indifferent to price, and the stock trades down until enough fundamental buyers absorb the supply. Investors who follow juniors closely track the closing dates of flow-through raises for exactly this reason. Our dilution tracker shows when each company's recent placements were issued and therefore when their restricted periods end, and the closed financings database records the size, price and structure of every completed raise so that you can judge how large the overhang will be.

Two things follow. If you are a flow-through subscriber, do not assume you will be able to exit at your entry price after four months; plan to hold through the overhang or to accept the discount as part of the cost. If you are a common shareholder, or a prospective one, the window after a large flow-through raise frees up is frequently the cheapest entry a junior will offer between discoveries.

Flow-through vs common shares: both sides of the trade

"Flow-through vs regular shares" is the question most readers arrive with, and the honest answer is that it depends on which side of the transaction you are on. The same feature that is an advantage to the issuer is a cost to a certain kind of buyer.

From the company's side

Juniors love flow-through because it is cheaper capital. Every share issued dilutes existing holders, and flow-through raises more money per share issued than a hard-dollar placement at a discount. A company selling one million flow-through shares at a 25% premium raises roughly 40% more than it would selling the same million hard-dollar shares at a 10% discount, and it can often do so without attaching a warrant that would dilute holders again later. The company gives up nothing it values, since its own tax pools are unusable, and in a weak market flow-through is frequently the only tranche that fills. The only real constraints are that the money must be spent on eligible Canadian exploration, not on salaries, marketing or foreign projects, and that the spending clock is running.

From the investor's side

The deemed-nil cost base is the part that surprises people. With a common share you are taxed only on the increase in value. With a flow-through share you have already deducted the purchase price, so the government treats every dollar you get back as profit. Because capital gains are included in income at a fraction of their value, half at the time of writing, while the deduction came off income in full, you still come out well ahead. You are converting a fully deductible outlay into a partially taxable gain, and deferring the tax on that gain until you choose to sell. That conversion, not the credit, is the core of the flow-through vs traditional equity comparison in mining.

The trade-off is the premium and the absence of a warrant. A hard-dollar unit bought at a discount with a full warrant gives you a cheaper entry and a second bite if the stock runs. A flow-through share gives you a tax result that is largely locked in on the day you subscribe, regardless of what the stock does afterwards. Which is better depends on your bracket and your conviction in the company, which is the subject of the next section.

When to choose flow-through shares, and when not to

Flow-through is a tool for a specific investor. It suits you if most of the following are true.

• You are a Canadian resident paying tax at a high marginal rate. The deduction is worth your marginal rate times the amount invested. At the top bracket in most provinces that is over half. At a low bracket it may not cover the premium.
• You are investing from a taxable account. Flow-through shares held in an RRSP, TFSA or other registered plan produce no deduction, because the plan does not pay tax. You would be paying a premium for nothing.
• You already want to own the company. The tax benefit reduces the cost of a position; it does not make a bad explorer a good one. Run the company through the same process you would use for any junior, and let the tax outcome be the bonus rather than the thesis.
• You can hold through the four-month legend and the selling that follows. If you need the money back in six months, the liquidity discount is likely to eat a large part of the benefit.
• You have income this year that you want to shelter. A bonus, a business sale, a large capital gain elsewhere. The look-back rule lets you deduct in the current year money the company spends next year, which is why so much flow-through is bought in December.

It does not suit you, and you should buy the common shares instead or not at all, if you are a non-resident of Canada with no Canadian taxable income, if the investment would sit inside a registered account, if your income is low enough that the deduction is worth less than the premium, or if you intend to trade the position rather than hold it. Corporations can subscribe for flow-through shares and receive the CEE deduction but cannot claim the METC or CMETC, which removes a large part of the appeal. Anyone near the threshold for alternative minimum tax should model the year before subscribing, since a large flow-through deduction is exactly the kind of preference item AMT is designed to catch.

Charity flow-through structures

A large part of the flow-through market is now sold through what the industry calls charity or donation flow-through. The structure has three parties. A donor subscribes for flow-through shares and receives the CEE deduction and credits in the usual way. The donor then immediately donates the shares to a registered charity and receives a donation tax credit for their fair market value. The charity, which has no use for illiquid junior mining paper, sells the shares the same day to a pre-arranged liquidity provider at a discount, and keeps the cash.

Stacked together, the exploration deduction, the federal and provincial credits and the donation credit can bring the donor's after-tax cost of a gift down to a small fraction of the amount the charity receives. The rules were tightened in 2011 so that the capital gain exemption on donated shares does not apply to the portion of the gain below the donor's original cost, which reduced but did not eliminate the benefit. The structure is arranged by specialist firms, involves several agreements signed in sequence, and is used by high-net-worth Canadians who would be making the donation anyway. From the explorer's point of view it is simply a flow-through financing with a very reliable buyer; from the market's point of view, the liquidity provider is a seller from day one of the free-trading period, which adds to the overhang described above.

Where to buy flow-through shares

You cannot buy flow-through shares on the exchange. Once a share is trading it is a common share, and the deduction went to whoever subscribed for it. Flow-through is bought at issue, and there are three routes in.

1. Private placement participation through a broker

Full-service brokerages that work in the resource space are offered allocations in placements by the issuer or the agent running the deal, and pass them on to clients who qualify. Qualifying usually means meeting a prospectus exemption under National Instrument 45-106, of which the most common is accredited investor status: broadly, an individual with net financial assets above $1 million, net assets above $5 million, or income above $200,000 (or $300,000 with a spouse) in each of the last two years with a reasonable expectation of the same this year. Other exemptions exist, including a minimum-investment exemption, the offering memorandum exemption, and the listed issuer financing exemption introduced in 2022 that lets eligible listed companies sell freely tradeable shares to retail investors under a short disclosure document. Whether a given flow-through tranche is available under one of those routes is up to the issuer and the agent.

2. Flow-through limited partnerships and funds

A flow-through limited partnership raises money from individuals, typically with a minimum in the low thousands of dollars and sold through advisors under a prospectus, and subscribes for flow-through shares across a basket of explorers. The deduction and credits flow to unitholders on a T5013 slip. After a set period, commonly one to two years, the partnership rolls into a mutual fund on a tax-deferred basis or liquidates. The advantage is diversification and no need for accredited status; the disadvantages are fees, no control over which companies are bought, and the partnership's own selling schedule, which is a large part of the liquidity discount discussed above. Flow through investments of this kind are the way most Canadians who own flow-through own it.

3. Directly from the company

Every financing begins with a news release, and smaller placements are frequently filled by the company's own shareholders and contacts without a broker in the middle. Reading the release, contacting investor relations and signing a subscription agreement is a normal way to participate, provided you qualify under an exemption. Our open financings page lists every junior mining raise currently accepting subscriptions, flags which tranches are flow-through, and lets you register the amount you want through the company's profile. The financings report tracks what has been announced and closed across the sector week by week, and the financing flow tool shows where flow-through money has been concentrating by commodity and by province, which is a reasonable proxy for where the credits are most generous.

How to read a flow-through announcement

A typical release reads something like: "The Company announces a non-brokered private placement of up to 4,000,000 flow-through shares at $0.30 per share and up to 5,000,000 units at $0.22 per unit, each unit consisting of one common share and one-half of one warrant exercisable at $0.35 for 24 months, for aggregate gross proceeds of up to $2,300,000. The gross proceeds from the flow-through shares will be used for Canadian Exploration Expenses that qualify as flow-through mining expenditures on the Company's properties in Ontario." Here is what to pull out of it.

• Flow-through price vs hard-dollar price. Here $0.30 against $0.22, a 36% premium of the flow-through over the unit price. Compare both with the closing price before the announcement. A wide gap tells you the company was able to charge fully for the tax benefit; a narrow one tells you it could not.
• Warrants. The units carry a half warrant; the flow-through shares carry none. That is normal, and it is a real difference in what each buyer gets for the money.
• "Flow-through mining expenditures." That phrase, rather than plain CEE, signals the spending is intended to qualify for the METC. If the release says "critical mineral flow-through shares" or cites the CMETC, the company is asserting the 30% rate; ask whether the qualified person's certification is in hand.
• Province and property. Determines which provincial credit, if any, stacks on top.
• Size relative to the float. Nine million new shares against, say, 60 million outstanding is 15% dilution, and four million of those will arrive on the market in a single block four months after closing. Our dilution tracker does the arithmetic across every placement a company has done.
• Finder's fees and insider participation. Usually further down. Insiders buying the flow-through tranche is a mild positive; insiders confined to the cheaper unit tranche while outsiders take the premium paper is worth noticing.

None of this replaces the fundamental work. A flow-through subscription is still a bet on a drill program, a management team and a jurisdiction, and the tax result only improves the odds; it does not change what is in the ground. Use the same checklist you would apply to any explorer, and browse the financing history on any profile in our company database to see how a company has treated its flow-through subscribers in previous rounds. Nothing on this page is tax advice; before subscribing, confirm the current credit rates, sunset dates and eligibility rules with the CRA, the relevant province, and your own accountant.

Frequently Asked Questions

Related

• How to Evaluate a Junior Mining Stock: a 10-point checklist
• How Junior Mining Companies Raise Money (Pillar Guide) →
• Private Placements and Warrants →
• Subscription Agreements Guide →
• Critical Minerals Companies (30% CMETC candidates) →
• Glossary: Flow-Through Shares →
• Financing Flow (Tool) →