Flow Through Shares: Investors and Governments beware - Report

CALGARY, Feb. 4, 2016 /CNW/ - Canada's tax code allows the use of flow-through shares on the assumption that they are a good way to spur new productive exploration and are also beneficial to investors. In reality, it appears that they are bad for both.

Flow-through shares (FTS) are a special type of common share issued by oil and gas or mineral exploration companies that allow the corporation to renounce, or "flow through" certain expenses that it has incurred to investors. They are designed for corporations that cannot make use of expense deductions from their taxes and so, through the use of these special type of shares, can pass along their expenses for shareholders to deduct from their own income taxes.

A report released today by The School of Public Policy and author Vijay Jog, examines rates of return earned by investors in FTS issued during the 2008–12 period and premiums received by companies issuing them. According to Jog, "While justification for FTS is that they promote activity in the oil and gas and mining exploration and development sectors, it is unclear whether investors received a reasonable rate of return."

FTS cost government $300 million in foregone tax revenues, however, "our overall conclusion is that FTS seem to do more harm than good and that the time has come to reconsider the wisdom of providing tax incentives such as FTS for investments in particular sectors of the economy."

The steepest price has arguably been borne by investors, with returns on flow-through shares performing poorly. For small companies that issued these shares, the annualized absolute return was a nearly 100 per cent loss. For larger companies, the returns were not as bad — negative 14 per cent — but still a loss. And if adjusted for corresponding benchmarks, the returns were even worse. From the $2.5 billion raised from Canadians using flow-through shares, investors have lost $1.2 billion.

They have hurt investors. They have hurt economic efficiency. They have distorted market competition. The incentives created by flow-through shares can only run counter to any desires among federal and provincial governments to diversify economies and reduce dependency on mineral and fossil fuel resources. And even where it remains a goal to increase investment in such resources. It is clear that flow-through shares or tax incentives similar to this policy mechanism are a poor way to achieve it.

The papers can be downloaded at http://www.policyschool.ucalgary.ca/?q=research

SOURCE The School of Public Policy - University of Calgary

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