Flow through shares ("FTS") have become a popular form of gifting for donors. The shares are tax-based financing incentives to resource corporations in the oil, gas, mining, renewable energy and energy conservation sectors. These shares were introduced in the 1990s when the mining and resource industry experienced low mineral prices and resulted in a downturn in exploration and were introduced to assist such industries to raise equity through flow through shares.

The FTS is a financing arrangement that permits an investor to invest in exploration by providing funding for the exploration and development activities of a resource corporation. For example, the funding would enable the corporation to incur Canadian exploration expenses, Canadian development expenses or Canadian oil and gas property expenses. The investor would acquire shares issued by the corporation as consideration. Deductions available to the corporation in relation to these resource expenditures would be flowed-through to the investor.[1] Accordingly, the deemed cost of such shares to the investor would be nil, and could result in a significant capital gain when the shares are ultimately sold. If the investor does not sell the shares, but instead donates them to a registered charity, capital gains taxes on the shares would be eliminated, if they are shares of a public corporation.

For example, assume a corporation plans to incur $1,000 of exploration expenses, and a subscriber pays $1,000 and is issued FTS as consideration for the funding. The subscriber enjoys a tax saving of $460 as a result (assuming a tax rate of 46%). If the subscriber gifts the FTS to a registered charity and, assuming the value of the share is, for example, $800,[2] the subscriber will receive a donation tax credit of $800. This will result in a further tax savings of $368. Thus the actual cost to the subscriber will have been approximately $172 and the subscriber will have made a charitable gift of $800.

The example demonstrates how the elimination of tax on the capital gains accruing on donations of publicly traded shares to registered charities when coupled with tax incentives on FTS has generated great interest and planning opportunities. As a result there has been heightened activity by promoters marketing the attractiveness of such shares. If the FTS are acquired for the sole purpose of gifting them to a registered charity then the donation of such shares may be an arrangement that technically qualifies as a tax shelter and thus subject to the tax shelter identification rules even though FTS are generally exempt from the tax shelter identification rules under the Income Tax Act . If a tax shelter is not registered under the Act then the deduction with respect to that tax shelter may be disallowed.

In CRA Income Tax Technical News No. 41 (December 23, 2009), CRA was asked the following question:

"Since both the flow through share rules and the rules to eliminate taxable capital gains from charitable donations of shares of public corporations are incentives aimed at encouraging such subscriptions and donations, what is the CRAs position with regard to whether such donations will be classified as a tax shelter (and subject to the tax shelter registration rules"

The response of CRA was as follows. The definition of "tax shelter" in subsection 237.1(1) of the Income Tax Act[3] ("the Act") includes a "gifting arrangement" which is defined in that subsection as any arrangement under which it may reasonably be considered, having regard to statements or representations made in connection with the arrangement, that if a person were to enter into the arrangement, the person would make a gift to a qualified donee. It should be noted that the exclusion of a flow-through share in paragraph (b) of the definition of "tax shelter" is in reference to the acquisition of a property that is a flow-through share but that has not been acquired pursuant to a "gifting arrangement".

Furthermore, to increase the likelihood that the CRA will allow deductions with respect to the donation of FTS to a registered charity, each FTS/donation arrangement should be registered as a tax shelter under the Act and issued an identification number by the CRA pursuant to subsection 237.1(2) of the Act.[4] The purpose of the tax shelter registration rules is to identify the arrangements that fall within the definition of "tax shelter" for review by the CRA. The CRA has already issued identification numbers in respect of several FTS/donation arrangements, and has published advance income tax rulings on such arrangements in recent years.[5] Each of these rulings relate to FTS/donation arrangements whereby FTS are donated to a registered charity which subsequently sells such shares to " liquidity providers".

CRA also notes that registration as a tax shelter and issuance of an identification number by the CRA in relation to a particular arrangement should not be construed as the CRA approving the arrangement. It also does not mean that a subsequent audit will not result in adjustments.

As a result, investors s who are interested in making donations of FTS to registered charities should ensure that promoters have registered the particular FTS/donation arrangement as a tax shelter and that an identification number has been issued and the investors must provide this identification number to CRA when claiming credits or deductions in respect of the tax shelter.. Furthermore, charities should inform investors of the possible tax shelter requirements that may result from gifting FTS to avoid reputational risks if investors are ultimately denied credits/deductions for failure to obtain a tax shelter identification number.

In the same Technical Newsletter, CRA commented on two recent cases. In the case of Maege v. the Queen, the Federal Court of Appeal considered whether a tax shelter existed in spite of the absence of statements or representations directly made to a taxpayer. The court affirmed the reasoning of the Tax Court of Canada in concluding that a tax shelter could exist in the absence of statements or representations made directly to the taxpayer. The case of Baxter v. The Queen addressed a similar issue. In light of the Maege decision, CRA was asked for its position regarding the significance of statements or representations made in the context of the definition of a tax shelter. The CRA response indicated that the decisions in these cases are consistent with its position that statements or representations do not have to be made to a particular investor in order for a particular investment to be considered a tax shelter.

One of the difficulties for charities which accept FTS is how to value such shares. Many FTS are subject to hold periods and may not retain their value during the hold period, and may not be marketable upon expiration of the hold period. Even when the shares are able to be sold within a short period of time after the charity has received them, the charity must ensure that they have determined the fair value of the shares for receipting purposes. Relevant factors to be considered in addition to the hold periods include the likely maintenance of the shares' value, and marketability of the shares after the hold period has expired. Charities should also consider whether the holding of the shares for a period of time is a prudent investment decision. As a result of all of these issues, charities should consider developing policies regarding donations of flow through shares.