Flow-through funds are tax shelters that mainly invest in the flow-through shares issued by junior mining and oil companies. These companies spend the proceeds from the shares they sell on mineral exploration and development, an activity that qualifies for certain tax credits and tax deferrals. These tax benefits “flow through” to investors in the fund. To take advantage of these benefits, investors need to hold the funds for a fixed period, usually 18 months to two years.
The problem with these tax shelters is that they may persuade you to make a risky investment you wouldn’t otherwise make. Moreover, a portion of the benefits are set aside for brokers and the fund’s organizers. What’s left may not be enough to pay you for taking on the extra risk, especially this year.
These tax shelters may post excellent results from time to time. However, as the current climate for resources and commodities shows, booms don’t last forever.
Keep in mind that most flow-through issuers are junior companies that are short on financing, or don’t have enough income to make full use of the tax benefits associated with their exploration. That’s why they sell these benefits to investors.
One example of this we saw was a flow-through fund that was set up so that you’d break even in two years if the underlying companies dropped 38%. But breaking even after two years is not a particularly attractive investment outcome. And, as we’ve seen recently, junior oil and mining stocks can drop a lot more than 38% in two years!
Now is a bad time for safe-money investors to buy junior mines and oils, directly or through tax shelters like flow-through funds.
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