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Resource tax shelters offer appealing tax savings to investors

by Wayne Cheveldayoff, 2005-09-15

Mavrix Fund Management recently kicked off the fall season for resource tax shelters with its offering of the Mavrix Resource Fund 2005-II Limited Partnership.

Resource tax shelters offer investors the opportunity to invest in a basket of junior mining and oil and gas explorers with the added benefit of a tax deduction for the full amount invested.

Such shelters have made a lot of money for investors in recent years and this is likely to continue if resource prices remain high.

Previous Mavrix limited partnerships have returned solid double-digit gains on an after-tax basis. For example, as the prospectus (see www.sedar.com) for the latest offering notes, the MRF 2004-I partnership recorded a 51 per cent after-tax cumulative return from inception in the first half of 2004 to July 31, 2005 for a resident of Ontario.

The MRF 2004-II partnership, initiated later in 2004, produced a 30-per-cent gain to July 31, 2005, while the MRF 2005-I partnership, with a start date in early 2005, had already gained 36 per cent by July 31, 2005.

The resource tax shelters take advantage of the special federal tax deductions designed to encourage oil and gas and mining exploration.

Resource companies, particularly small ones that have more deductions than revenue, are allowed to flow excess deductions through to investors via specially created flow-through shares.

The limited partnerships buy these flow-through shares and investors in the partnership units – generally people in high tax brackets – then use these deductions for themselves.

Because these deductions are valuable, resource companies can usually extract a premium from the market for the flow-through shares. Cinch Energy, a Calgary based oil and gas explorer, recently issued regular common shares at $3.40 per share but at the same time also issued flow-through shares at $4.25 per share – a 25-per-cent premium.

Anyone at the highest tax bracket investing $10,000 in Mavrix’s MRF 2005-II partnership will be able to claim close to $10,000 as a deductible expense against any other income in 2005 (assuming the alternative minimum tax is not triggered).

For the highest-bracket investors in Ontario, the deduction would trigger tax savings and thereby reduce the after-tax purchase cost to $4,851, according to the prospectus. The comparable after-tax cost would be $4,812 in New Brunswick and $5,522 in Alberta where the highest marginal individual income tax rate is 39% (versus around 46 per cent in Ontario and New Brunswick).

When the partnership units are dissolved in approximately 18 months, investors will have to pay capital gains taxes on anything received at that time (since the deduction effectively lowers the adjusted cost base of the original investment to zero), although this can be further postponed.

Part of the advantage of resource tax shelters is that investors don’t have to pay capital gains tax in the year the partnerships are dissolved. Instead, if they choose to roll the partnership units into the units of a resource mutual fund, taxes would need to be paid only when the mutual fund units are sold later.

At dissolution of the partnership or eventual sale of mutual fund units, the proceeds received would only have to be $6,317 to breakeven on an after-tax basis for an Ontario investor at the highest tax bracket ($6,284 in New Brunswick and $6,860 in Alberta). While nothing is guaranteed, this is something that should be fairly easy for the managers to achieve – particularly if the resource boom continues – since close to $10,000 is originally being invested.

For managing the partnership, Mavrix gets a 2.25-per-cent annual management fee, plus an incentive bonus of 20 per cent of anything the partnership earns above a 12-per-cent annual return. There is also a 7.75-per-cent agents’ fee paid up front to investment advisors.

While Mavrix was first out of the gate this fall, there will soon be more resource tax shelters to choose from.

While the tax-shelter aspect is appealing, resource tax shelters aren’t for everyone. They are basically for those who have topped up their RRSPs, paid off their mortgages, tucked away some money for emergencies, and still have funds available for investment.

Another important consideration is the outlook for resource prices. If you don’t think the boom will continue, you probably should stay clear.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.


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©2005 Wayne Cheveldayoff