SmartInvesting.ca

List of Articles

Resource tax shelters have produced sizeable after-tax gains for investors

by Wayne Cheveldayoff, 2006-10-26

Resource tax shelters have made a lot of money for Canadian investors in recent years and this is likely to continue if commodity markets remain reasonably strong – something that is likely if Asian economies continue to grow rapidly.

There currently are about a dozen resource tax shelters being marketed to investors.

An example of one of the larger ones is Canada Dominion Resources 2006 II Limited Partnership, managed by Goodman and Co. Investment Counsel, which also manages Dynamic Mutual Funds.

The prospectus (available at www.sedar.com) shows that previous Canada Dominion Resources partnerships have provided investors with high after-tax returns.

The 2003 partnership produced a compound annualized after-tax return of 44.8 per cent from the initiation date of December 4, 2003 until the partnership was converted into a mutual fund on February 7, 2005.

Investors in the subsequent 2004 partnership obtained an annualized return of 31 per cent from June 1, 2004 to February 17, 2006.

The 2005 partnership was up 99.6 per cent over 16 months to the end of August 2006.

Since 1998, there have been 16 Canada Dominion Resource partnerships that have raised $743 million from more than 14,000 investors.

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

Resource explorers, particularly small ones that have more deductions than revenues, are allowed to flow excess deductions and credits through to investors via specially created flow-through common 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.

Anyone investing $10,000 in the Canada Dominion Resource partnership would be able to claim the full $10,000 as a deductible expense against other income in 2006 (assuming the alternative minimum tax is not triggered).

For an investor in Ontario at the highest tax bracket (46.4-per-cent marginal rate), the flow-through deductions and credits would trigger tax savings of $5,180 and thereby reduce the after-tax purchase cost to $4,820 (known as money at risk), according to the prospectus. The comparable after-tax cost would range from $4,590 in Newfoundland (where the marginal tax rate is highest) to $5,570 in low-tax Alberta.

When the partnership units are dissolved in about 18 months, investors will have to pay capital gains taxes on anything received at that time (since the deductions effectively lower the adjusted cost base of the original investment to zero), although this can be further postponed if investors choose to roll the partnership units into mutual fund units. If so, capital gains taxes would need to be paid only when the mutual fund units are sold later.

At dissolution of the partnership or eventual sale of the mutual fund units, the proceeds received would only have to be $6,270 to breakeven on an after-tax basis for an Ontario investor at the highest tax bracket ($6,070 in Newfoundland and $6,920 in Alberta).

Fees going to the managers include a 2-per-cent annual management fee, plus an incentive bonus of 20% of anything the partnership earns above a 12-per-cent return. There is also an agent’s fee of 6.75 per cent going to the selling broker.

Other partnerships for which prospectuses have been filed at Sedar recently include: MSP 2006 Resource Limited Partnership; MRF 2006 II Resource Limited Partnership; Mavrix Explore 2006 – II FT Limited Partnership; FrontierALT Energy 2006-II Flow-Through Limited Partnership; Fairway Energy (06) Flow-Through Limited Partnership; Enervest FTS Limited Partnership 2006 II; Catapult Energy Small Cap FTS Limited Partnership; Qwest Energy 2006-II Flow-Through Limited Partnership; and Northern Precious Metals 2006 Limited Partnership.

While the tax shelter aspect is appealing, resource tax shelters are not be for everyone. They are basically for those in high tax brackets who have a fair amount already socked away for emergency purposes and in RRSPs and still have funds available for investment.

It is also important to keep in mind that these tax shelters are a bet that the resource sector will continue to do well and that the managers will invest in enough companies that are sufficiently successful in their exploration activities to sustain the value of the common shares being held by the partnership and thereby allow investors to profit.

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.

The URL for this page is http://www.smartinvesting.ca/articles/20061026010100.html .


©2006 Wayne Cheveldayoff