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For Quebeckers, it pays to play at home

Fabrice Taylor is a chartered financial analyst.

ftaylor@globeandmail.com

If you could make a potentially risky investment with up to two-thirds of your capital effectively insured by the government, would you?

Given that "potentially risky" implies potentially rewarding, the answer is probably yes because that insurance policy cuts your risk while leaving your potential upside intact. That's the essence of flow-through investing.

A column a couple of weeks ago on the subject yielded an e-mail from a Montreal broker who spelled out a little-known detail about flow-through investments in Quebec. It makes you want to move there.

If you're like me, your eyes start to glaze over when you think about taxes, but getting a better deal from your silent partner in Ottawa - i.e., the taxman - is the easiest way to increase your wealth. It's worth the effort, so stay with me.

Quebeckers are often deprived of the things we take for granted, such as those contests that aren't open to residents of la belle province. They're also deprived of a lot of investment opportunities because the cost of doing business there - such as translating financial literature into French and the language barrier in general - is prohibitive, especially for smaller offerings.

Yet smaller funds are often the best ones, and Quebec, whose tax system is semi-autonomous, gives its residents rich tax breaks on flow-through offerings - but only certain ones (more on that later).

In the rest of Canada flow-through investments are 100-per-cent tax deductible: For every buck you invest, your taxable income drops by a buck. In Quebec, however, for every buck you invest your taxable income drops by as much $1.44. On top of this, there are capital-gains benefits to flow-through investments in Quebec.

These numbers come from the literature for the Jov Diversified Quebec flow-through fund, which our Montreal broker pointed me to, asking why the benefits are so much better in this province. The answer is typical of Quebec. The province, not surprisingly, gives better tax breaks if the money is invested at home.

If you live in British Columbia and buy flow-through investments, it doesn't matter if all the money is invested in Alberta; you'll get your tax break. Not so in Quebec. Money invested elsewhere gets less of a deduction - substantially so. But money invested domestically can yield the prodigious benefits mentioned above.

There are lots of resource plays in Quebec, of course, but if I lived there and wanted flow-through shares, I probably wouldn't want a fund that invested only locally. For starters, you're practically shut out of the oil-and-gas sector if you're only in Quebec. (It has some marginal gas resource, but that's about it.)

But even if you run the numbers at 75 per cent - the Jov flow-through fund says that's minimum it will invest in Quebec but judging from the attention energy gets in the literature, I wouldn't be surprised if it were the maximum - the tax breaks are still outstanding in relative terms, as the accompanying table shows.

The Jov fund has one of the hottest managers in the sector right now, but there are other products offered by fund managers Mavrix Fund Management and Pathway Asset Management. Be careful about one thing: Some funds offered in Quebec are national, meaning they don't benefit from the uniquely nationalistic tax largesse the province offers.

There's a second point worth making about these investments in general. A good barometer of future success in a particular investment is how well it's selling. When no one wants to buy stocks, buy them. When no one wants to buy natural gas, buy gas.

When no one wants to buy flow-through investments, buy flow-through investments. This year is not shaping up to be a great year, with $340-million raised so far and it looks like it might finish at $400-million. The number was $2-billion in 2007.

Clearly, you didn't want to be a buyer in 2007, when $2-billion became roughly $300-million - because there was too much money chasing a limited and finite amount of success.

Using this yardstick, this year looks like it'll be a lot better, especially for our Québécois brothers and sisters.

***

Vive la différence

Quebeckers have more fun when it comes to tax breaks for resource companies

Outside Quebec Quebec
Quebec 100% 75%**
Assumed marginal tax rate45%48.2%48.2%
Investment amount$5,000$5,000$5,000
Net flow-through share and other tax savings$2,408$3,450$3,189.50
Capital gains tax*-$1,125-$606-$735.75
Total tax deductions $1,283$2,844$2,453.75
At-risk capital$2,641$1,600$1,860.25
Break-even proceeds$3,345$1,821$2,202
Downside protection33%64%56%
*Assumes the investment is sold for $5,000.
**Estimate.
Source: The Globe and Mail

© 2007 The Globe and Mail. All rights reserved.

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