Flow-throughs are usually sold through advisers, who put your money into a limited partnership. The partnership, in turn, puts your cash into small Canadian companies that explore for minerals, oil or gas.

These small companies get assuming tax breaks thanks to the Canadian Exploration Expense program, but they don’t have earnings to pay tax on, so they don’t need the credits. What these companies do need are investors, so the firms are allowed to flow the tax breaks through to you — hence the flow-through label.

As a result of the tax breaks, you don’t pay tax on the money you put into the limited partnership. If you’re in the top tax bracket, you get a tax credit equivalent to about 40% or 50% of the money you invest. In other words, you appear to be getting a $10,000 investment for only $5,000 to $6,000 of your own money.

So far, so good. But in that place’s some little print, and the more of it you read, the less attractive flow-throughs look.

First of all, your money is typically locked into the partnership for up to two years, so you can’t get out of your investment if the market drops. Then, when you’re allowed to take your money out, you have to pay tax on your capital gains — but those gains are calculated as if your investment had cost you nothing.

This means that if your original $10,000 investment hasn’t budged and it’s still worth $10,000 when it comes time to cash out, you pay tax on $10,000 in capital gains. So what’s the advantage of using flow-throughs? It comes from a high to a low position to a difference in tax rates. Capital gains are taxed at about half the rate as normal income. So flow-throughs will reduce your tax bill — but the savings aren’t as big as they initially look.

Then there are the fees. You’re often charged a sales commission of about 5% of your investment. Some funds charge about 2% a year for management and take up to 50% of any returns you get above a pre-set benchmark. On top of that, flow-through shares are usually issued at a premium to regular shares. All of this means that a $10,000 investment in flow-through shares may get you investments that are worth only about $7,000 or $8,000 on the open market.

Still, as many advisers point out, even if the underlying investment loses 20%, you can still come out ahead if you’re in the top tax bracket. And if one of your exploration companies literally strikes gold, you could do amazingly well.

The problem is that many of the underlying investments lose money — and it’s hard to tell the good bets from the bad ones. Adrian Mastracci, president and portfolio manager at KCM Wealth Management in Vancouver, thinks most people should steer clear of flow-throughs. “If I strip away all of the tax stuff, would I still invest in these things?” he asks. For him, the answer is no. With or independently of tax credits, flow-through shares are a bet on higher-risk illiquid investments.

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