Editorial Thank Wilson for small mercies

There’s no doubt about it. Michael Wilson’s white paper on tax reform proved something of a blow to the mining industry in that it watered down flow-through share financing for mineral exploration. While the bottom didn’t fall out of the popular tax incentive (many in the industry had predicted it would), the attractiveness of this method of financing will almost certainly diminish over the time. But the degree to which flow-through’s popularity will deteriorate is uncertain. The industry will just have to wait and see.

Mr Wilson’s decision to phase out “earned depletion allowance” (which provides a tax writeoff in excess of the amounts actually spent for exploration and development) was unfortunate — though not very surprising. He had said all along that he planned to eliminate special tax incentives, and earned depletion was, without question, a special incentive. The fact that it is doing much more good than harm (especially by contributing to regional development in remote northern communities) seems not to have been grasped by the minister.

In order to create a level economic playing field, with lower over-all tax rates and a broadened tax base, a number of so-called “tax shelters” had to be sacrificed. Flow-through was one of them. (Movies were another. The white paper reduces the writeoff on investment in Canadian television shows and films to 30 per cent from 100 per cent over two years).

The Finance Department is aware that the reduction to flow- through will be a bitter pill to swallow, so the industry will be made to swallow it in stages. The deduction that flows through to the investor will be reduced from 133 1/3 per cent to 116 2/3 per cent on July 1, 1988. It will then be further reduced to 100 per cent on July 1, 1989. The important question to ask, of course, is: will a 100% deduction be sufficiently attractive to investors, considering the high-risk nature of much mining stock. Mining analyst Patrick Mars is doubtful: “These reductions (of earned depletion), together with the modifications to the capital gains exemption applicable upon the subsequent sale of the shares, will adversely impact a junior resource company’s ability to raise risk capital via flow- through shares beyond early 1989.”

Besides the end of earned depletion and new provisions to “investment losses rules” which would limit the ability of investors to shelter their flow-through shares from capital gains (see our lead story on page one), several other clouds are looming on the flow-through horizon. Chief of these is the planned cutback in tax-free capital gains to $100,000 from $500,000 and an increase in the rate at which capital gains are taxed (75% beginning in 1990, compared to 50% today). What this means is that, for future sales of flow-through shares, capital gains will be severely taxed. This is outrageous and will probably render flow-through unattractive to many investors.

On the other hand, there are virtually no other tax shelters left in Canada (the Finance Department has systematically shut down almost all of them over the past years). And mining may very well benefit from the fact that other industries are unable to pass off any tax writeoffs to investors. There is really nothing comparable to flow-through.

Another plus is that tax reform will serve to bring Canada’s tax system more in line with that of the U.S. reform, causing us to be reasonably competitive with our neighbors to the south.

Let’s hope the industry adjusts to Mr Wilson’s new provisions. The mining sector put forth a strong lobby on behalf of flow-through, and we should all feel relieved that the mechanism itself was retained. Thank God (or Michael Wilson) for small mercies.