Vitality of Canadian mining depends on flow through

The vitality of Canada’s exploration and mining industry depends heavily on the preservation of flow- through financing in a viable form. The tax reform measures announced by Finance Minister Michael Wilson last Dec 16 fall short of accomplishing this goal.

These changes, when combined with the present state of the stock market, will seriously hamper our industry’s ability to raise risk capital for mineral exploration in Canada. The mining industry has made a major contribution to the Canadian economy and, as a result of the benefits of flow-through financing, is on the verge of dramatically improving the level of employment and prosperity in many traditionally economically depressed regions. And yet, this highly successful government program is being severely weakened by the proposed new tax regulations.

As documented in the January issue of The Northern Miner Magazine, 32 new mines have committed to come on-stream in 1987 and 1988, largely because of the stimulation provided by flow-through share funding.

The Prospectors and Developers Association of Canada is concerned that the planned tax reform will lead to a major downturn in the fragile mining industry. Economic instability

The mining industry is well known for its tendency to suffer from boom-and-bust cycles. Metal prices change abruptly from time to time, but the long lead times required to hire staff, develop programs, and locate and drill targets, have often led to an inability to make the most of periods of favorable gold and other commodity prices. This means that all too often projects started in good times are terminated at the beginning of an economic slowdown. Like agriculture and other resource-based industry, the mining industry needs the support of a favorable tax environment to reach its potential — without suffering the devastation that follows periodic downturns.

Since 1983, flow-through financing has given the industry a life- saving boost and this has created the current vigor. But the next wave of production committals will depend on continued financial support of advanced exploration projects. A quick count has identified 58 such projects across Canada which are candidates for advancement to producer status: five in British Columbia, two in the Northwest Territories, two in Saskatchewan, two in Manitoba, 18 in Ontario, 24 in Quebec, one in New Brunswick and four in Nova Scotia.

The income from the operations of the already-committed and potential mines will lead to significantly increased tax revenues as a result of the short-term reduction in revenues based on flow-through tax sheltering. Economically weak regions

Many northern and rural communities, especially the resource- based, single industry towns, have benefited significantly in terms of dollars and employment at a crucial time when many of them were wrestling with serious, sometimes almost desperate, economic conditions.

Flow-through stimulation works at the core level of the community, affecting the prosperity of the retail, service and professional sectors, as well as the mining community itself. It works in a relatively short time frame and in an equitable, objective manner which no government grant system or transfer payment scheme could possibly duplicate. Also important is the fact that the system works without the necessity of bureaucratic overhead.

There are numerous examples of how successful flow-through financing has been. G. F. Pearce, clerk administrator of Smithers, B.C., reports significant increases in sales for a number of area businesses: heavy equipment rentals, trucking contractors, vehicle rentals and purchases, drilling contracts, local suppliers, local accommodation rentals, office rentals, field supplies, reclamation work, surveying, restaurant business and local hardware stores.

Flow-through-funded exploration near Wawa, Ont., has resulted in expenditures of approximately $55 million over the past three years. A production decision has been announced for the Kremzar mine and two or three more are expected in the near future. In an economic impact report about the area prepared in June, 1987, the town’s economic development co-ordinator, J. A. Thibert, anticipates pre-production expenditures of $80 million, operating expenditures of $32 million, a total employment increase of up to 945, anticipated population increase of up to 537 and increased personal income from direct and indirect employment of up to $26.5 million per year.

This type of growth is occurring in mining communities across Canada. The effect on employment in economically-depressed areas has been profound. For example, in the Abitibi-Temiscamingue region in Quebec, the unemployment rate has dropped from 24.8% in 1984 to 6.3% today. According to Jerome Dinn, minister of mines in Newfoundland, employment in the exploration and mining industry in his province increased 16.7% in 1987. Why cripple flow-throughs?

Given the admirable success of the flow-through financing tax program, why has the federal government moved to all but eliminate the usefulness of flow-through financings by 1990?

Based on the tax reform papers tabled in 1987, it is clear that the PDAC and other members of the industry succeeded in convincing the government to retain the flow- through mechanism itself and the 100% exploration expense deduction. However, it would appear that mining exploration depletion allowance (meda) will be a victim of tax reform as it is reduced from 33 1/3% to 16 2/3% on July 1 and then eliminated completely on Jan 1, 1990. Serious consequences

The effects of this tax reform are extremely threatening to many Canadians.

The consequences of a decline in the issue of flow-through shares will be dramatic. Unemployment in mining communities will rise. Current exploration projects will be interrupted. The discovery rate of mineral deposits will decline. Existing reserves will not be replaced. Corporate concentration in the exploration sector will be the rule of the day, as junior companies find that they cannot compete with major companies.

The pdac predicts that flow- through financing plans will be seriously curbed or cancelled, many junior companies which have relied exclusively on equity financing will be forced out of the market and many advanced exploration projects will be vulnerable to postponement or cancellation. Too successful in 1987

The government may feel that the dramatic increase in flow- through financing in 1987 indicates that the program is too attractive, and that enough stimulation has been achieved already.

However, the pdac views 1987 as an exceptional year. There are a number of reasons why the high volume of exploration dollars raised by flow-through in 1987 should not be regarded as typical. A common opinion is that nearly two years’ worth of flow-through funds were raised last year due to predictions of unfavorable tax legislation in the February, 1987, budget and the June, 1987, tax reform white paper.

The pdac contends that the 33 1/3% meda must retained if flow-through funding is to continue to serve as an exemplary means of raising risk capital for the junior exploration sector. There are sound arguments that support the position that the 1987 level of flow- through funding would be restored to more reasonable levels even if the 33 1/3% meda was retained under tax reform. Lower personal tax rates, a higher capital gains tax and the alternative minimum tax will serve to provide checks and balances in the amount of money raised by flow-through, even where the 33 1/3% meda exists. Compromise solution

The pdac has made numerous submissions to the government recommending two relatively low- profile tax changes which, if adopted, would regain the economic viability of flow-through. These somewhat technical changes, which have considerable merit, are as follows:

First, the cost of a flow-through share for capital gains purposes would be equal to the equivalent of the investor’s after-tax cost of the share instead of nil.

And second, the “cumulative net investment loss” rules, which restrict an investor’s access to the $100,000 capital gains exemption, should be revised to exclude any reference to the investor’s exploration expense deduction.

This compromise solution to a difficult problem has the unanimous support of the entire exploration community, and could be adopted by the government without political repercussions. What now?

While the government claims to appreciate the valuable contribution made by flow-through to the economic and social fabric of mining towns and communities across the nation, dialogue between the industry and government seems to have stalled.

Concerned citizens throughout Canada are painfully aware of the likely impact of the government’s proposed tax reform measures on their economic well-being. Resentment is gathering momentum and a federal election is looming in the not-too-distant future. Wilson has indicated in the House of Commons that he is prepared to meet with representatives of the exploration industry. It is in the best interest of all concerned that such a meeting take place sooner rather than later.

Our efforts to maintain the vitality of this unique form of exploration incentive and regional development will continue in earnest. The pdac urges industry representatives to maintain their dialogue with mps and mayors of resource- based communities and to continue voicing their concerns to Finance Minister Wilson. John Larche is president of the Prospectors and Developers Association of Canada.