Financing the future of exploration

The following is an edited and condensed version of a presentation given by incoming Prospectors and Developers Association of Canada (PDAC) president, Scott Jobin-Bevans to the Association of Mining and Exploration Companies (AMEC) in Perth, Australia.

Many factors are needed to develop a robust, sustainable mining industry. But nothing is more important than exploration. We all know the mantra “if it can’t be grown it must be mined and if you don’t find it, you can’t mine it.” But as we know and have experienced first hand (painfully), commodity prices and the markets can be a challenge. Add the high costs associated with resource exploration and development and the time it takes to make a discovery and you have an investment sector that offers a very attractive return on investment but at the same time it is nerve-racking and high-risk. This is where the junior exploration sector thrives, with the mining industry relying more and more on the juniors and prospectors to take on the risk and make the discoveries so they can build the mines of tomorrow.

So how do we finance this exploration risk? Lately, like many of you, I can’t help think of taxes and the mining industry, probably more than ever since your government took the industry by surprise in May with its announcement of the proposed Resource Super Profits Tax — a shot heard around the world by the mining industry, and one that despite all its complexities represents a threat to an important part of the Australian economy and other mining jurisdictions around the globe. I do recognize the importance of this tax issue but I would like to put this aside for now and talk about a different kind of tax — a good one — a tax-credit system that we refer to in Canada as flow-through. As with all taxes it’s not entirely pain-free, but for the last 27 years it’s been giving a boost to mineral exploration within Canada. In fact, a global mining research organization, Metals Economics Group, recognizes the flowthrough tax credit system as being a key reason why Canada leads the world in mineral exploration and mining.

The challenge for our industry is to find a way to finance exploration. And that is the wisdom behind the Canadian flow-through tax credit. It helps companies raise exploration capital by reducing the risk to investors. Through this, companies are able to raise more capital than they would if investors, alone, were left taking on the risk. Flowthrough enables small exploration companies, which usually don’t have any cash-flow, to pass along — or flow-through — eligible costs to investors, who use them to reduce and defer their taxes. A 100% flow-through tax credit was added to Canadian tax laws in the 1950s and became popular in the oil patch in the 1970s after capital gains taxes were introduced. It was not until the 1980s that the tax credit was used by mineral exploration companies and since then the PDAC has been a big advocate, working to improve and enhance the system. Exploration companies issuing flow-through shares renounce the deductions that would normally be available to them and “flow-through” the deduction to the investor. After a specified hold period, these flow-through shares behave as common shares in the capital of the company. At issuance they bring special tax-credit benefits to investors and as a result, they’re a somewhat complex tax instrument, on which the government has imposed a number of restrictions: proceeds of flow-through issues can only be used to finance projects located in Canada. They can only pay for eligible exploration expenses, such as field crews and drilling “money into the ground”, and general administration expenses are not allowable expenditures. Recently, through the efforts of the PDAC and others, some aspects of community consultation, including First Nations’ engagement and consultation as well as environmental baseline studies, were made eligible.

Ten years ago, the Canadian federal government, recognizing the positive economic impact of this tax-credit, introduced “super-flow- through” or the Mineral Exploration Tax Credit (METC) which provided an additional 15% tax credit on top of the regular provincially based flow-through credit.

Clearly, the Canadian government saw the value of the flow-through credit as a long-term investment in the creation of mines — and the revenue and jobs that come from them — at home, in Canada.

The METC, which is combined with provincial and territorial flow-through, has become so popular that all the provinces and territories — even the smallest one that doesn’t have an operating mine yet — supplement it to encourage exploration within their own jurisdiction.

I won’t get into all the tax details, but for an investor to take advantage of all of the federal and provincial flow-through incentives available, the net cost of investing in qualifying “grassroots” exploration is cut by more than 50% by way of tax credits.

For example, an investor in a top tax bracket — say 46% in Canada — who invests $1,000, can claim 100% of this amount on their annual tax return — a $460 tax benefit — then claim an extra 15% tax credit. The investor can also claim additional provincial tax credits depending on their province.

Canada has been at the top of world exploration spending since 2002, following the introduction of super-flow-through. Previously, Australia held claim to the top spot. Last year, Canada accounted for 16% of world’s exploration spending. It was followed by Australia at 13%. Australia has a tight hold on second spot, with spending roughly equal to that of the next two countries combined — Peru at 7% of global spending and the U.S. at 6%.The 3% difference between our two countries, represents about $250 million in spending, but those who understand the critical importance of exploration to mining, can appreciate the significance of this difference.

Although flow-through financing is a relatively small proportion of the total amount that’s been spent on exploration in Canada since super flow-through was introduced in 2000, this proportion does increase during the downturns. We don’t necessarily depend on flow-through to attract substantial investment to Canada — but clearly flow-through plays a critical role in financing and exploration within Canada.

One of their key benefits is that flowthrough funding can help smooth financial market volatility. The biggest benefit is it allows for the funding of grassroots exploration — the most high-risk of all. The flowthrough financing structure supports newly emerging junior explorers that are trying to establish themselves as they build fundamentals.

In late 2008 and through 2009 — a challenging time we would love to forget — many Canadian companies were able to raise flowthrough funds, even for grassroots projects in Canada, although other conventional sources of capital were much more difficult to access.

As we know all too well, it can take hundreds, if not thousands, of searches before a new mine is found. But one mine, even if it isn’t as big as Galore Creek in British Columbia., can pay for the “cost” of the flow-through credits — this is important to recognize by the government; this is not just a tax break or deferment, it is a real investment that can realize huge gains for the economy. The Canadian government has estimated the average annual cost of the program at about $250 million — and the returns far outweigh the cost. The cost to the federal government in forgone tax revenues is offset by an increase in exploration expenditures and economic spinoffs — thereby increases taxes to the government flow-through has been one of the best “regional economic development” programs ever initiated by the government, even though it was not designed for this purpose. Field exploration work puts capital into the hands of local stakeholders in remote Canadian communities where economic opportunities are in short supply. Almo
st every major discovery in Canada involves at least one flowthrough financing. And many projects have several.

As with everything there are a few negatives to be pointed out. I mentioned the hold period that is attached to the issuance of flowthrough shares — typically it is four months. Because you are typically selling flow-through shares to investors who are only looking for the tax credit, they are not generally in it for the long haul and so once the hold period comes off the shares and they are free trading, they will usually sell the shares — dumping them into the market which can lead to a dramatic reduction in your stock price. Another drawback to flow-through is the requirement that all funds must be spent within one year of renunciation. This can cause inappropriate or rushed spending of the flow-through funds just to be sure the funds are disposed of within the one year period. Funds raised from flow-through financing can’t be used for overhead costs associated with running your company and so hard dollars from issuing common shares are required — however when market conditions change dramatically as they did in 2008, it can create problems.

It’s unfortunate Australia missed an opportunity this year to add a tax-credit system such as flow-through and I hope I’ve demonstrated that a system like this is a much more significant addition to economic growth than it might look like on paper.