Editorial In flow-through limbo

Many in Canada’s mineral exploration industry feel they’re in a state of limbo; activity today is certainly not at the level of 1987’s hectic pace, but neither have the dark days of the early 1980s returned. No one is too sure just what the future holds for the industry, but there’s little doubt that a change is taking place the results of which could affect the industry for years.

The change, no doubt, was inevitable. The pace of activity during 1987 couldn’t reasonably be expected to continue. It was fuelled not only by a buoyant stock market and healthy gold prices, but by flow-through financing and, perhaps more important, the threat that the incentive to invest built into flow-through financings would end shortly. That threat caused investors to flock to the tax shelter mechanism, desperate to get a tax break before it was done away with. The result was a surge of investment in junior mining companies, and an unsustainable level of exploration activity in order to spend that money before March 1, 1988.

But since then, the world has changed, particularly the world of mineral exploration in Canada. The stock market crash in October, 1988, scared many investors off junior resource issues altogether. The gold price has been soft and getting softer. And, of course, the rules for flow-through financing have been changed.

When the Prospectors and Developers Association of Canada held its annual meeting in March of this year, delegates were already ambivalent about the state of the industry. The previous year had been just about the best in memory with abundant funds from eager investors leading to some significant discoveries. But, in late 1987, the federal government made it clear it planned to phase out the feature of flow-through that made it most attractive. It was that policy that had delegates to the PDAC’s annual meeting uneasy. They were jubilant having come off a good year, but the outlook without flow-through was uncertain.

A vigorous lobbying campaign by residents of mining communities was successful in convincing the government to reconsider. Mining has not often been able to mount successful campaigns on political issues, but this was the exception probably because it came from the communities themselves and therefore represented votes that politicians could not ignore. Flow-through would live and be as generous for investors as ever, but the mechanism for providing the mechanism would be changed. Instead of a tax shelter, flow-through would now be a government grant. Flow-through would still exist in the sense that the grant would go to the company doing the exploration and the company could then “flow-through” the grant to the individual investors.

The industry hailed the announcement of the new flow- through rules, the Canadian Exploration Incentive Program, as a victory. The incentive for mineral exploration was still intact, even if it did come in a slightly different package.

Now, however, the ultimate impact of the changes are in doubt. The grant system offers the same “bottom line” incentive to investors — that is, the opportunity to buy stock relatively cheap because the money is going into mineral exploration — but somehow it’s just not the same.

Previously, an investor could use the tax shelter against income from any source. Now, the primary benefit is in reducing capital gains tax. That’s a significant change, not only in how valuable it might prove to be for individual investors, but in how complicated the system becomes. And if it’s complicated, junior resource companies have a marketing problem.

It may be that investors are just waiting on the sidelines until the fourth quarter of the year. That’s when the “old” flow-through schemes were most popular because that’s when investors started to look for tax shelters to protect their income.

Perhaps the junior companies themselves had been caught up in that flurry of financing and work commitments of late 1987 when there were doubts that flow-through would survive at all. In that case, the current uncertainty could prove to be purely temporary, an aberration that will not have a lasting effect.

And perhaps, as many of those exploration companies that had become adept at raising and spending flow-through money enter the production stage, the demand for flow-through financing has tapered off. Those companies now need the tax shelters themselves and aren’t likely to pass them on to individual investors.

The fear is, however, that the change is more significant. Not only has the more complicated nature of the new flow-through scheme frightened investors off, the idea of moving from a tax shelter system to a system of grants just doesn’t have the same appeal. To shelter one’s hard-earned income from the tax man is one thing; to accept government grants is quite another.

The federal government’s changes to flow-through in the name of tax reform were a poor second choice to leaving the system alone. Nevertheless, it was a compromise solution that both the government and the industry felt they could live with. The final result of unnecessary tampering, however, may be that both will suffer severe hardship.