Flow-through shares should be treated like other capital

If you attended the Prospectors and Developers Association of Canada’s annual convention in Toronto recently, no doubt you will have noticed that many of the 3,000 or so delegates were wearing a badge displaying the message: “Fair play is real cost base.” Achieving a real cost base for flow-through shares is the key ingredient in the PDAC’s position with respect to the survival of financing for the junior mining sector now that the Canadian Exploration Incentive Program (CEIP) has fallen victim to the most recent federal budget.

Gaining a sympathetic ear from Ottawa will require a large degree of solidarity on this issue on the part of the Canadian mineral industry. Ottawa needs to hear the same message coming from all quarters. It is imperative that everyone understands how unfair the current tax treatment of flow-through shares is and how establishing a real cost base will act to balance the situation and revitalize the junior mining sector.

Prior to 1989, the availability of the mining exploration depletion allowance (MEDA) through the income tax system made flow-through shares attractive investments. MEDA was repealed as part of tax reform and was replaced by CEIP starting in 1989. CEIP was repealed in February, 1990, but some proposed grandfathering rules will make CEIP available to a limited extent for the balance of 1990. This year is, in essence, a transitional year.

Starting in 1991, without CEIP, flow-through shares will be unmarketable. They will be even less attractive than they were prior to 1983 when this financing mechanism was little used, if at all, by the Canadian mineral industry.

Flow-through shares do not need government grants to make them attractive. What they need is fair tax treatment.

There are certain rules in the Canadian Income Tax Act which pertain specifically to flow- through shares and which result in unfair treatment as compared with other capital properties, such as land, bonds, and shares of blue-chip stocks. They may be referred to as the Cost Base Rule and the CNIL Rule.

The Cost Base Rule requires an investor, upon the sale of shares, to declare a zero cost base instead of a real cost base. The CNIL Rule denies the investor full access to the $100,000 capital gains exemption.

The Cost Base Rule is by far the most onerous of the two. By having to declare an after-tax cost (out-of-pocket expense) of zero, the investor is forced to declare the total proceeds from the sale of shares for capital gains tax, at a rate of 75%, resulting in a marked negative effect on the investor’s net return on investment. On the sale of any other type of share or capital property, the investor is allowed to deduct the after-tax costs from the proceeds of the sale, thus significantly diminishing his exposure to capital gains tax and maximizing net return on investment.

The solution to the problem is easy. The Cost Base and CNIL penalties imposed on flow- through shares must be removed so that a sale of a flow-through share is treated in the same way as a sale of any capital property.

It is clear that the result would be a revitalization of flow- through financing in terms of net return to the investor and the re-establishment of a market- driven incentive that does not require a bureaucracy to administer it.

Fair play is real cost base. Write to Finance Minister Wilson, Mines Minister Jake Epp and to your local MP in support of this position. The PDAC would be happy to send you one of our buttons. Please call or write to the Prospectors and Developers Association of Canada, Suite 1002, 74 Victoria St., Toronto, Ont. M5C 2A5, tel: (416) 362-1969, fax: (416) 362-0101. Anthony Andrews is managing director of the Prospectors and Developers Association of Canada.