Future of flow-through financing rests with federal finance

By the time you read this, a nerve-racking chapter in Canadian mining history will have reached its climax. For many in the industry, expecially i the junior sector, June 18, 1987, will be remembered as Judgment Day. That is the day federal Finance Minister Michael Wilson is to descend from Parliament Hill and hand down his long- awaited white paper on tax reform — and with it, the future of flow- through share financing for mineral exploration. Whether or not Mr Wilson will outlaw or seriously alter flow- through, seen by many as a tax shelter, has been the cause of much t speculation over the past year. Little wonder. Since 1983, more than $900 million has been raised using the popular tax preference, reports 9 federal Mines Minister Gerald Merrithew (a strong supporter of flow-through). Last year about $475 million was raised, he says. And in 1987, between $650 million and $700 million is expected to be raised, or at least negotiated, according to the Mineral Policy Sector of Ottawa-based Energy, Mines and Resources. Moreover, by 1988, Canada will be able to credit about 25 gold mines to flow- through, says mining consultant Edward Thompson. (That’s assuming gold prices remain around the current $400-$450(US)-per-oz level.)

Flow-through shares provide investors with considerable tax breaks for investing in junior companies which perform exploration work. The federal government allows a tax writeoff of $1.33 for every dollar spent. A typical flow- through share issue allows two types of deductions: a 100% deduction on account of “Canadian exploration expense;” and a 33 1/3% deduction on account of “mining exploration depletion allowance.” Together, these two deductions allow the flow-through investor to deduct up to 133 1/3% of the cost of his investment.

The fact remains, however, that flow-through is a tax preference, and tax preferences are a no-no under tax reform. Mr Wilson has made it clear that some of Canada’s favorite tax breaks could vanish as the system is overhauled, the purpose being to create a more equitable environment for investors and to ensure that a large majority of Canadians pay less income tax. He has also stated that flow- through is part of a broad review of tax policy undertaken by the Finance Department.

In 1986 major tax reform was passed in the U.S., resulting in personal income tax brackets of 15% and 28%. The top rate was previously 50%. Also, corporate tax rates are to drop to 34% from 46%.

The Finance Department has steadfastly refused to explain how specific industries will be affected by Canadian tax reform. But in March Mr Wilson’s press secretary, Richard Remilard, told The Northern Miner: “We have made it fairly clear that our intention is to get rates down and remove tax preferences … and flow-through shares are a tax preference.”

He then added: “We are also sensitive to the impact of tax reform on industries and regions across the country . . . and Mr Wilson is very sensitive to the entire mining sector. You can underline that.”

Mr Wilson himself has admitted there is a need for some preferences in the tax system — at least in order to compensate for regional disparity.

The result of all this uncertainty is that members of Canada’s mining industry have spent the past eight months biting their nails over the future of flow-through. Despite strong lobbying efforts by groups such as the Prospectors and Developers Association of Canada (pda), a great many questions remain unanswered: Will flow-through survive intact? Will it be tinkered with or reduced? Or will it be killed outright?

The nail-biting began in September, 1986, when, in an exclusive interview with The Northern Miner, Quebec Mines Minister Raymond tax reform and that the Quebec government (which was then offering up to 166.6% n on top of the 133.3% offered federally) might follow suit.

(In December the Quebec government reduced its double depletion writeoff of 166.6% to the same amount offered federally. The move is seen by many as an t attempt to reduce pressure on Ottawa to increase the federal deduction to m 166.6%.) `Shooting itself in the foot’

Mr Savoie now believes flow- through will be retained at the current level v of 133.3%. He says Ottawa would be be “shooting itself in the foot” if it did otherwise.

“The Golden Triangle area of Quebec (comprising Rouyn, Val d’Or and Chibougamau) has benefitted tremendously from flow- through. There are about a eight mines in Abitibi that will be in production shortly — and it’s all due principally to flow-through.”

He has asked Ottawa to maintain flow-through in Quebec for 3-year periods a in order to give some stability to the tax structure. (The federal government collects personal income taxes from all provinces except Quebec, which o operates its own income tax system.)

Mr Savoie’s optimism is shared by many mining analysts, including Robert o Parsons, chairman of the pda’s tax committee. He doesn’t think tax reform a will have any serious effect on flow-through because, he says, the Finance Department. is convinced the mechanism is working well.

But he explains that tax reform is seen as a threat because the principles of such reform, as enunciated by the Finance Department, call for tax neutrality. Indeed, part of the thrust of Mr Wilson’s tax reform seems to be that certain industries should not be favored over others.

“There is a feeling in the Finance Department that our tax system has favored capital-intensive industries as opposed to service industries, which are believed to be more important to Canada’s economy in the future,” Mr Parsons says. “But I don’t consider mineral exploration a capital-intensive industry, so flow-through should be safe. The major capital spending (on machines and equipment) occurs when a mine is brought into production — not before.”

He added that Ottawa’s biggest worry regarding flow-through is that the public perceives it as a tax shelter; and under U.S.-style tax reform, tax shelters are considered undesirable. He stressed, however, that flow-through is not a tax shelter, per se, but a mechanism which allows the junior sector to obtain the tax benefits which senior companies already receive. Under new income tax rules “earned” depletion allowance is deductible against any source of income. (However, mining companies have been eligible for depletion since 1953. The allowance is so-named because it recognizes the depleting nature of the mining operation’s raw material.)

“The mechanism is not creating benefits which aren’t already in place. It’s just shifting the tax benefits from one taxpayer to another,” he says. For the past six months federal Mines Minister Merrithew has been urging the industry to maintain a steady stream of petitions, resolutions and letters to the finance minister, stressing the portance of flow-through. Whether or not such lobbying has paid off remains to be seen.

If Mr Wilson maintains flow- through in its current form, the industry can count its blessings. If he does not, the lobbying will almost certainly intensify — which means the finance minister may be in for a long, hot summer.