Ottawa offers grants as substitute for earned depletion allowance

The flow-through saga has taken a new turn with the introduction of grants as a replacement for the controversial earned depletion allowance.

The new program is designed to aid junior mining and oil and gas companies which raise exploration dollars by issuing flow-through shares. The announcement comes after months of intense lobbying by the mining industry to persuade the government to revoke its plan to weaken flow- through. (Under tax reform, the current flow- through structure is considered too generous an incentive.)

While Finance Minister Michael Wilson reaffirmed his decision to phase out the 33 1/3% earned depletion allowance, he has extended it for six more months. As of Dec 31, 1989, it is to be eliminated.

Wilson explained the extension as an “interim measure ” to bridge the period of the introduction of the new scheme, called the Canadian Exploration Incentive Program (CEIP).

The program is expected to deliver more than $200 million a year to the junior resource sector, according to Energy, Mines and Resources Canada. It would generate more than $700 million annually in activity and more than 12,000 man-years of employment. (That compares with the estimated $1 billion raised by flow-through financing in the mining industry last year.)

Walter Kitts of Energy, Mines and Resources Canada told The Northern Miner that the program is primarily a response to the stock market crash of last October, which had a negative effect on the market for exploration issues. He also described it as a response to strong lobbying efforts and as an attempt to maintain the integrity of tax reform (which called for the elimination of tax breaks, such as earned depletion).

Under CEIP, any corporation that uses flow-through may apply for the grant, If the company can show that it has incurred its exploration expenses, as outlined in the Income Tax Act, a grant amounting to 30% of those expenditures will be paid. For example, for every dollar that such a company spends on grassroots exploration, a grant of 30 cents would be paid. Since the 30 cents is income for the company, it would be taxable. (The program itself does not discriminate between junior and major companies. But it is believed that major mining companies would not bother applying for the grants. As they become profitable, they become taxable and would, therefore, not use flow- through but keep the available tax deductions for themselves.) CEIP will only provide up to $3 million in grants per corporation per year (a ceiling of $10 million is placed on the corporation’s eligible expenses). Junior companies covered

However, in a speech, Minister of State for Mines Gerald Merrithew said most junior mining and oil and gas companies are completely covered by the program, which becomes effective Jan 1, 1989.

“In fact, this level of 30% under CEIP is somewhat more generous that the previous depletion incentive,” Merrithew said. “But we feel this is warranted by current market conditions.”

The 30% rate will be in effect at least until Dec 31, 1990. After 1990, the rate may be adjusted up or down according to what shape the markets are in.

Kitts said the 30% figure was arrived at because “it seems to provide a level of incentive that will satisfy the financing of high-risk junior mining projects.

“It is hoped that this (30% rate) will serve to reactivate flow- through financing again,” he continued. “The government is very concerned about the flow-through share system dying. It has proven very useful to the industry.”

Merrithew said the aim of CEIP is to maintain grassroots mineral and petroleum exploration. The program will help companies raise money on an ongoing basis, he added, so that they won’t have to wait for the end of the taxation year to get a refund. More generous

“Thus, the incentive will be not only slightly more generous (than the total 133 1/3% flow-through writeoff now available), but quicker.”

(When asked how long it would take for CEIP applications to be approved, Kitts said: “I have no idea, but the industry has indicated that a 3-month turnaround time would be acceptable.”)

Both Merrithew and Kitts insisted that CEIP is not a grant system in the normal sense. “There is no bureaucratic discretion as to who gets the money,” Merrithew explained. “Eligibility is already fairly well understood under present rules and if you qualify under those rules, you qualify for CEIP.”

Regional offices will deliver the program. Office locations will include Vancouver, B.C., Kirkland Lake, Ont., Val d’Or, Que., Saint John, N.B., and St. John’s, Nfld. Two offices already exist — in Calgary, Alta., and Weyburn, Sask.

Edward Thompson, president of Mingold Resources and past chairman of the Prospectors and Developers Association of Canada, told The Northern Miner that CEIP seems essentially to be depletion by another name. “It may be a little more complicated (than the current flow-through structure), but it seems comparable,” he said. He added it is preferable for such programs to be built into the tax system because that causes them to be more permanent. “Programs like this can be cut off fairly quickly,” he said. Introduced in 1954

The flow-through shares plan was introduced in 1954. But it was altered in 1983 when the Liberal government amended the Income Tax Act to allow the transfer of the earned depletion deduction to individuals. The result was a tax writeoff in excess of the amounts actually spent by individual investors for exploration and development.

Most flow-throughs are offered through limited partnerships that pool the shares of various mining companies performing exploration. Since 1983, these companies have succeeded in raising unprecedented amounts of investment dollars. Energy and Mines Minister Marcel Masse has estimated that from 1983 to 1987, the capital generated by flow-through jumped 2,800%. Among the chief beneficiaries of the high levels of exploration activity have been Canada’s mining communities.

Under current flow-through rules, each dollar invested by an individual in Canadian mining exploration provides a tax writeoff of $1.33. Tax reform has called for the end of the extra 33 cents earned depletion writeoff. For individuals, the 33 1/3% rate at which depletion can be earned will be effective until Dec 31, 1988. It will then be eliminated for all expenses that earn the new 30% grant. For corporations, however, the rate will still drop to 16 2/3% from 33 1/3% on July 1, 1988, as originally planned. It will be eliminated completely as of Dec 31, 1989.