Seeks reversal of flow-through changes

The severe blow to flow-through shares caused by the recent white paper on tax reform was not fully intended by the government, and affected companies should push for changes as soon as possible, according to a major management consultant company.

In a written analysis, Toronto- based Coopers & Lybrand says proposed changes to the Income Tax Act “may severely limit the ability of mining companies to raise exploration and development capital using flow-through shares and will increase the cost of bringing new mines into production…”

The report explains that the ability of mining companies to transfer the tax benefits of exploration and development expenditures, including the related depletion deductions, to individual taxpayers has been a critical factor in raising the risk capital necessary to fund exploration programs. This has been made possible by the use of flow- through shares and limited partnerships. Difficulty accessing capital

But mining companies will find it “extremely difficult” to access this capital in the future and only at a substantially increased cost, the report says. It cites several tax reform proposals which are likely to cause this: * “The earned depletion allowance, including the special mining exploration depletion allowance associated with “grassroots” exploration, is to be phased out. The rate at which it can be earned will be reduced from 33120/3003 1/2303 1/2% to 16220/3003 1/2303 1/2% for eligible expenditures incurred after June 30, 1988.” After June 30, 1989, earned depletion will be eliminated completely. * “Investors in flow-through shares or resource partnership units are generally left with an investment which has a nominal cost base for tax purposes. The ability to sell this investment and realize an exempt capital gain under the capital gains exemption has been an important selling feature. The proposal to reduce the amount of capital gains eligible for the exemption by cumulative “net investment losses” after 1987 will substantially reduce the availability of the capital gains exemption to such investments (N.M., June 29/87). An individual’s net investment loss for this purpose will include his share of deductions attributed to a resource flow- through share… The adverse impact of this change is exacerbated by the increasing of the taxable portion of a capital gain to 3/4 by 1990 and the limitation of the lifetime capital gains exemption to $100,000. * “While the drop in the top federal marginal tax rate to 29% in 1988 is welcome, it will have the effect of increasing the after-tax cost of flow-through shares to investors. * “Expenses incurred in issuing shares and partnership units are currently deductible for tax purposes. One of the major reasons for using public limited partnerships to issue flow-through shares is the ability to transfer these tax deductions to the investors. The white paper proposes that such costs be amortized over a 5-year period for expenses incurred after 1987 with respect to partnership interests issued after that date. This will reduce part of the existing tax advantage of flow-through share investments.”

The report adds, however, that the white paper contains major benefits for existing (as opposed to non-) producers in that the income tax burden on mature producing mines will be reduced. Besides the tax rate reduction to be enjoyed by the industry, the existing 25% resource allowance deduction is to be maintained.