Mining exploration requires a great deal of capital and many small or mid-sized corporations struggle to fund their exploration activities. There may be a unique tax-assisted financing tool available to such companies, called flow-through shares (FTS). Essentially, a mining company can issue new FTS to investors at a higher price than it would receive for "normal" shares, making it easier to raise money for exploration and development.

When a mining company (let's call it Mineco) spends money on exploration in Canada, for tax purposes these amounts are accumulated in "pools," which can be deducted against income earned in determining Mineco's taxable income and tax payable. The normal rule is that only Mineco can use tax deductions from its expenditures.

However, the key element of FTS financing is that the initial purchaser of a FTS from Mineco is entitled to use some of Mineco's qualifying deductions generated from exploration expenditures. If Mineco does not have significant taxable income and is unlikely to use these "pools" of tax deductions anytime soon, investors who are themselves taxable will be willing to pay more to subscribe for FTS of Mineco, because acquiring those shares entitles them to use some of Mineco's tax deductions to reduce their own tax payable. A FTS is a share of Mineco that "flows through" certain Mineco expenses to subscribers for those newly-issued shares (FTS Investors). Effectively, the FTS Investors are treated as if they (and not Mineco) had incurred those deductible expenses themselves for tax purposes. Because Mineco receives a higher price for issuing FTS than it would for issuing its "regular" shares, it is able to reduce its cost of capital.

To create a valid FTS financing of a mining company, the following requirements must be met:

  • The principal business of Mineco must be mining, exploring for or processing minerals (or holding the shares of companies whose principal business meets this test);
  • The FTS themselves issued to the investors by Mineco must meet certain conditions. In essence, the shares must be "ordinary" common shares that participate fully in the risks and benefits of the corporation's activities, with no terms or agreements reducing the holder's risk from holding common shares;
  • There must be a written agreement (a "subscription agreement") between Mineco and the FTS Investors governing the issuance of the FTS. The subscription agreement must be carefully drafted. For example, it is acceptable to include terms requiring Mineco to indemnify the investors for any federal or provincial income taxes they owe if Mineco doesn't incur the qualifying exploration expenses that it promises to incur within the period specified, but not any interest on or penalties relating to such taxes.

The most common form of FTS financing is a "grassroots CEE" FTS financing, which allows FTS Investors to use the renounced expenditures more quickly, but limits Mineco to a narrower range of qualifying expenditures. In essence, grassroots CEE represents most mining exploration expenditures: expenses incurred to determine the existence, location, extent or quality of a mineral resource in Canada, including in the course of prospecting, geological/geophysical/geochemical surveying, drilling, trenching, digging test pits or sampling. Excluded are (1) expenses included in the cost of depreciable property or in Mineco's "Canadian development expense," and (2) expenses relating to a mine that is already in commercial production. Also, "Canadian exploration and development overhead expenses" (e.g. administration, management or financing expenses) are not eligible to be renounced under a FTS transaction.

The rules governing FTS are complex, but for those companies that are able to comply, FTS's can be a powerful financing option for mining companies engaged in mineral exploration in Canada. For more information on FTS's and the taxation of mining in Canada generally, please see www.miningtaxcanada.com

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