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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
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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