Flow-through shares are an excellent way for many companies spanning multiple industries to raise capital, particularly junior firms in the mining, oil and gas, and renewable energy sectors. As a result of recent changes, flow-through shares could become even more attractive for both issuer corporations and certain investors.
When changes were first proposed to Canada's alternative minimum tax regime in 2023, concerns were raised that they would present an obstacle to certain Canadians looking to invest in flow-through shares. Thanks to recently revised proposals released by Canada's Department of Finance, this obstacle may soon be removed.
The federal government also recently extended access to the 15% Mineral Exploration Tax Credit until March 31, 2025 and continues to make the 30% Critical Mineral Exploration Tax Credit available until March 31, 2027. Both of these special investment tax credits can be accessed by investors in flow-through shares.
In this brief article, we explain how these developments may positively impact the flow-through share financing and charitable flow-through markets.
What are flow-through shares?
It is important to first understand flow-through shares and how they help companies.
Corporations in a range of industries, including mining, oil and gas, and renewable energy,can issue flow-through shares to help finance projects.
However, they are of particular value to junior mining exploration corporations, many of whom are in non-taxable positions and do not need to deduct their resource expenses. These corporations often encounter difficulty when raising capital to finance certain categories of exploration and development activities.
Flow-through shares permit the issuer corporation to transfer the resource expenses to its investors. This is an attractive way for investors to shelter other income through the use of the expenses that "flow" to them from the issuer corporation. As a result of these benefits, flow-through shares can typically be issued at a premium compared to common shares and are an attractive form of financing.
What is a charitable flow-through?
A charitable flow-through is a Canadian structured financing mechanism that aims to remove market and liquidity risk while combining both flow-through shares and charitable donation tax credits. Charitable flow-throughs benefit both Canadian charities and the not-for-profit sector and the Canadian resource exploration and development sector by significantly reducing an investor's after-tax cost of giving, while enabling greater access to capital for natural resource companies exploring and developing in Canada.
How it works:
- Donors buy flow-through shares to access their tax benefits.
- Donors gift shares to the Canadian charity of their choice.
- Charities immediately sell the shares to an institutional or strategic investor.
What are special investment tax credits and how can investors benefit from them?
Broadly speaking, special investment tax credits are tax credits aimed at supporting companies focused on industry-specific projects. Both the Mineral Exploration Tax Credit ("METC") and Critical Mineral Exploration Tax Credit ("CMETC") are special investment tax credits that support companies focused on critical mineral exploration.
It is important to note that both are available to issuer corporations that renounce them to flow-through share investors, but CMETC cannot be claimed in addition to METC.
The 15% METC was first introduced in 2021 and helps mineral exploration companies — particularly junior mineral exploration companies — raise capital by providing investors with an additional incentive to finance early-stage mineral exploration using flow-through shares. Initially slated to expire in 2024, the availability of the METC was recently extended until March 31, 2025.
The federal government introduced the 30% CMETC in 2022, which supports certain critical mineral exploration expenses incurred in Canada. It applies to expenses targeted at minerals used in producing batteries and permanent magnets, clean technology, or semi-conductors. The CMETC expires on March 31, 2027.
Provincial tax credits similar to the CMETC and METC may also be available for corporations with operations in certain provinces.
What is the alternative minimum tax and how does it impact flow-through share and charitable flow-through financing?
The alternative minimum tax ("AMT") is essentially a second tax calculation, without the benefit of certain credits, deductions and exemptions.
It generally applies to individuals, estates, and trusts that earn a significant portion of their income as dividends or from capital gains or use deductions or tax credits to significantly reduce their tax payable. If a taxpayer's AMT calculation results in a higher amount of tax payable than that under a taxpayer's ordinary tax bill, the taxpayer generally must pay the "minimum tax" established by AMT.
In other words, Canadian taxpayers pay the higher amount between either ordinary tax or AMT.
Generally, AMT has acted as a disincentive to invest in flow-through shares for taxpayers with AMT exposure. The expenses that flow up to investors are effectively ignored for purposes of calculating AMT. This generally makes it more likely that AMT will apply when taxpayers invest using flow-through shares.
As a result, the issuer corporation's expenses (and by extension the flow-through shares themselves) are relatively less valuable for these investors.
Proposed changes should positively impact flow-through share and charitable flow-through financing markets
In 2023, the federal government released draft legislation proposing certain changes to the AMT regime, including an increase in the AMT rate to 20.5% and an inclusion of 100% of capital gains in the AMT calculation. This would have made flow-through shares even less attractive for those with AMT exposure by making it more likely that the AMT would apply to taxpayers investing in flow-through shares.
Consequently, these changes would have decreased the attractiveness of flow-through share financing for issuer corporations.
The latest release of draft AMT legislation proposes a change in approach that would eliminate this disincentive and is expected to positively impact the attractiveness of flow-through shares for both investors and issuers. The draft legislation proposes to repeal portions of the Income Tax Act that previously made taxpayers include the deductions from flow-through shares.
If given Royal Assent, the changes would apply as of 2024 and should make flow-through share financing more attractive to investors that are sensitive to AMT, such as those with a lot of credits, deductions, and gains in a year and comparatively less income from fully taxable sources.
The proposed changes reflect a positive development for the flow-through share market. With this welcome proposal, the federal government appears to have acknowledged that the AMT's purpose is not to limit access to the benefits conferred on investors and issuer corporations by Canada's flow-through share market.
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