FACTS & FIGURES — Deferred taxes — debunking myths

The Canadian media have, of late, focused attention on deferred taxes. Special interest groups and political organizations out to criticize spending cuts have targeted deferred tax balances as an example of how corporations are somehow cheating the tax system by not paying their fair share.

Newspapers often carry articles critical of government for not going after the money “owed to it” by companies who “defer”

taxes. Deliberately, or through their own lack of understanding, the media are participating in the creation of what amounts to a misleading public perception of tax avoidance on behalf of

corporations.

The issue of deferred taxes and “corporate welfare bums” first gained national media attention during the 1972 federal election, and has since become highly politicized. Mining is so

capital-intensive that it is important for us to appreciate the fundamentals of how deferred tax balances come to exist, just as it is important for us to do our part to debunk the myths

surrounding the issue.

First, there are not tens of billions of dollars owing to the government of Canada. To defer taxes does not mean a company is not paying the full tax it is required to pay. Believe me, they pay. Reporting deferred taxes on financial statements is simply a way to reflect the difference in how income tax expense is

reported according to Canadian Institute of Chartered Accountants rules and how income tax actually payable to the government is determined according to the Canadian Income Tax Act.

Second, the Income Tax Act exists for two reasons: as a vehicle through which the government raises taxes and as a way to put economic policy into effect. For example, to encourage capital investment in the mineral sector, the Act permits a company to claim Capital Cost Allowance (CCA, the tax equivalent of

accounting depreciation) and Canadian Development Expense (CDE, the tax equivalent of accounting depletion) at higher rates than the company would record depreciation and depletion for

accounting and financial reporting purposes.

When a company invests in mine development and mining equipment, for accounting purposes the costs are not deducted from income in the year of acquisition but, rather, are charged to income

(“amortized”) over the assets’ estimated economic lives. In the case of equipment, depreciation is taken over the estimated life of the equipment. Development costs are amortized on a

units-of-production basis based on estimated economically

recoverable reserves. The charge to earnings related to the

amortization of development costs is called depletion.

Because deferred taxes are reported on the liability side of a balance sheet, financial statement users may be misled into

drawing the conclusion that the amounts are legally owing to Revenue Canada. But this is not the case. These amounts should be viewed as a provision for taxes that will be payable in the

future, provided the company remains profitable.

We should also explore how companies amass such large, deferred tax credits on their balance sheets. If a mining company develops only one (profitable) mine which it operates for the mine life without replacing equipment or doing any further exploration or development, eventually the deferred tax balance will be zero.

Realistically, however, we know the company will have to continue to reinvest earnings in equipment and to develop new orebodies if it is to be a going concern and provide returns to its investors.

As long as the company continues to replace assets, CCA and CDE for the new capital will keep the overall CCA and CDE deductions higher than accounting depreciation and depletion, and the

deferred tax balance on the company’s balance sheet will continue to grow. This is especially true during inflationary times when the cost to replace assets is higher than the price at which they were originally purchased.

— The author is controller for Westmin Resources and chairman of the Mining Association of British Columbia’s tax committee.