Ottawa keeps the lid on future of flow-through

Many of the roughly 2,000 delegates came to last week’s Prospectors and Developers convention seeking relief from their fear that flow-through share funding for mineral exploration is doomed. They had heard that an assistant to federal Finance Minister Michael Wilson was to speak on tax reform and its effects on junior mine financing.

What they received was a very mild sedative.

“I can assure you that the finance department and Mr Wilson are very aware of the special needs of capital- intensive, high-risk sectors of the economy,” David Dodge, assistant deputy minister for tax policy, told a packed room at the Royal York Hotel. “They are aware that it is appropriate, even in a broad-based, low-rate tax system, to recognize these special needs.”

After warning that all “special incentives” in all industries are being closely examined, he said it would be premature to discuss any of the specific measures contained in Mr Wilson’s tax reform paper, expected in late spring.

The finance minister has promised to remove many corporate and personal exemptions and loopholes in order to create a more equitable environment for investors. As a result, there has been much speculation that he will eliminate or dramatically alter the rules for flow- through financing, considered by many to be a tax shelter.

Following the speech, he told The Northern Miner only Mr Wilson could comment on plans for the popular tax incentive. The finance minister was unavailable for comment at presstime. However, his press secretary, Richard Remillard, said the finance department considers it unfair to inform some industries, and not others, of the specific impact of tax reform. “I don’t mean to be flippant, but you’ll just have to wait ’til spring,” he said.

When asked whether the department considers flow- through to be a “tax shelter,” Mr Remillard said: “I won’t answer that directly because I think `tax shelter’ is a pejorative term. We have made it fairly clear that our intention is to get rates down and remove tax preferences … and flow- hrough shares are a tax preference.”

He would not say whether the department perceives flow-through as an “unfair” preference.

But he added: “We are also sensitive to the impact of tax reform on industries and regions across the country … and Mr Wilson is very sensitive to the entire mining sector. You can underline that.”

Mr Dodge did say he agreed with two of the preceeding speakers (Prof Basil Kalymon of the University of Toronto and mining consultant Edward Thompson) when they said flow-through contributes to neutrality in the mining tax system. One reason for this is that the introduction, in 1983, of the mining exploration depletion allowance has enabled flow-through investors in junior companies to achieve the same deductions as the senior companies, which have enjoyed similar benefits for about 30 years (N.M. Feb 9/87).

He added that although flow- through is often attacked in the popular press as a “scam,” this is inaccurate. “It is a mechanism which allows whatever benefits are allowed in the system to flow through to the investor.”

Flow-through shares provide investors with considerable tax breaks for investing in junior companies which perform exploration work. The federal government allows a tax writeoff of $1.33 for every dollar spent.

“The mining sector in Canada is enjoying an exploration boom in spite of a continuing decline in base metals prices,” Mr Dodge said. “This activity, as we know, has been driven to a large extent by flow- through.

He then added: “The mining corporations enjoy a number of benefits and, over-all, they enjoy a very good tax rate relative to other sectors of the economy. The average effective rate of tax for Canada’s mining sector is only about 14% (as measured by the ratio of taxable income to book income).” Risk capital

On another note, he said tax reform will definitely address the need for risk capital in Canadian industries.

“But I remind you that the best incentive for us all is to keep more of what you earn and pay less to the government. The way to achieve that is to lower tax rates; and this is the real objective of tax reform.”

In May, 1985, the Finance Dept. released a paper outlining some potential changes to the tax laws. Ottawa has been working on corporate tax reform ever since, Mr Dodge said. The trend is seen by some as an attempt by the federal government to align Canada’s tax system with that of the U.S., where major tax reform was signed into law last year.

“One of the key principles guiding tax reform is that tax rates should come down and that the tax base should be broadened,” Mr Dodge declared.

Using the U.S. as an example, he said that next year federal tax rates in that country will have dropped to 34% from 46%. “And most U.S. states are now in the process of reviewing their taxes so that they can drop their rates.

“It’s important to be aware that a number of other countries are also undertaking tax overhauls which are likely to result in lower tax rates. Australia, the U.K., Germany and even the Scandinavian countries are currently engaged in this process.”

Opposition Leader John Turner has denounced the federal government’s tax reform agenda as a “fraud,” aimed solely at winning votes and at covering up huge tax hikes that have already taken place. Depression persists

In a separate speech, Prof Basil Kalymon of the U of T’s Faculty of Management Studies cautioned that the mining industry is still in a depression. Before the government decides to alter the flow-through regulations, it should be aware that the economic conditions under which the mechanism was introduced (in 1983) have not changed dramatically, he said.

(In the paper, Tax Reform and Canada’s Mining Industry, the Mining Association of Canada says exploration for non-energy minerals in Canada would have declined to a negligible level if flow-through shares had not been introduced following the recession of 1981-82. “This could still happen if this stimulus to exploration were removed,” the paper states.)

In a study soon to be released by the Centre for Resource Studies at Queen’s University, Prof Kalymon has analysed the effects of flow- through from 1983 to mid-1986. His study shows that the level of equity funds raised through flow-through shares has increased to $309 million in 1985 from $42.4 million in 1983 (the mac expects the total for 1986 to be about $500 million). Small issue trend Prof Kalymon said the amounts raised since 1983 are consistent with the sizeable growth in exploration activity over this p eriod. While most issues of flow-through shares are below $1 million, these small issues accounted for only 12.9% of the total value of shares issued in 1983-84 and for 21.1% in 1985-86. Nevertheless he said the trend is toward an increased percentage of smaller issues both in number and in terms of the amount raised. This reflects the increase in flow-through shares issued through the Vancouver Stock Exchange, which specializes in junior issues.

In his report, Prof Kalymon predicts that the appeal of flow-through shares to senior companies will decline as these companies regain taxable status. “With taxable corporate income, companies have little incentive to issue flow-through shares since the tax benefits can be used internally. Thus flow-through shares tend to stabliize exploration activity by providing equity financing incentives under conditions of poor profitability while declining in use as industry conditions improve.” (As cited by the mac.)

The report concludes: “Clearly, significant restrictions on flow- through shares will effectively destroy the basis for their existence.”

Revenue Canada has extended to March 31 the filing of certain forms and information returns related to flow-through shares.

New forms and information returns have been issued to record the information related to flow- through shares. The deadline for filing these forms was earlier set for March 19.