Flow-through shares

Flow-through shares are a type of common shares issued by eligible corporations in the mining, oil and gas, and renewable energy and conservation sectors in Canada. Flow-through shares permit a qualifying corporation to “renounce” certain exploration expenses to its flow-through subscribers, who are then entitled to deduct the full cost of the shares against their personal income for the year in which the shares were purchased. In effect, from an income tax perspective, the subscribers are treated as if they had incurred the expenses instead of the corporation.

This results in significant income tax savings for the flow-through subscribers in the form of deductions from income and investment tax credits for individuals (excluding trusts) that are available for certain flow-through investments targeting grassroots exploration. Meanwhile, the corporation benefits from issuing flow-through shares at a premium price compared to the market price of the corporation’s ordinary shares and the corporation also benefits by raising some often-difficult-to-obtain cash from equity investors.

The qualifying expenditures that a mining company may renounce include certain Canadian Exploration Expenses (“CEE”) as set out in the Income Tax Act (Canada) (“ITA”). Flow-through shares may also be issued in view of renouncing certain Canadian Development Expenses (“CDE”); however, such deductions may not be used in full in the year of subscription. Other than the tax benefits, flow-through shares are similar to all other common shares of a corporation.

History of flow-through shares

The Canadian flow-through share regime was introduced by the federal government as a tax-based financing incentive to encourage investment in Canada’s mining sector.[1] The policy premise underlying the regime is two-fold.

  • First, a typical early-stage mining company has difficulty raising capital to finance its exploration and development activities since mining projects involve high upfront costs and long lead times to determine the existence of any economically viable minerals before any subsequent production and revenue generation can occur.
  • Second, many junior mining companies also have no net income for tax purposes and find themselves unable to take advantage of the deductibility of their exploration and development expenses. This is particularly important given that there are up to seven times more junior than senior mining companies in Canada.[2]

Furthermore, certain provinces (specifically, British Columbia, Saskatchewan, Manitoba and Ontario) offer additional tax credits,  often referred to as “super flow-through,” while Quebec offers additional deductions from income. These incentives are only available to taxpayers residing in, or otherwise taxable in, the applicable province where the exploration is taking place.[3]

Importance of the mining industry to Canada

An additional justification for why the mining industry deserves to receive highly favourable tax treatment is because the mining industry holds a unique and important competitive advantage for Canada – it is arguably the foundational industry underlying the nation’s economy and all other industries. Due to its nature, mining is characterized by early-stage, high-risk, long-term investment requirements to find and develop a mine into commercial production. On average, it took 15.7 years for the 127 mines that opened in the world during the last two decades to move from first discovery to commercial production.[4] Despite these challenges, Canada is a leading global producer of minerals and metals.

Furthermore, Canada is the leading global market for the financing of exploration and mining. Over 40% of the world’s public mining companies are listed on the Toronto Stock Exchange (TSX) and the TSX Venture Exchange (TSXV), making them the world’s biggest exchanges for mining and top choices globally for new mining listings. An important factor that contributed to this capital markets success after the Bre-X scandal in the late 1990s was the adoption of National Instrument 43–101 Standards of Disclosure for Mineral Projects (“NI 43–101”) in 2001. NI 43–101 is a Canadian provincial securities rule that requires both private and public companies to provide detailed independent “technical reports” to investors when certain milestones are triggered.

Opportunity for global leadership in the green revolution

It is becoming increasingly evident that the global clean energy revolution is well underway. Critical minerals (including nickel, lithium, copper, cobalt, graphite and rare earths) will form the building blocks for the clean economy – they are used to manufacture a wide range of important technology: solar panels, batteries, electric vehicles, wind turbines, telecommunications infrastructure, and healthcare devices, just to name a few. To add some perspective, an electric car typically requires six times the mineral inputs as a traditional car[5] and onshore wind plants generally require nine times more mineral inputs than a comparative gas-fired power plant.

Consequently, the International Energy Agency estimates that the global energy sector’s needs for critical minerals could increase by as much as six times by 2040, with annual global demand reaching up to $770 billion.[6] Canada, which already has a robust mining industry, has the “generational opportunity” to solidify its position a world leader in this growing sector.[7]

A call for reform

Under the current regime, flow-through shares apply solely to CEE and certain CDE relating to mineral resources in Canada. We propose that the ITA be amended so that CEE would include expenses incurred in Canada directly related to the preparation of the technical reports that are required by NI 43–101 for pre-production mineral resources.

“Canadian exploration expense” is defined in subsection 66.1(6) of the ITA. Paragraph (f) of that definition is the paragraph that is generally relevant to expenses incurred in the course of mining exploration. Paragraph (f) states, in part:

“Canadian exploration expense” of a taxpayer means any expense incurred after May 6, 1974, that is:

(f) any expense incurred by the taxpayer … for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada including such an expense for environmental studies or community consultations (including … studies or consultations that are undertaken to obtain a right, licence or privilege for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada) and any expense incurred in the course of

(i) prospecting,

(ii) carrying out geological, geophysical or geochemical surveys,

(iii) drilling by rotary, diamond, percussion or other methods, or

(iv) trenching, digging test pits and preliminary sampling, …

As explained in the Canada Revenue Agency (“CRA”) guidelines shared with the industry,[8] in order for an exploration expense to qualify as a CEE pursuant to paragraph (f), it must be an expense incurred by a taxpayer “for the purpose of determining the existence, location, extent, or quality of a mineral resource” (the “CEE Purpose Test”). The CRA’s position is that in order for an exploration expense to be a CEE under paragraph (f) above, the CEE Purpose Test must be strictly met. According to the CRA, the fact that a corporation’s expense may be necessary for commercial or securities law reasons (e.g., to complete a technical report pursuant to NI 43–101) is not directly relevant to the issue of whether the requirements of paragraph (f) have been met. The CRA has determined that the word “quality” in the CEE Purpose Test is to be interpreted narrowly and should be limited to the physical characteristics of the mineral resource and should not include expenses related to determining the economic viability of a mineral property. Expenditures related to the preparation of a preliminary economic assessment (“PEA”) (also known as a scoping study), a pre-feasibility study (“PFS”) or a feasibility study (“FS”), including the collation of the data and the analysis of the project, do not meet the CEE Purpose Test. According to the CRA, such expenses should be considered as operating expenses rather than CEE or CDE.

However, PEAs, PFSs and FSs are mission-critical, compulsory reports that reduce the risk of economic failure and they are required by Canadian provincial securities law requirements. These technical reports are necessary in the development of mineral properties in Canada where the disclosure provided by such reports is necessary to obtain the financial support of early-stage, pre-production investors. The tax policies of the federal government should align and be harmonious with both:

  • the federal government’s aspirations with the Canadian Critical Minerals Strategy and the Canadian Minerals and Metals Plan; and
  • the requirements of Canada’s provincial governments and their securities commissions in regard to the preparation of technical reports such as PEAs, PFSs and FSs that are prepared in accordance with NI 43–101.

Flow-through tax treatment should be provided for these expenses too by amending the definition of CEE in subsection 66.1(6) of the ITA to expressly include expenses related to the preparation of the technical reports that are required by NI 43–101 for pre-production mineral resources.

In order to make this change palatable even to the most hawkish of critic who may be resistant to change, we propose that there be a requirement that in order for an expense related to the preparation of technical reports such as PEAs, PFSs and FSs to qualify as a CEE, that such expense must be spent domestically in Canada. This requirement will help to further enhance the development of the mining and mining-services industries in Canada so that the country can continue to develop and maintain a sustainable competitive advantage in an ever-increasingly competitive world. The more Canada furthers its #1 position as the go-to place for global mining finance and technical services, the more the country will benefit. These are important considerations in an era of threatened international trade wars, tariff barriers and security-of-supply risks. 

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[1] 1966 R.C.T. Vol. 4, Chp. 23.

[2] https://natural-resources.canada.ca/minerals-mining/canadian-mineral-exploration/8290

[3] https://investingnews.com/tax-benefits-flow-through-shares-in-mining-and-exploration/

[4]https://www.spglobal.com/market-intelligence/en/news-insights/research/discovery-to-production-averages-15-7-years-for-127-mines

[5] https://440megatonnes.ca/insight/canada-critical-minerals-clean-energy-transition/

[6] https://440megatonnes.ca/insight/canada-critical-minerals-clean-energy-transition/

[7]https://www.iea.org/news/clean-energy-demand-for-critical-minerals-set-to-soar-as-the-world-pursues-net-zero-goals

[8] CRA Document 2020–0873931E5 – CEE – Economic Assessments; see also CRA, CRA Document 2020–0873931I7 – Cover Letter – Mining Expenditure Review Table.