As part of its COVID-19 Economic Response Plan, the Government of Canada recently announced, on July 10, 2020, that it will propose new legislation to extend the timelines by 12 months for junior mining exploration and other flow-through share issuers for spending the capital they raise via flow-through shares financing.
Junior mineral exploration plays a vital role in Canada’s mining industry. Indeed, the exploration and development of mineral deposits, which are usually conducted by junior mining companies, ensure the mining industry’s long-term viability, create jobs, and attract investment. These companies, which tend to be smaller in size, often have no operating revenue and have difficulty raising capital to finance their exploration and development activities.
Flow-through shares (FTSs) are a tax mechanism through which junior mining companies can more easily finance their exploration activities. FTSs are newly issued common shares that allow the issuer corporation, in this case, a junior mining company, to transfer an eligible Canadian exploration expense (CEE) to the investor. An income tax deduction equivalent to the amount invested can then be claimed by such investor. Thus the FTSs regime allows the junior mining company to monetize the income tax deductions of which it cannot immediately take advantage. Since a junior mining company does not generate enough income at the exploration stage to apply the tax deductions derived from CEE, those deductions are more valuable to the subscribers than to the company.
The FTS federal and provincial tax legislations also provides tax incentives in the form of additional income tax deductions, income tax credits and/or capital gain exemption to investors who acquire FTSs. FTSs have similar legal attributes to common shares, but are generally issued at a premium. All these tax incentives contribute to making an investment in FTSs attractive to individuals, provided, of course, that the junior mining exploration company honours its undertakings under the FTSs subscription agreement, in particular as to the fiscal characterization of expenditures and the meeting of the various strict deadlines.
Two regimes currently apply to the timelines for spending capital raised via FTSs: the general rule and the “look-back” rule.
A. General rule
Under the general rule, the issuing corporation must incur the CEE to be renounced in favour of the FTS investors within a 24-month period from the date on which the flow-through share subscription agreement is entered into. The issuing corporation then has until March of the first calendar year beginning after the 24-month period to renounce the CEE in favor of the FTS investors.
B. “Look-back” rule
Under the “look-back” rule, a FTSs issuer can make an advance renunciation of the eligible CEE with an effective renunciation date on the last day of the calendar year in which the FTSs subscription agreement has been entered into, despite not yet having incurred the expenses. This rule is, however, contingent on the FTSs issuer committing to incur the eligible CEE in the calendar year following the execution of the FTSs subscription agreement.
The federal government’s proposed changes grants junior mining companies and other FTSs issuers whose operations have been affected by the COVID-19 pandemic additional time to incur the eligible CEE. The details regarding what will be considered an issuer “affected by the COVID-19 pandemic” have not yet been made available to the public.
Specifically, the government proposal would extend the period to incur CEE under both the general rule and the “look-back” rule by 12 months for FTSs subscription agreements entered into on or after March 1, 2018 and before 2021, when using the general rule, or for agreements entered into in 2019 or 2020, when using the look-back rule.
In addition, the government proposes to apply Part XII.6 tax relief for investors who have entered into FTS agreements in 2019 or 2020. Essentially, Part XII.6 will apply as though eligible CEE were incurred up to one year earlier than the date they were actually incurred. However, if such expenses are not actually incurred by the end of 2021 for 2019 FTSs subscription agreements or 2022 for 2020 FTSs subscription agreements, no relief will be available.
Status of the proposal
In order to enact this proposal, the federal government’s next step is to introduce draft legislation on the changes, which is not currently available to Parliament. Thereafter, the draft legislation must undergo a series of readings by Parliament. Once the draft legislation has been debated and voted on, it is sent to the Senate for its consideration, and then subsequently sent to the Governor General for royal assent. While this can be a lengthy process, the enactment of COVID-19 measures has been relatively swift, with some bills having attained royal assent within days of their first reading.
It should also be noted that additional concerns were raised with respect to the limitations imposed by the COVID-19 pandemic on the types of work and exploration that could be done. To address this problem, members of the industry have been advocating for a temporary expansion of the criteria for eligible CEE to include administration costs and desktop geological works for at least 18 months, starting on April 1, 2020.