Canada’s Natural Resources – Now and for the Future
Flow-Through Share Financing for Junior Mining Companies
Canada’s Experience
Robert J. ClarkNatural Resources Canada
November 2007
Canada’s Natural Resources – Now and for the Future 2
Presentation Outline
1. What is a Flow-Through Share ?
2. Development of Flow-Through Shares
3. Key Factors in the Success of Flow-Through Shares 4. Analyzing the Effectiveness of Flow-Through Shares
5. International Interest in the Mechanism
Canada’s Natural Resources – Now and for the Future 3
Simplified Definition of a Flow-Through Share:
A Flow-Though Share is a type of common share which allows a “principal-business corporation” to transfer the tax deductions to investors, who can apply them against their personal or corporate income tax.
A “principal-business corporation” is a corporation involved in exploration, production and processing of a minerals, or oil and gas; or in renewable energy and conservation activities.
1. What is a Flow-Through Share ?
Canada’s Natural Resources – Now and for the Future 4
0
875.328
1750.657
2625.985
3501.314
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
i
Expl
orat
ion
Expe
nditu
res
($ m
illoi
n)
Seniors Juniors MPI
Constant 2006 $ millions
ITCE15% tax credit
MEDA, 33 1/3%
2. Development of Flow-Through Shares
1981, proceeds subject to capital gain tax
1985-1994, $100K lifetime capital gains exemption
1996,Look back rule
2001, capital gain inclusion rate reduced to 50%
Other developments
:
CEIP30%
MPI1971=100
Canada’s Natural Resources – Now and for the Future 5
Canada’s Share of Worldwide Exploration
Pacific/SE Asia7.7%
United States9.8%
Rest of the World8.3%
Africa14.7%
Australia19.3%
Canada12.1%
Latin America28.1%
2007 Worldwide Exploration Spending by Region
Source: Metals Economics Group
1999 Worldwide Exploration Spending by Region
Latin America21.8%
Pacific and SE Asia4.0%
United States7.9%
Rest of World16.6%
Africa16.1%
Australia12.4%
Canada21.2%
Canada’s Natural Resources – Now and for the Future 6
3. Key Factors in the Success of Flow-Through Shares
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Key Factors – Canada’s Junior Mining Companies
Around 100 “Senior” mining companies (with one or more producing mines) ranging from: Large integrated global producers (e.g., Teck Cominco
Limited) to; One mine companies (e.g., Tahera Diamond
Corporation). Around 1100 “Junior” exploration/mining companies or
private exploration/mining syndicates, with no financial interest in a producing mine and no cash flow. Their assets are exploration properties and they raise money by issuing shares.
Placer miners/small-scale miners.
Canada’s Natural Resources – Now and for the Future 8
Mining Companies on Selected Stock Exchanges, 2006
0
375
750
1125
1500
Canada Australia United Kingdom South Africa
AIM-LSE NYSE-
AMEX
Notes: 1 Discounting inter listings. As at December 31, 2006.Source: TSX Group based on information from AMEX, ASX, CDNX, JSE, LSE, NASDAQ, NYSE, TSX.
ASXJSE
TSXVenture
TSX
(Number of companies1)
Canada’s Natural Resources – Now and for the Future 9
Key Factors - Canada’s Expertise in Mining Financing
Canada is home to the TSX and TSX Venture Stock Exchanges which together account for over approximately 40% of the world’s equity financing for exploration and mine development in 2006.
Canada is home to over 200 financial and legal companies which provide specialist services to the mining industry.
Flow-Through Limited Partnerships have played a significant role in raising financing for exploration and mining and provide a diversification to the investor.
Canada’s Natural Resources – Now and for the Future 10
Canada’s Equity Capital Markets
Sources: Toronto Stock Exchange; Gamah International; Natural Resources Canada.
Equity Financing for Exploration and Mining Companies Raised Through Stock Exchanges Based in Selected Regions of the World
2006 = $31.7 B2000 = $3.2 B
US1.1%
Australia3.5%
Rest of World8.1%
Canada44.3%
S. Africa4.9%
UK38.0%
China9.5%
US3.6%
Australia8.7%
Rest of World3.8%
Canada38.2%
S. Africa0.6%
UK35.7%
Canada’s Natural Resources – Now and for the Future 11
Key Factors - Government Support
Governments at the federal, provincial and territorial levels forego the time value of the 100% deduction for exploration, which is claimed by the investor long before a junior mining company would have revenues against which to claim it.
When additional incentives are offered by the federal government, some provinces provide add-on incentives creating so-called “Super Flow-Through”. In 2007, the federal government provides an additional 15% tax credit, which is boosted by additional incentives in British Columbia, Manitoba, Ontario and Quebec.
Canada’s Natural Resources – Now and for the Future 12
Investors receive a 100% income tax deduction for Canadian Exploration Expenses.
Since the corporate tax rate is lower than the top personal tax rate, the tax deduction is more valuable in the hands of the individual.
On the sale of the shares, only 50% of realized capital gains are included in income.
For surface exploration, the investor may be eligible for the federal 15% tax credit, and complementary provincial tax credits (BC 20%, Manitoba 10% and Ontario 5%) or in Quebec an additional 50% deduction from taxable income.
Key Factors - Tax Advantages for Investors
Canada’s Natural Resources – Now and for the Future 13
Tax Advantages by Province/Territory
$0
$250.0000000000000512
$500.0000000000001024
$750.0000000000001536
$1,000.0000000000002048
Qué Man NLD PEINB NWT NUV
$519$506$490$484$476$451$447$440$437$433$410$383$284
After-Tax Cost of a $1,000 Investment in Flow-Through Shares Top Marginal Tax Rates for 2007
Provinces and Territories
Federal Tax Reduction Federal Tax CreditProv/Terr Tax Reduction Prov/Terr Tax CreditNet Cost
Canada’s Natural Resources – Now and for the Future 14
4. Analyzing the Effectiveness of Flow-Through Shares
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Analysis available on the effectiveness of flow-through shares: Flow-Through Shares – An Evaluation Report –
Finance Canada 1994. Queen’s University Studies on Costs of
Exploration for Gold (1987,1989 and 1992). Reports on taxation issues by the
Intergovernmental Working Group on the Mineral Industry (2002 to 2006).
Studies of Mineral Discoveries by Natural Resources Canada and the Prospectors and Developers Association of Canada (PDAC).
Effectiveness of Flow-Through Shares
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Criteria Used in Analyzing Effectiveness
Relevance – Whether Programs Meet Expectations of Stakeholders
Effectiveness – Success
Cost Effectiveness
Mineral Discoveries
Cost of Mineral Discoveries
Ease of Administration and Compliance
Canada’s Natural Resources – Now and for the Future 17
To Government Addresses government priorities. Helps stimulate exploration and
encourages risk taking. Unusable or unused tax benefits
transferred to investors providing a premium on market price of shares.
To Industry Meet priorities of industry during periods
when additional incentives are offered.
Relevance
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0
275
550
825
1100
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006(p) 2007(i)
Off-Mine-Site Exploration Work Phase Expenditures by Type of Company, 1997-2007
($ millions)
Junior Companies Senior Companies
Relevance - Timeliness
Investment TaxCredit for Exploration
Canada’s Natural Resources – Now and for the Future 19
Effectiveness - Success
Pros Accounts for a significant portion of Canadian
mineral exploration financing (up to 60%) when add-on credits are available and other financing is difficult to obtain.
Benefits the economy of Canada, particularly in Ontario, British Columbia, Québec, Nunavut and the Northwest Territories.
Cons Exploration costs were inflated before 1996
because of the short timeframe to complete the work.
Canada’s Natural Resources – Now and for the Future 20
BritishColumbi
a$425 M Alberta
$15 M
Manitoba$103 M
Ontario$519 M
Quebec$385 M
NorthwestTerritories
$153 M
Newfoundland and Labrador$160 M
NewBrunswick
$31 M
Nova Scotia $27 M
Saskatchewan$277 M
Yukon$144 M Nunavut
$267 M
2007 Total = $2506 Million
Source: Natural Resources Canada, from the federal-provincial-territorial survey of Mineral Exploration, Deposit Appraisal and Mine Complex Development Expenditures. Based on revised company spending intentions compiled in August 2007 (totals could vary slightly as data are in final validation stage).
Effectiveness – Regional Distribution
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Note: Includes on-mine-site plus off-mine-site activities for field work and overhead
0
500
1,000
1,500
2,000
1975 1979 1983 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006p
Exploration Expenditures by Mineral Commodity Sought (2006$)
$ m
illio
n
Metals PreciousMetals BaseMetals UraniumDiamondsOther
Effectiveness – Commodity Emphasis
Canada’s Natural Resources – Now and for the Future 22
Cost Effectiveness to Government
For period 1987 – 1991: Federal tax expenditures = $462.9M; Incremental Renunciations = $1,205.6M (49% of actual); Incremental Renunciations )Federal Tax
Expenditures = 2.6 That is one dollar of tax expenditure during this
period resulted in $2.6 of new (incremental) exploration spending (from Finance Canada report 1994).
For the period 2000 – 2007, the multiplier appears to be of a similar magnitude.
Canada’s Natural Resources – Now and for the Future 23
Cost EffectivenessTo The Investor
1986 – 1990 Investment performance was better for direct
investment in a mining corporation, than in a limited partnership.
The early investors got equity in better projects than later investors.
The risk nature of exploration meant that the usual negative return from investment had to be offset by significant tax incentives.
2000 – 2007 Private placements reducing sharing of premium. Lower levels of investment and proportionately more
good projects available.
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Cost EffectivenessTo The Mining Company
Finance Canada concluded that FTS provided significant incentive for exploration by non-taxpaying companies (junior companies without production).
Fully taxpaying firms would not wish to pass their tax deductions to an investor.
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Cost Effectiveness to the Public - Mineral Discoveries
Studies by Queen’s University indicated that the cost of discovering an ounce of gold rose rapidly in the late 1980s, however, Canada’s gold production doubled from 5% to 10% of the global share by 1990.
Prominent discoveries attributed in part to flow-through shares by the Prospectors and Developers Association of Canada: Ekati Diamond Mine – Charles Fipke – NWT Louvicourt Base Metal Mine – Aur Resources – Québec Lindsley Base Metal Mine – Falconbridge – Ontario Eskay Creek Gold Mine – Prime Resources – BC Jericho Diamond Mine – Tahera- Nunavut Ni Rim South - Falconbridge – Ontario.
Canada’s Natural Resources – Now and for the Future 26
Ease of Administration
Pros Tax based programs are administered through
existing government structures. The federal, and most provincial governments, have
harmonized their rules and about 11 federal employees handle most of the administration.
Cons The modification of tax legislation and design of forms
and administrative procedures is required to ensure that only eligible expenses are claimed.
Rules for the tax incentives are complex and expenses and renunciations require precise tracking.
Canada’s Natural Resources – Now and for the Future 27
Bottom Line
The principal beneficiaries of flow-through shares are junior mining companies who can obtain funds for exploration, partly in exchange for tax deductions that they would not be able to use.
Exploration is restricted to Canada, and new mines provide economic benefits to Canada and particularly to northern and rural communities.
Investors in flow-through shares reduce their income
tax and have shares of variable value in a mining company or a mutual fund.
The direct costs to the government are modest.
Canada’s Natural Resources – Now and for the Future 28
5. International Interest
Australia has had forms of flow-through shares at different times. Since 2001, industry and state governments have advocated the re-introduction of the mechanism. Information has been provided to the federal and state governments.
South Africa has studied the mechanism for several years; a “Canada–South Africa Government Roundtable” was held in Pretoria in February 2003. Currently, a joint working group headed by the National Treasury, is evaluating the need for and the potential scope of flow-through shares in South Africa.
Chile has obtained information on the mechanism.