The 2012 federal budget represents something of a mixed bag for the mining community. While the investment tax credit (ITC) for holders of flow-through shares was renewed for another year, other ITCs for mining corporations are being eliminated (ITCs are a dollar-for-dollar reduction in tax payable). Also, foreign multinationals with Canadian subsidiaries will be subject to new anti-avoidance measures.
METC extension good news for mineral exploration
The Mineral Exploration Tax Credit (METC) provides an incentive for individuals to invest in mineral exploration companies through flow-through shares (FTS) in the form of a 15 per cent ITC. FTS are an important financing tool that allows a Canadian mining corporation to issue equity to investors at a higher price than it would receive for “normal” shares because investors are entitled to claim the corporation’s tax deductions that “flow through” the shares.
In addition to these “flowed-through deductions,” when certain mining exploration expenses incurred by the corporation (at or above ground level) in Canada and renounced to a holder of flow-through shares – who is an individual – that holder is entitled to an ITC equal to 15 per cent of the renounced qualifying expenditures.
The Income Tax Act required that qualifying expenditures be incurred by the corporation by the end of 2012, and be renounced to the investor under an agreement made before April 2012. The budget extends the 15 per cent METC for another year, by extending both the date for incurring qualifying expenditures to the end of 2013, and the deadline for entering into the flow-through share subscription agreement governing renunciation to March 31, 2013. This extension of the ITC preserves the benefits of an important financing tool for Canadian miners, and is very welcome, although it would be preferable for this ITC to be made permanent.
Cuts to ITCs impact incentives for some mining projects
Canadian corporations engaged in pre-production exploration and development activities for diamonds, or base or precious metals, were entitled to an ITC equal to 10 per cent of the amount of qualifying expenditures. The budget phases out the pre-production mining expenditure ITC.
For pre-production exploration expenditures, the ITC will continue to apply at the 10 per cent rate for expenditures incurred in 2012. The rate will drop to five per cent for expenditures incurred in 2013, and there will be no ITC for expenditures incurred in subsequent years. For pre-production development expenditures, the 10 per cent rate will apply for expenditures incurred in 2012 and in 2013, and drop to seven per cent for expenditures incurred in 2014 and to four per cent for expenditures incurred in 2015. There will be no ITC in subsequent years. The elimination of this ITC is disappointing because it has been an important incentive for the mining industry to undertake high-risk mineral exploration activity.
The Atlantic investment tax credit, a 10 per cent ITC for expenditures on property used in certain activities occurring in Atlantic Canada, is also being phased out for expenditures incurred on mining, and oil and gas activities. The 10 per cent ITC rate will apply for expenditures on qualifying property acquired before 2014, and will be reduced to five per cent for property acquired in 2014-15. There will be no ITC in subsequent years. This initiative will eliminate an important incentive for mining in Atlantic Canada.
News for foreign corporations with Canadian subsidiaries
Canadian corporations are limited in the amount of interest expense they can deduct for tax purposes on debt owing to non-residents of Canada who are (or who are related to) significant shareholders of the Canadian corporation (for example, a foreign parent of a Canadian subsidiary). Pre-budget, the amount of debt that was interest-deductible for tax purposes was limited to $2 for every $1 of equity. The budget reduces this limit to $1.5 of debt for every $1 of equity (effective for taxation years beginning after 2012). Foreign corporations with Canadian subsidiaries need to review their financing before 2013.
A separate measure deals with investments made by Canadian subsidiaries of foreign corporations. This measure applies where the Canadian subsidiary acquires an interest (debt or equity) in a foreign corporation, as is typically the case when a new foreign project is started. Unless it can be shown that the investment was not made primarily for Canadian tax reasons, the investment may trigger Canadian dividend withholding tax. The scope of this rule is very broad, and foreign mining companies need to consider it when their Canadian subsidiaries make any foreign investment.
Read more about flow-through shares at miningtaxcanada.com.
Steve Suarez is a partner in the Toronto office of Borden Ladner Gervais LLP. He advises clients on the tax aspects of business transactions and operations (particularly in the mining sector), and operates Mining Tax Canaada, a website on tax issues of relevance to the mining community.