February 2013

MAC Economic Commentary

New taxation measures threaten Canadian junior miners

By Pierre Gratton

Canada is home to the largest concentration of junior companies in the world, hosting 70 per cent. In 2011, 152 new juniors listed on the TSX Venture – representing one firm every two and half days. These new companies made up around 12 per cent of the exchange’s total 1,275 listings for the year. In 2012, Canadian-based enterprises accounted for the largest share – 37 per cent or $7.5 billion – of global exploration spending. Roughly 800 of these are actively exploring outside of Canada in over 100 countries. In fact, Canadian firms represent the largest share of exploration spending in the United States, Central and South America, Europe and Africa.

TSX-listed mining companies operate approximately 3,500 projects, 63 per cent of which are located abroad. An additional 2,408 projects outside of Canada are owned by TSX Venture-listed companies. Both local and foreign investors injected a total of $7.25 billion in TSX and TSX-V mining companies operating projects outside of Canada, compared to $2.16 billion raised for mining groups with projects located within the country.

This is global leadership. Unfortunately, it may be about to erode. The new federal Foreign Affiliate Dumping (FAD) rules throw a wrench into the junior mining industry’s successful business model by impeding the financing of certain key mining transactions – transactions that do not belong to the debt-dumping activity the rules are designed to catch. By imposing extra costs on “investments” made by foreign-­controlled Canadian mining companies in foreign affiliates, the FAD rules: 1) make Canadian junior mining companies less attractive to foreign majors; 2) render Canada less attractive as a destination for new junior mining companies with foreign projects; and 3) risk eroding Canada’s world-class junior mining sector, as well as the Canadian financial and supply sectors that currently support the industry.

To understand how FAD rules will impact the mining industry, it is crucial to recognize the relationship between the affected transactions and the financial synergy of both junior and major miners. Junior companies are frequently required by law to be localized in the country in which they are operating through the creation of a foreign affiliate (FA). The FA possesses the land holdings and the exploration licences for the host country, and manages the operations of the project. In many cases, the foreign-controlled corporation resident in Canada (CRIC) – the company that owns the FA – is a holding company whose raison d’être is to finance the activities of the FA. These high value-added activities can be conducted in Canada or anywhere else, and they represent found money for Canada that expands its tax base.

When it comes time to develop an exploration project, the junior CRIC will often partner with a major mining company (often a non-resident), usually in the form of the foreign major investing in the junior CRIC. In turn, the junior CRIC finances its FA’s development activities abroad. Throughout this pro­cess, the foreign major frequently makes a bid for the remaining shares of the junior CRIC, thus acquiring the company, the company’s FA and the exploration project it is developing.

In a majority of cases, investors use Canadian corporations as a vehicle for investing in mining projects outside of Canada. These transactions are not undertaken because of any perceived Canadian tax benefit. Rather, investors are attracted to the infrastructure that is Canada’s competitive mining advantage: the specialist bankers, lawyers, accountants, geologists, the TSX and TSX-V exchanges, and the Canadian corporate and securities laws applicable to corporations created and listed here.

These investors currently choose to come to Canada, but they have alternatives. Over the past few months, MAC, PDAC and many financial, legal and accounting communities have been working hard to convince the Department of Finance Canada to revise these rules – with some success. But many problems remain, and the new rules effectively create incentives for those already here to leave for a more favourable tax jurisdiction. International competition for high-value financing and management activities arising from mining projects is intense. This is true in regions like Africa, Latin America and Asia, but particularly in the United Kingdom. The U.K. recently revised its tax regime to make it very attractive for foreign investors to use domestic companies for foreign projects – the exact opposite of the policy direction set by the FAD rules.

The impact of losing new mining companies to other countries is significant to Canada. In 2011, TSX Venture-listed juniors raised $5.9 billion in equity capital. These companies are serviced by a robust mining supply sector – the second largest in the world. If the junior sector erodes, the supporting financial, legal and other areas of expertise that surround it – namely, our competitive advantage – will erode along with it. Our industry must continue to work to resolve this issue in a way that enables the government of Canada to achieve its original policy objective without adversely affecting the Canadian mining industry.


Pierre Gratton is president and CEO of The Mining Association of Canada.

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