Canada’s flow through shares surge despite capital gains  

Concerns surrounding the capital gains tax increase haven’t stopped Toronto markets from issuing the highest number of flow-through shares (FTS) in five years, according to new data.

There were 2.9 billion FTS issued last year, generating over C$1 billion for the mining sector and accounting for 10% of mining equity financings, says TMX, owner of the TSX and TSXV.  

It’s become a critical tool for the exploration funding system, according to Kendra Johnston, managing director of PearTree Securities, a boutique financing firm focused on the junior Canadian resource sector.  

“[FTS are] focused on incentivizing the exploration and development phase of the mining sector which is the high-risk, high-reward phase,” Johnston said in an interview. “You need high-risk capital.”  

FTS allow mining, oil and gas, and renewable energy corporations to issue common shares with a federal Canadian Exploration Expense (CEE) tax deduction attached, incentivizing investors to claim the deduction or pass the shares on to a charity for an added tax deduction.  

Based on data from the TSX, S&P Global, the Prospectors & Developers Association of Canada, and PearTree’s books, Johnston says FTS raise about 84% of all money for exploration across Canada. Charity flow-throughs gather 72%, and traditional flow-through 12%. 

Concerns

Despite the increased appetite for FTS this year, investors have some concerns, says Peter Nicholson, president and founder of Ottawa-based WCPD., a financial services firm focused on structured FTS. The capital gains inclusion rate is set to increase next January and the Federal Mineral Exploration Tax Credit (METC) was slated to expire this month until the government extended it on Monday for two years.

“Flow-through shares have a zero adjusted cost base (ACB), meaning that when you sell them, even at a loss, it triggers a capital gain,” Nicholson said.  

“Under the new tax rule, however, the capital gain jumps to 66% on dollar one, effectively killing this transaction,” he said.  

On the individual side, large buyers purchasing C$1 million or more in FTS face steeper losses. He estimates that the capital gains increase could kill around 40% of all junior mining FTS financing. 

The FTS system has other drawbacks. There’s an inherent risk in investing in junior miners and explorers that typically have no revenue and rely on fundraising for operations.  

“Junior mineral exploration companies are often more volatile than blue chip companies but larger mining companies could also issue flow-through shares,” said Geoff Clarke, partner and lead of the mining law practice at Miller Thomson LLP. 

He points out that while FTS are susceptible to swings in commodity prices or regulatory changes, there’s no additional volatility by being FTS. However, they can be subject to hold periods or thinly traded, making them hard to sell at a favourable price. Liquidity comes down to the issuer and the specific exploration project, he said.  

“Because of the tax advantage attractiveness, in volatile or bear market times for the mineral sector those are sometimes the only funds that could be raised,” Clarke said.  

Challenges aside, both Miller and PearTree’s Johnston agree Canada’s FTS is the highest-rated incentive for investing in the industry. Here’s how other mining jurisdictions stack up. 

Australia

Australia introduced the Exploration Development Incentive (EDI) in 2014, replacing it with the Junior Minerals Exploration Incentive (JMEI). The program allows eligible juniors with no taxable income to pass tax credits from exploration expenditures to Australian resident investors. 

“It’s not as broad as Canada, where flow through shares can also cover oil and gas,” Clarke said.  

Under the JMEI, the incentive for investors is delivered via a non-refundable tax credit rather than a deduction of their income.  

“It’s a little bit more comparable to provincial-run programs in Canada,” Johnston said, likening it to an exploration grant. “You submit a project proposal and budget, and then they give you a portion of the budget to go out and execute that plan.” 

United States 

In the U.S., the Percentage Depletion Allowance focuses on producers.  

“It includes oil and gas, and says, if you are in this sector, we’re going to let you have a faster depreciation and capital cost allowance,” Clarke said. “It’s letting them save money on tax by accelerating their expenses during the depletion phase.”  

To be eligible, you need income from mineral extraction. Companies can claim an ongoing tax deduction of their gross income from extraction, the lawyer said. The allowance is capped at half of net taxable income from the property and deduction rates are 15% for gold, silver and copper and 5% to 22% for other minerals.  

Clarke points out that, unlike FTS, the allowance doesn’t address the risks, money and time spent to take a project from discovery to production.  

“But it does [acknowledge] the resource sector is special and should get some incentive.” 

United Kingdom 

The UK’s primary vessels for incentivizing investment in exploration are Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs). With EIS, shareholders can claim 30% tax relief on investments up to £1 million (C$1.8 million) per year.  

“[The EIS] does target early-stage enterprises, but it’s very different from Canada,” Clarke said. “They can’t be on a recognized stock exchange.” 

VCTs are similar to public investment trusts. They invest in small, high-growth and high-risk companies in the U.K.  

“You could potentially have an exploration fund that would put all of these small-cap companies into one place, and then they could sell a share of the fund to the investors,” Johnston said. Like EIS, VCT Shareholders can claim up to 30% tax relief on investments but the threshold is lower at £200,000 per year (provided the investment is held for five years). 

South Africa 

South Africa has Mining Capital Allowances, allowing companies engaged in exploration, development and production to deduct capital expenditures related to mining operations. There’s also the Accelerated Depreciation Allowance which allows for faster depreciation of qualifying assets.  

“You have to be making a profit to benefit from the depreciation expense,” Clarke said. “It’s a very different system. It’s not encouraging investment, it’s not specifically targeting exploration.” 

While the capital gains tax and the potential expiration of the METC threaten to stunt investment in exploration, both Johnston and Clarke agree the FTS system will continue to bring investors through the door.  

“Decades ago, [Canada] recognized the importance of capital formulation in the mining process – [something] these accelerated depreciation models don’t recognize at all,” Clarke said.  

“[FTS] recognizes that this starts with capital formation to fund those men and women who are out in their boots walking across the Ring of Fire and the swamps by Hudson Bay.”