Although the financing measure has had tremendous success, it appears Ottawa will let it expire at the end of the month

By Catherine Harris | March 2007

The era of super flow-though financing for mineral exploration is scheduled to come to an end this month after a six-year run. But the jury is still out on whether the loss of the tax credit will deflate the general popularity of flow-through products, which are heading for another record-breaking year.

Flow-through shares are issued by Canadian companies and allow individual shareholders to deduct from their personal income the money junior mining companies spend on exploration in Canada. Regular flow-though financing allows a 100% deduction, while “super” flow-throughs give inves-tors an extra 15% tax credit. The SFT credit is set to expire on March 31.

The federal government introduced SFT financing in 2000 to help resuscitate the Canadian mineral exploration industry, which had been in decline for several years and was losing investment dollars to the high-tech sector. Several provinces have topped up the federal incentive by offering their own tax credits, ranging from 5% in Ontario to 20% in British Columbia.

After a sluggish start, SFT shares became a hit with high net-worth investors as metals prices rose, helping Canada become one of the world’s top destinations for exploration dollars. In 2006, Canada captured 19% of the record US$7.13 billion budgeted for mineral exploration worldwide, according to Halifax-based Metal Economics Group.

Flow-through financings in general also appear to be heading for a record, hitting $600 million by the end of October 2006. Since the tax credit was introduced, companies issuing flow-through shares for exploration have raised almost $1.9 billion and made hundreds of grassroots discoveries, according to the Prospectors and Developers Association of Canada.

For an investor in Ontario’s highest tax bracket, the after-tax cost of a common, non-registered $30,000 SFT investment is approximately $13,000. Using SFT shares, the investor gets a powerful tax shelter as well as the potential upside of a mineral discovery by the company. The tax deductions can be carried back three years or carried forward seven years.

But the extraordinary success of the SFT program, combined with record metals prices, may have rendered the tax credit obsolete. Although it has been renewed several times over the years, the federal Conservatives are expected to allow the credit to expire at the end of March despite intense lobbying by the PDAC to keep it alive. The provincial governments, with the exception of Quebec, will probably follow the federal lead.

“We are not an industry in cri-sis anymore,” says Gerald Har-per of Toronto-based Gamah International Ltd. , a consultancy that tracks financings in the global mining sector. “We have more money than we can spend. We are reaching the point at which we cannot efficiently spend the financing we do have available, not only in Canada but around the world.”

And any flow-through money left unspent within a year of the company renouncing exploration expenses to shareholders is not only subject to a 10% fee, but must also be returned to the investor as income, Harper points out. As shortages of labour and equipment required to do the work become increasingly acute, the probability of money sitting in the bank increases. So, too, does the chance that companies will spend the money just to get rid of it.

Such a situation happened two decades ago, when a similar program, the mineral exploration depletion allowance, was introduced as a stimulant. The program became so popular with investors that juniors flush with cash began throwing money at uneconomical prospects. Spending on mineral exploration in Canada reached $1.3 billion before the government withdrew the tax incentive in 1998.

Today — although restrictions on how flow-through money is used have helped quell abuse of the program — similar demand for flow-through shares and their associated tax benefits may signal that the SFT tax credit has outlived its usefulness again.

“We raised $15 million in 2006, the most to date, and 2007 promises to be double that,” says David Mason, chairman and managing director of Augen Capital Corp. , a Toronto-based investment firm that offers flow-through share funds. “The investment tax credit is nice, but it’s only a small portion of the total rate of return.”

Augen has had a 66% average after-tax rate of return on its limited partnership funds issued since 1999. For the past three years, the return has been 98%. In 2006, the LP portfolio included juniors involved in exploration for gold (35%), uranium (25%), base metals (21%), oil and gas (15%) and other minerals (4%).