Tax breaks are a rare breed for most investors nowadays. But one that has endured is the deduction -- and, in some cases, a credit as well -- for investments in certain resource companies.
A tax deduction is available to investors who purchase flow-through shares of qualifying oil-and-gas and mining companies, which are permitted to pass on -- or "flow through" -- their tax expenses to shareholders. Up to 100% of a company's eligible exploration expenses may be deducted from the taxpayer's income, as well as up to 30% of eligible development expenses.
The shares must be newly issued, through either private placement or public listing, in order to qualify for flow-through tax treatment. These shares must be owned directly by an individual investor, or through a limited partnership that holds flow-through shares.
Flow-through shares usually are issued by smaller resource exploration companies that are yet to generate net taxable income, and thus are unable to write off their expenses. By passing on the tax benefit to investors, companies generally can issue new equity at a price somewhat higher than if no tax incentive was available.
A purchase of flow-through shares of a company engaged in mineral exploration can provide the investor with a 15% tax credit, in addition to the deduction. This credit's survival has been tenuous, however, as it has been subject to renewal each year by taxation authorities, the most recent stay of execution being the March 22, 2017 federal budget, which extended its availability for another year.
Expenses eligible for the credit, which is non-refundable, include qualifying "grassroots" mineral exploration incurred before 2019, says Lisa Somers, a tax partner with KPMG in Canada. "In order to qualify, the mining company must conduct the grassroots exploration activity from or above the surface of the earth, for the purpose of determining the existence or location of a mineral resource."
To be eligible for the extended tax credit, individual investors must have entered into a flow-through-share agreement with the issuing corporation -- in other words, purchased the shares with the appropriate documentation -- by the end of March 2018. The mining company later issues a T101 information slip to the investor. The T101 specifies the amount of resource expenses that are tax-deductible in the investor's hands, as well as specifying whether they qualify for the 15% credit (see box 128). (For an investment through a limited partnership, this information is provided on a T5013A slip). Ontario, Quebec, British Columbia, Manitoba and Saskatchewan offer provincial tax credits that are similar to the federal credit.
Note that the amount of the tax savings from the 15% credit is taxable in the year after the year in which the credit is claimed (see example below). "So, with respect to the 15% tax credit, essentially the individual taxpayer receives the after-tax benefit only," Somers says.
Of importance is a "look-back" rule, which allows the investor to use the credit during the year in which the investment is made -- even if the money isn't used by the company until the following year.
"For example, funds raised with the credit during the first three months of 2018 can support eligible exploration of a mining company until the end of 2019," Somers says. "If the funds are raised in 2018 but not spent until 2019, the mining company may still renounce the tax deductions to the individual investor with an effective date of Dec. 31, 2018."
As with other equity purchases, when flow-through shares are sold, only one-half of any capital gain is reported as income. Similarly, a capital loss can be used to reduce capital gains from other investments during the current year or any of the past three years, or retained for use in a future year.
Somers provided the following example of the impact of the deduction and tax credit on a $10,000 investment in the flow-through shares of a mineral-exploration company by an Ontario resident with a marginal tax rate of 40%. The example assumes no alternative minimum tax is payable, and that the deduction and tax credit both are claimed in year 1 and the income from the tax-credit is reported as income in year 2.
| Benefit of income deduction in year 1 | ($10,000 X 40%) | $4,000 | |
| Benefit of 15% credit in year 1 | ($10,000 X 15%) | + $1,500 | |
| Combined benefit of deduction and credit | $5,500 | ||
| Taxation of 15% credit in year 2 | ($1,500 X 40%) | - $600 | |
| Net benefit of deduction and credit | $4,900 | ||
| Net benefit of credit only | ($1,500 - $600) | $900 |
