1. FAQ on the Mineral Exploration Tax Credit (METC)
2. FAQ on Flow-through Share Renunciation Rules
3. Mining laws

FAQ on the Mineral Exploration Tax Credit (METC)

Program's Purpose and Scope

Q.

Why is the METC program only available to flow-through share investors?

A.

Junior mining companies, which are small exploration companies with no production revenue, are the hardest hit by the current exploration downturn. Yet, they are a most important player in the search for base- and precious-metal deposits in Canada. By reducing the up-front cost of flow-through shares, which are a principal source of financing for junior mining companies, the program will temporarily assist these companies in raising the equity financing needed to pursue their exploration activities and create value for all Canadians.

Program Benefits

Q.

Does claiming the METC affect the amount of Canadian Exploration Expenses (CEE) that I can deduct in calculating my taxable income?

A.

The short answer to this question is yes, but with a delay of one taxation year. When filing an income tax return for the year in which a tax credit is claimed, a taxpayer does not need to reduce the CEE deduction that relates to the investment that earned the tax credit. However, the tax credit has to be included in what is called the Cumulative Canadian Exploration Expenses (CCEE) account, which is going to affect the taxpayer's tax calculations for the following year.

To understand the reason for this delay, one must examine two elements of the tax calculations relating to exploration expenses:

• The CCEE of a taxpayer are the residual exploration expenses that remain to be deducted for a future year after subtracting all deductions and government assistance (including tax credits) previously and currently claimed. When the sum of cumulative deductions and government assistance is higher than actual exploration expenses, the CCEE account gives rise to a negative balance.
• The CEE is the amount of eligible expenses deemed to be incurred in the current taxation year.

The amount that a taxpayer can claim in any given year is the previous year's balance of the CCEE account, plus any CEE earned in the current year, if the netting out of these two amounts is a positive number. Otherwise, this amount has to be included as income by the taxpayer.

Let's work out a numerical example. During taxation year 2000, a taxpayer invests $1000 in eligible exploration activities. For the year 2000 tax filing, the taxpayer can claim 15%, or $150, as METC and deduct $1000 as CEE. If the starting balance of the taxpayer's CCEE account was 0, the end balance becomes:

CCEE opening balance:

plus eligible expenses: $ 0
minus CEE claimed: $1000
minus METC claimed: $ 150
CCEE closing balance:$ 150 -

This means that this taxpayer will have to include $150 as income in his/her 2001 tax return, unless he/she earns at least $150 of additional CEE during that year. If the taxpayer's marginal tax rate is 50%, this income inclusion causes the tax credit to lose half of its face value.

Marginal tax rate: 50%

Net tax benefit from investment: $1000 x .5 + $150 - $150 x .5 = $500 + $150 -$75 = $575

Net after-tax cost: $1000 - $575 = $425

Q.

What is the effect of claiming an additional tax credit provided by a province or a territory on my tax calculations?

A.

When a taxpayer claims a provincial or territorial tax credit in addition to the METC in respect of his/her flow-through share investment, his/her out-of-pocket cost is reduced accordingly. To reflect the net cost of the investment, the CEE deduction that the taxpayer can claim must be reduced by a corresponding amount for federal and provincial/territorial income tax purposes. Since the CEE is also the base upon which the METC is calculated, the amount of METC a taxpayer can claim will also be reduced in proportion to the provincial/territorial tax credit rate.

For example, a taxpayer is deemed to incur $1000 of eligible exploration expenses during taxation year 2000 via a flow-through share investment. The taxpayer's province or territory of residence offers a 20% tax credit for exploration incurred in the province or territory. The following illustrates the tax consequences of claiming the additional tax credit:

Initial investment: $1000

Provincial/territorial tax credit claimed: $ 200

Amount of expenses eligible as CEE: $ 800

METC (15% of above): $ 120

Income inclusion in 2001: $ 120 -

Net tax benefit at 50% tax rate: $200 + $800 x .5 + $120 - $120 x .5 = $660

After-tax cost: $1000 - $660 = $340

Persons Qualifying for the Tax Credit

Q.

Could a company under any circumstances be regarded as an "individual" and be able to obtain the tax credit?

A.

No, an "individual" is defined in the Income Tax Act as meaning a person other than a corporation.

Eligible Exploration Expenses

Q.

Will the limit of one tonne be strictly applied as the lower limit of a "mini-bulk-sample" and counted as part of the annual 1000-tonne limit?

A.

Yes! The wording is clear and there should be no attempt to collect lots of small bulk-samples. The purpose of this limit was to allow normal samples from drill cores and outcrops to be collected without a limit since these samples are normally much less than one tonne in weight.

Q.

How would you define a "mineral resource" for the purposes of sampling that would be subject to the 1000 tonnes per calendar year limit?

A.

The "mineral resource" would be a deposit of minerals of the type described in the brochure, namely all the deposits listed in Section 248(2) of the ITA except coal, bituminous sands or oil shale deposits. A single "mineral resource" would be a single deposit. If in doubt about how far a particular mineral resource may extend, you can ask for a ruling from the Canada Customs and Revenue Agency.

Reorganization and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
Canada Customs and Revenue Agency
16th Floor, Tower A
Place de Ville
320 Queen Street
Ottawa, Ontario K1A 0L5

Renunciation of Canadian Exploration Expenses That Do Not Qualify as Flow-Through Mining Expenditures to Flow-Through Share Investors

Q.

The METC brochure refers to other types of exploration expenses under (f) and (g) of sub-section 66.1(6) of the ITA. What are these expenses?

A.

The "purpose test" for expenses under (f) is the same as the "purpose test" for the FTME, in that the expenses are incurred "for the purpose of determining the existence, location, extent and quality of a mineral resource." However the difference is that under this section there is no 15-tonne or 1000-tonne limit on bulk-samples and underground work qualifies.

The purpose test under (g) is different, namely, expenses are incurred "for the purpose of bringing a new mine in Canada into production in reasonable commercial quantities and incurred before the coming into production of the new mine." These expenses include those incurred in clearing and removing overburden, stripping and sinking a mine shaft, and/or constructing an adit or other underground entry.

Advantages for the Taxpayer of Investing in Flow-Through Shares

Q.

Your brochure states that the after-tax cost to a taxpayer would be 41% of the initial investment. The PDAC brochure comes to different numbers according to the province of residence of the investor. How do you reconcile the discrepancy?

A.

The figure appearing in the NRCan brochure is for illustrative purposes only. Its purpose is to provide an order of magnitude for the tax relief value of the different tax incentives offered by the federal and provincial/territorial governments for a flow-through share investment. The bottom line is that with the METC, the after-tax cost of a flow-through share investment is reduced to significantly less than 50% of the investment. The tax savings would be greater if additional provincial/territorial incentives are provided.

The value of tax incentives shown in the figure were calculated using a weighted average of the top marginal tax rates applicable in the eight provinces and territories that did not offer additional incentives at the time the brochure was published. The results do not take into account the reduction of the CEE pool that would take place as a result of claiming the METC in the year following the investment. To obtain the results that correspond to the specific circumstances of an investor would require the use of the appropriate tax rate and the taking into account of provincial/territorial incentives that may apply. Since, the specific tax benefits that apply are contingent on the particular conditions of the flow-through share agreement, companies envisaging a flow-through share issue are advised to seek qualified professional advice.

FAQ on Flow-through Share Renunciation Rules

Warning: Renunciations rules and other rules applying to flow-through shares (FTS) are complex. Qualified professional advice should always be sought to help structure FTS agreements and apply compliance rules. The questions and answers provided below should not be considered a substitute for this qualified advice; they were designed to offer only general guidance on how renunciation rules work.

Q.

When does a corporation issuing flow-through shares have to renounce exploration expenditures to the investor and what does this entail?

A.

In short, flow-through share (FTS) investors would expect to receive the Canadian Exploration Expenses (CEE) renounced by the FTS issuing corporation no later than 90 days after the end of the calendar year in which they make their FTS investment. This would allow them to claim the CEE (and possibly, the Investment Tax Credit for Exploration in Canada associated with it) for the taxation year in which the investment is made. For example, if an investor made an investment in FTS in June 2001, he/she would expect to receive a renunciation related to that investment before April 1, 2002, so that he/she can apply the CEE deduction (and any related Investment Tax Credit for Exploration in Canada) to his/her 2001 tax return.

Overview of Renunciation Rules

Rules that allow a corporation to renounce certain CEE incurred by the corporation to a FTS investor are found in subsection 66(12.6) of the Income Tax Act (the Act). Subsection 66(12.62) of the Act closely parallels subsection 66(12.6) in respect of the renunciation of Canadian Development Expenses (CDE). While this overview focuses on CEE renunciations, it may also apply to CDE renunciations.

In order for the corporation (which must be a principal business corporation) to make a renunciation under subsection 66(12.6), the investor must have given consideration to the corporation, under a written agreement, for the issuance of FTS of the corporation. Principal business corporations, for these purposes, are corporations whose principal business is mineral exploration, mining and mineral processing.

The issuing corporation must also file with the Canada Customs and Revenue Agency (CCRA) a prescribed form (Form T100), together with a copy of the selling instrument or agreement to issue the shares, normally no later than the last day of the month following the month in which the agreement to issue the shares is entered into. CCRA will then assign an identification number to the form and notify the corporation of that number.

The term "selling instrument" [as defined in subsection 66(15) of the Act] means a prospectus, registration statement, offering memorandum or other similar document that describes the terms of the agreement pursuant to which a corporation offers to issue FTS.

How Soon Can a Corporation Renounce CEE Funded by FTS?

After the above conditions have been satisfied, the corporation may renounce qualifying expenses [as described in subsection 66(12.66) of the Act] to the investor in respect of the FTS. Qualifying expenses include most CEE.

If a corporation renounces in the first 90 days of a particular calendar year qualifying expenses that the issuer has incurred or plans to incur in the particular year, such expenses are deemed to have been incurred at the end of the preceding calendar year for income tax purposes. If a renunciation is made before April 1 for expenses that have not yet been incurred, the corporation must incur the qualifying expenses before the end of the calendar year during which the renunciation is actually made.

Qualifying expenses renounced after April 1 of a particular year cannot be deducted in the preceding year, but may be deducted in the current year by the FTS investor. If a renunciation is made after April 1 for expenses that have not yet been incurred, the corporation must incur the qualifying expenses no later than the end of the calendar year following the year in which the renunciation is actually made.

What is the Latest Point When a Corporation Must Make Its Renunciations?

Of course, subsection 66(12.6) does not require that a corporation renounce CEE before expenses are actually incurred. But this subsection provides that the corporation must incur the CEE during the period commencing on the day the agreement was entered into and ending 24 months after the end of the month in which the agreement was signed. Then, the renunciation must be made before March of the first calendar year following the period in which the expenses are incurred. For example, if the corporation and an investor entered into a FTS agreement in November 2001, the expenses must be incurred before December 2003 and the renunciation must be made before March 2004. However, if a fraction of these expenses were to be incurred in September 2002, the renunciation of the incurred expenses must be made before March 2003.

Certain mineral exploration expenses financed by FTS also earn a Mineral Exploration Tax Credit (METC) in Canada and, under certain conditions, additional provincial/territorial tax credits. The rules of the METC program further restrict the application of the rule described in the above paragraph. According to the METC rules, exploration expenses must be incurred before January 1, 2004, to qualify for the tax credit. The renunciation of such expenses must be made at the end of February 2004 at the latest.

Other Effects of a Renunciation

An effect of the renunciation by the principal business corporation to the FTS investor is that the investor will be considered as having incurred the qualifying expenses. It follows that the principal business corporation also relinquishes the tax benefit (deduction and credit) related to the renounced expenses to the FTS investor.

Q.

Can renunciation for exploration expenditures take place before having performed the work?

A.

Yes, expenditures can be renounced to FTS investors prior to the actual exploration expenses being incurred. But once the renunciation is made, the corporation has up to the end of the calendar year following the year in which the renunciation effectively took place (that is, the taxation year in which the expenses are deemed to be incurred for tax purposes) to incur the qualifying expenses. For example, an investor who purchased flow-through shares on June 1, 2001, can receive the renounced exploration expenditure on December 30, 2001, and the corporation has up to the end of December 2002 to actually perform the related exploration work.

Q.

How long does a mineral exploration company have to spend the money raised in the FTS financing?

A.

After the renunciation is made, expenses must have been incurred by the end of the calendar year following the year including the effective date of the renunciation. If the renunciation has not yet been made, expenses must have been incurred within the period commencing on the date the relevant FTS agreement was signed and ending 24 months after the end of the month in which that FTS agreement was signed. Therefore, a principal business corporation has up to 25 months less a day to incur the expenses after the FTS agreement is signed.

Q.

When does the mineral exploration company incur interest costs for unspent funds raised by FTS financing?

A.

In order for qualifying expenses to be deemed to have been incurred at the end of a particular taxation (calendar) year, the corporation must renounce those expenses no later than the end of March of the following year. The issuer must incur eligible exploration expenses by the end of that latter year. The issuer must pay an interest charge on each monthly unspent balance (amount renounced minus cumulative incurred eligible expenses) after March 1st of the year after the one in which the expenses are deemed to be incurred for tax purposes. The monthly interest rate is 1/12 of the annual interest rate prescribed for the purpose of subsection 164(3) of the Act, pursuant to regulation 4301(b), which is colloquially referred to as the T-bill rate + 2%.

At the end of this calendar year, a fee will be imposed if the share issuer company has unspent funds. This fee amounts to 10% of the unspent amount. Investors are not subject to the charges on unspent funds and to the 10% fee. However, they will have to include the unspent portion of their FTS investment into income for income tax purposes. To illustrate how this process works, here is an example:

• On June 1, 2001, Ms. Investor purchases Flow-Through Shares from XYZ exploration company for $1000.
• For the year 2001, Ms. Investor receives a $1000 deduction and claims a $150 tax credit for her FTS investment.
• XYZ exploration company can wait until March 1, 2002, to spend the proceeds of Ms. Investor's FTS without incurring an interest charge.
• After March 1, 2002, XYZ exploration company has until the end of December 31, 2002, to spend the money that it raised, but it must pay a monthly interest charge on the unspent fund balance at the end of each month.
• If there are still unspent funds after the end of 2002, a fee of 10% of the unspent funds would apply and this would be paid by XYZ exploration company.
• If only $800 of the original $1000 FTS investment of Ms. Investor was spent, she would receive the $200 in unspent funds and include this amount into income for her 2002 personal income tax return.

There are also penalties for a company that renounces an amount in excess of the amount that it is entitled to. There is a penalty under subsection 162(7) of the ITA for failing to reduce the renunciation under subsection 66(12.73)(a)(i) within 30 days of being notified in writing by the Minister or, if under subparagraph 66(12.73)(a)(ii), before March of year three. This penalty will the median value of the following amounts or if two amounts are the same, then that amount would be applied as the penalty.

• Minimum penalty $100
• $25 × number of days in default
• Maximum penalty $25 × 100 days ($2500)

A person who, knowingly or under circumstances amounting to gross negligence, has made or has participated in making a false statement or omission with respect to renounced expenses may be liable to a penalty of 25% of the amount of such excess in accordance with subsection 163 (2.2) of the ITA.

Q.

What is the interest charge applied to unspent money that was raised by FTS?

A.

See the detailed explanation related to Question 4. The prescribed interest rate for unspent FTS funds is 7% per year (effective December 2001). For example, if XYZ exploration company had $200 in unspent funds, it would have to pay $1.17 per month in interest costs ($1.17 per month = $200 × 7% ÷ 12).

Q.

Does the exploration expenditure have to be applied to a specific exploration project?

A.

Funds raised by flow-through shares need not be applied to a specific project or location for federal income tax purposes. The proceeds of flow-through shares can serve to finance eligible exploration expenditures at several locations in different provinces. CEE deductions and the federal METC apply to all qualifying exploration expenses throughout Canada.

However, FTS funding must be allocated to specific provinces if some of the expenses qualify for special provincial/territorial tax incentives. The tax credit programs of British Columbia, Ontario and Saskatchewan and the enhanced flow-through share deduction program of Quebec only apply to exploration expenses incurred in these respective provinces.

Q.

Do the wages and salaries of geologists performing the work in the field qualify as allowable exploration expenditures?

A.

Salaries and wages of geologists performing qualifying exploration activities on eligible properties would qualify as allowable exploration expenditures. For example, the wages of geologists that are conducting geological surveys or interpreting drilling results on a gold property should be eligible as exploration expenses.

Mining laws

Q.

What are the laws that regulate mining in Canada?

A.

Under the Constitution, the power to regulate mineral exploration, development, conservation, and management is generally one of exclusive provincial jurisdiction. Each of the provinces has adopted a statute or ordinance that governs the exploration for, and the acquisition and exploitation of, state-owned minerals within their respective jurisdictions. There is also general provincial legislation for environmental, workplace safety, and labour purposes that has an impact on mining activities.

The federal government enjoys the same powers in respect of minerals on federal public lands. Moreover, the federal legislative powers over minerals are exclusive in the three federal territories and in the offshore. The Constitution also provides the federal government with certain powers that apply concurrently with provincial legislation over specific aspects of mineral activities, such as interprovincial and international trade. The federal government also has the power to declare a local work, such as a mine, to be for the general advantage of Canada and thereby assume regulatory authority over such work. This declaratory power was used in 1946 to exert federal control over uranium and other related substances. The Atomic Energy Control Act declares that all works and undertakings for the production, refinement or treatment of such substances are subject to the regulatory authority of the federal Canadian Nuclear Safety Commission. Approval from the Commission is necessary for the development, operation or commissioning of any uranium mining facility, but prospecting and exploration for uranium are not specifically controlled.