Flow-Through Share Financing for Junior Mining Companies Canada

Canada’s Natural Resources – Now and for the Future

Flow-Through Share Financing for Junior Mining Companies

Canada’s Experience

Robert J. ClarkNatural Resources Canada

November 2007

Canada’s Natural Resources – Now and for the Future 2

Presentation Outline

1. What is a Flow-Through Share ?

2. Development of Flow-Through Shares

3. Key Factors in the Success of Flow-Through Shares 4. Analyzing the Effectiveness of Flow-Through Shares

5. International Interest in the Mechanism


Simplified Definition of a Flow-Through Share:

A Flow-Though Share is a type of common share which allows a “principal-business corporation” to transfer the tax deductions to investors, who can apply them against their personal or corporate income tax.

A “principal-business corporation” is a corporation involved in exploration, production and processing of a minerals, or oil and gas; or in renewable energy and conservation activities.

1. What is a Flow-Through Share ?


0

875.328

1750.657

2625.985

3501.314

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

i

Expl

orat

ion

Expe

nditu

res

($ m

illoi

n)

Seniors Juniors MPI

Constant 2006 $ millions

ITCE15% tax credit

MEDA, 33 1/3%

2. Development of Flow-Through Shares

1981, proceeds subject to capital gain tax

1985-1994, $100K lifetime capital gains exemption

1996,Look back rule

2001, capital gain inclusion rate reduced to 50%

Other developments

:

CEIP30%

MPI1971=100


Canada’s Share of Worldwide Exploration

Pacific/SE Asia7.7%

United States9.8%

Rest of the World8.3%

Africa14.7%

Australia19.3%

Canada12.1%

Latin America28.1%

2007 Worldwide Exploration Spending by Region

Source: Metals Economics Group

1999 Worldwide Exploration Spending by Region

Latin America21.8%

Pacific and SE Asia4.0%

United States7.9%

Rest of World16.6%

Africa16.1%

Australia12.4%

Canada21.2%


3. Key Factors in the Success of Flow-Through Shares


Key Factors – Canada’s Junior Mining Companies

Around 100 “Senior” mining companies (with one or more producing mines) ranging from: Large integrated global producers (e.g., Teck Cominco

Limited) to; One mine companies (e.g., Tahera Diamond

Corporation). Around 1100 “Junior” exploration/mining companies or

private exploration/mining syndicates, with no financial interest in a producing mine and no cash flow. Their assets are exploration properties and they raise money by issuing shares.

Placer miners/small-scale miners.


Mining Companies on Selected Stock Exchanges, 2006

0

375

750

1125

1500

Canada Australia United Kingdom South Africa

AIM-LSE NYSE-

AMEX

Notes: 1 Discounting inter listings. As at December 31, 2006.Source: TSX Group based on information from AMEX, ASX, CDNX, JSE, LSE, NASDAQ, NYSE, TSX.

ASXJSE

TSXVenture

TSX

(Number of companies1)


Key Factors - Canada’s Expertise in Mining Financing

Canada is home to the TSX and TSX Venture Stock Exchanges which together account for over approximately 40% of the world’s equity financing for exploration and mine development in 2006.

Canada is home to over 200 financial and legal companies which provide specialist services to the mining industry.

Flow-Through Limited Partnerships have played a significant role in raising financing for exploration and mining and provide a diversification to the investor.


Canada’s Equity Capital Markets

Sources: Toronto Stock Exchange; Gamah International; Natural Resources Canada.

Equity Financing for Exploration and Mining Companies Raised Through Stock Exchanges Based in Selected Regions of the World

2006 = $31.7 B2000 = $3.2 B

US1.1%

Australia3.5%

Rest of World8.1%

Canada44.3%

S. Africa4.9%

UK38.0%

China9.5%

US3.6%

Australia8.7%

Rest of World3.8%

Canada38.2%

S. Africa0.6%

UK35.7%


Key Factors - Government Support

Governments at the federal, provincial and territorial levels forego the time value of the 100% deduction for exploration, which is claimed by the investor long before a junior mining company would have revenues against which to claim it.

When additional incentives are offered by the federal government, some provinces provide add-on incentives creating so-called “Super Flow-Through”. In 2007, the federal government provides an additional 15% tax credit, which is boosted by additional incentives in British Columbia, Manitoba, Ontario and Quebec.


Investors receive a 100% income tax deduction for Canadian Exploration Expenses.

Since the corporate tax rate is lower than the top personal tax rate, the tax deduction is more valuable in the hands of the individual.

On the sale of the shares, only 50% of realized capital gains are included in income.

For surface exploration, the investor may be eligible for the federal 15% tax credit, and complementary provincial tax credits (BC 20%, Manitoba 10% and Ontario 5%) or in Quebec an additional 50% deduction from taxable income.

Key Factors - Tax Advantages for Investors


Tax Advantages by Province/Territory

$0

$250.0000000000000512

$500.0000000000001024

$750.0000000000001536

$1,000.0000000000002048

Qué Man NLD PEINB NWT NUV

$519$506$490$484$476$451$447$440$437$433$410$383$284

After-Tax Cost of a $1,000 Investment in Flow-Through Shares Top Marginal Tax Rates for 2007

Provinces and Territories

Federal Tax Reduction Federal Tax CreditProv/Terr Tax Reduction Prov/Terr Tax CreditNet Cost


4. Analyzing the Effectiveness of Flow-Through Shares


Analysis available on the effectiveness of flow-through shares: Flow-Through Shares – An Evaluation Report –

Finance Canada 1994. Queen’s University Studies on Costs of

Exploration for Gold (1987,1989 and 1992). Reports on taxation issues by the

Intergovernmental Working Group on the Mineral Industry (2002 to 2006).

Studies of Mineral Discoveries by Natural Resources Canada and the Prospectors and Developers Association of Canada (PDAC).

Effectiveness of Flow-Through Shares


Criteria Used in Analyzing Effectiveness

Relevance – Whether Programs Meet Expectations of Stakeholders

Effectiveness – Success

Cost Effectiveness

Mineral Discoveries

Cost of Mineral Discoveries

Ease of Administration and Compliance


To Government Addresses government priorities. Helps stimulate exploration and

encourages risk taking. Unusable or unused tax benefits

transferred to investors providing a premium on market price of shares.

To Industry Meet priorities of industry during periods

when additional incentives are offered.

Relevance


0

275

550

825

1100

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006(p) 2007(i)

Off-Mine-Site Exploration Work Phase Expenditures by Type of Company, 1997-2007

($ millions)

Junior Companies Senior Companies

Relevance - Timeliness

Investment TaxCredit for Exploration


Effectiveness - Success

Pros Accounts for a significant portion of Canadian

mineral exploration financing (up to 60%) when add-on credits are available and other financing is difficult to obtain.

Benefits the economy of Canada, particularly in Ontario, British Columbia, Québec, Nunavut and the Northwest Territories.

Cons Exploration costs were inflated before 1996

because of the short timeframe to complete the work.


BritishColumbi

a$425 M Alberta

$15 M

Manitoba$103 M

Ontario$519 M

Quebec$385 M

NorthwestTerritories

$153 M

Newfoundland and Labrador$160 M

NewBrunswick

$31 M

Nova Scotia $27 M

Saskatchewan$277 M

Yukon$144 M Nunavut

$267 M

2007 Total = $2506 Million

Source: Natural Resources Canada, from the federal-provincial-territorial survey of Mineral Exploration, Deposit Appraisal and Mine Complex Development Expenditures. Based on revised company spending intentions compiled in August 2007 (totals could vary slightly as data are in final validation stage).

Effectiveness – Regional Distribution


Note: Includes on-mine-site plus off-mine-site activities for field work and overhead

0

500

1,000

1,500

2,000

1975 1979 1983 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006p

Exploration Expenditures by Mineral Commodity Sought (2006$)

$ m

illio

n

Metals PreciousMetals BaseMetals UraniumDiamondsOther

Effectiveness – Commodity Emphasis


Cost Effectiveness to Government

For period 1987 – 1991: Federal tax expenditures = $462.9M; Incremental Renunciations = $1,205.6M (49% of actual); Incremental Renunciations )Federal Tax

Expenditures = 2.6 That is one dollar of tax expenditure during this

period resulted in $2.6 of new (incremental) exploration spending (from Finance Canada report 1994).

For the period 2000 – 2007, the multiplier appears to be of a similar magnitude.


Cost EffectivenessTo The Investor

1986 – 1990 Investment performance was better for direct

investment in a mining corporation, than in a limited partnership.

The early investors got equity in better projects than later investors.

The risk nature of exploration meant that the usual negative return from investment had to be offset by significant tax incentives.

2000 – 2007 Private placements reducing sharing of premium. Lower levels of investment and proportionately more

good projects available.


Cost EffectivenessTo The Mining Company

Finance Canada concluded that FTS provided significant incentive for exploration by non-taxpaying companies (junior companies without production).

Fully taxpaying firms would not wish to pass their tax deductions to an investor.


Cost Effectiveness to the Public - Mineral Discoveries

Studies by Queen’s University indicated that the cost of discovering an ounce of gold rose rapidly in the late 1980s, however, Canada’s gold production doubled from 5% to 10% of the global share by 1990.

Prominent discoveries attributed in part to flow-through shares by the Prospectors and Developers Association of Canada: Ekati Diamond Mine – Charles Fipke – NWT Louvicourt Base Metal Mine – Aur Resources – Québec Lindsley Base Metal Mine – Falconbridge – Ontario Eskay Creek Gold Mine – Prime Resources – BC Jericho Diamond Mine – Tahera- Nunavut Ni Rim South - Falconbridge – Ontario.


Ease of Administration

Pros Tax based programs are administered through

existing government structures. The federal, and most provincial governments, have

harmonized their rules and about 11 federal employees handle most of the administration.

Cons The modification of tax legislation and design of forms

and administrative procedures is required to ensure that only eligible expenses are claimed.

Rules for the tax incentives are complex and expenses and renunciations require precise tracking.


Bottom Line

The principal beneficiaries of flow-through shares are junior mining companies who can obtain funds for exploration, partly in exchange for tax deductions that they would not be able to use.

Exploration is restricted to Canada, and new mines provide economic benefits to Canada and particularly to northern and rural communities.

Investors in flow-through shares reduce their income

tax and have shares of variable value in a mining company or a mutual fund.

The direct costs to the government are modest.


5. International Interest

Australia has had forms of flow-through shares at different times. Since 2001, industry and state governments have advocated the re-introduction of the mechanism. Information has been provided to the federal and state governments.

South Africa has studied the mechanism for several years; a “Canada–South Africa Government Roundtable” was held in Pretoria in February 2003. Currently, a joint working group headed by the National Treasury, is evaluating the need for and the potential scope of flow-through shares in South Africa.

Chile has obtained information on the mechanism.

Documents

Flow-Through Share Financing for Junior Mining Companies Canada