Canada has announced a variety of initiatives to transition its economy toward a greener future. But progress has been frustratingly slow, largely due to Canada’s inability to produce enough “critical minerals.” The International Energy Agency recently summarized the importance of critical minerals as follows:
“Lithium, nickel, cobalt, manganese and graphite are crucial to battery performance, longevity and energy density. Rare earth elements are essential for permanent magnets that are vital for wind turbines and EV motors. Electricity networks need a huge amount of copper and aluminum, with copper being a cornerstone for all electricity-related technologies.”
The head of the IEA has urged Canada to ramp up production of critical minerals essential to net-zero sources that can replace fossil fuels and ensure the energy security of Western countries. For example, despite that Natural Resources Canada says the country is “host to a number of advanced exploration projects and some of the largest reserves and resources” of rare earth elements, it’s not producing them in commercial quantities.
Canada’s tax system could have a major impact on expanding production of strategically vital critical minerals. While existing tax incentives focus largely on mineral exploration, many Canadian mining companies have cited difficulty obtaining financing to fund the production and development that can turn a known resource into a functioning mine. Moreover, post-extraction activities further along the low-carbon technology supply chain (smelting, refining, processing, and manufacturing) are capital-intensive and difficult to finance, particularly in the current economic environment.
The logical answer to this problem is to reduce the cost and risk of bringing a critical mineral mine in Canada into production. This can be achieved by treating substantial expenditures similarly to other forms of expenses that the government is seeking to incentivize.
Flow-Through Shares and Tax Credits
Flow-through shares have been an important source of financing in the mining sector for decades and a key competitive advantage for Canada’s mining sector. They allow mining corporations to monetize the benefit of tax deductions they incur on qualifying expenditures by transferring (or renouncing) those tax deductions to investors who subscribe for flow-through shares of the mining company. This lets them act as a source of funding—that is, the mining company receives the subscription proceeds from investors who subscribe for its flow-through shares.
Certain mining company expenditures also entitle investors who are natural persons (not corporations) to further benefit from an investment tax credit, or a reduction of their owed taxes. This makes flow-through shares an attractive investment that lowers the cost of financing for mining companies engaging in the relevant qualifying activity.
Canadian mining companies segregate their expenses into different categories that have different tax treatment. Expressed broadly, Canadian exploration expenses are fully deductible in the year incurred. Expenses on building an actual mine and bringing it into production used to be included in exploration expenses but have been classified as Canadian development expenses since 2013 and are pooled to allow the taxpayer to deduct 45% of each year on a declining balance basis. This makes development expenses less attractive than exploration expenses, although a mining company can renounce both to flow-through share investors.
In its 2022 budget, the Canadian government announced a new critical mineral exploration tax credit that provides an enhanced investment tax credit for exploration activities relating to critical minerals, using the existing flow-through shares infrastructure. Individual investors may claim the new exploration tax credit if they purchase flow-through shares issued by mining companies that incur qualifying exploration expenses on critical mineral exploration and renounce that expense to the flow-through share investors.
Supporting Critical Mineral Mine Construction
To accelerate critical mineral mine production, Canada should amend the tax regime to make it less risky and costly for companies to build mines whose primary output will be critical minerals. This can be done by extending to the relevant expenditures the same advantageous tax treatment that is offered to other activities the government has prioritized for similar reasons. Specifically, the government should:
- Reclassify critical mineral pre-production expenses as Canadian exploration expenses (that is, revert back to the pre-2013 treatment of such expenditures), and
- Provide corresponding immediate-deduction treatment for comparable expenditures on equipment and similar items used primarily in (or in the construction of) a critical mineral mine in Canada, as is provided to specified clean energy equipment.
By allowing mining companies to deduct the costs of building critical mineral mines in Canada in the year in which they are incurred, both the cost of financing such activities and the risk in undertaking them would be materially lessened.
The same reasoning applies to extending the existing form of tax-advantaged financing applicable to critical mineral exploration to other related green economy activities. This would unlock badly needed private-sector capital for low-carbon businesses struggling to fund projects needed to advance Canada’s green economy. The attractiveness of offering flow-through shares to potential investors, which affects the premium they’re willing to pay to a mining company issuing them, depends on three tax aspects:
- Whether the mining company is renouncing exploration or development expenditures to investors;
- What type of investment tax credit investors receive for subscribing for the flow-through shares; and
- Whether the renounced expenditures qualify for the “look-back” rule, allowing the mining company to issue flow-through shares before incurring the expenditures being renounced.
In addition to reclassifying critical mineral pre-production expenses as exploration expenses, they also should be made eligible for both the flow-through shares’ “look-back” rule and the new critical mineral exploration tax credit. This would allow critical mineral mining companies to access private-sector financing for mine construction, using proven financing tools and requiring minimal revision to the tax statute. Expanding favorable tax treatment to downstream, critical mineral activities would greatly help financing that capital-intensive work.
Canada has the opportunity to use its tax laws to kick-start critical mineral mine construction without waiting for further government action. If we as a country are serious about leading the new low-carbon economy and safeguarding our supply of the mineral resources that are essential to it, optimizing our tax system with a few simple changes to get critical mineral mines into production is an obvious and logical first step.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Steve Suarez is a partner in the Toronto office of Borden Ladner Gervais LLP. He also administers the websites Business Tax Canada and Mining Tax Canada.
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