Juniors face GST financing costs

Consider a typical mining exploration company (Explorco), formed by a prospector or promoter “vending” properties into a newly incorporated or newly reorganized corporation for shares of that corporation. Explorco raises funds from the private placement or public issue of shares and carries out exploration work on the properties.

Unfortunately, most such programs do not meet instant success. Work may be suspended pending the raising of additional funds or the development of different exploration theories. If the properties do show promise, often they are then “farmed out” to a larger mining company for development. Explorco’s interest may be reduced to a modest working interest or a carried royalty interest.

How will GST affect the Explorcos of Canada? The government has indicated that rights to explore for, or exploit, mining properties will not bear GST. Further, the recipient of royalty income from a mining property will not bear GST. Nevertheless, Explorco will be considered to be carrying on a commercial operation and will be entitled to input tax credits on the GST it pays. Explorco will have to pay GST on most of its exploration expenditures, such as professional fees paid to geologists, engineers and other advisers, charges from drilling and mining contractors, and equipment rentals. It will almost always be in an excess input credit position. To obtain its GST refunds, it will have to register as a “vendor,” keep sufficiently detailed records to identify the GST it has paid, file for refunds and await reimbursement.

It is not yet known how rapidly such reimbursement will occur. A technical paper published by the government to explain some details of the GST only says that interest will be paid on refunds commencing 21 days after the date the refund claim is received by Revenue Canada.

Clearly Explorco will face additional administrative costs, for which it will not be reimbursed, and additional financing costs for the period between paying GST and obtaining the refund.

There will be additional GST costs charged indirectly to Explorco that it will not recover. Some of the services paid for by Explorco will be “tax exempt”; that is GST will not be added to the charges to Explorco but the supplier will not obtain refunds for the GST it has paid. Examples of such services will be liability and property insurance, and underwriting services. It must be assumed that the suppliers will attempt to increase their charges to maintain their margins. In addition, GST will undoubtedly have a general inflationary effect. These increased costs will increase Explorco’s financing requirements and its business risk.

An Explorco is generally short of cash, and typically pays for many of the assets and services it acquires by issuing its shares directly to the supplier. In the case of shares issued to acquire exploration properties, there will be no GST consequences, since the sale of such properties will not attract GST. Also, there will be no GST payable when an Explorco issues shares to a broker for underwriting services; such services are tax exempt.

However, if Explorco agrees to issues shares to a geologist for consulting services, or issues shares to acquire depreciable property, such as a test mill, it appears GST will be payable based on the value of the shares issued. Since the supplier is required to collect and remit GST it seems likely Explorco will have to pay the GST component in cash and then seek a refund from the government through the input credit process.

Many exploration programs are carried out jointly by two or more Explorcos under the direction of one operator, pursuant to agreement calling for the formation of a formal joint venture if advanced exploration and/or mine development is warranted. The technical paper states that if an activity is carried on by a partnership, it is the partnership that will be the GST registrant, collecting and remitting the GST and applying for input credit refunds. Since no definition of partnership is given, and there is no reference to joint ventures, it is unclear whether the operator, the individual participant or the “joint venture” will be responsible for GST compliance.

The Income Tax Act provides rules under which the tax deductions for Canadian exploration expenses can be transferred to subscribers by renouncing the expenses pursuant to a flow-through share agreement. The amount of the remuneration cannot exceed the amount paid by the subscriber and cannot exceed the qualifying expense incurred by the exploration company, net of any related rebate of tax. It appears the exploration company will be entitled to a refund of the GST paid on the exploration activities, but it will only be able to renounce the net amount to subscribers. Put another way, the Explorco will have to finance the GST component itself until it receives the input credit refund.

No matter which part of the Explorco’s business you look at, you reach the same conclusion. The GST will add significant additional financing requirements and additional administrative costs. Barry Dent and John Playfair are tax partners with Clarkson Gordon/ Ernst & Young.

]]>