EDITORIAL PAGE (September 23, 1991)

The legacy from the enthusiastic marketing of flow-through shares in the 1980s is still with us. The burst of exploration activity paid for by flow-through added considerably to Canada’s mineral database and led to many significant discoveries such as Eskay Creek in northwestern British Columbia. But there was a downside to flow-through, too.

One of the problems of flow-through shares was their notoriety for providing a tax credit to investors. They are seldom known for their track record of financing projects that have outlined economic deposits. After they served their purpose to investors as a tax shelter, they were often quickly sold. That posed a constant threat to companies’ share price performance because as soon as the stock price showed any upward movement, the flow-through shares were dumped, further depressing the share price. That, in turn, led to investors questioning whether mining shares could ever prove to be a rewarding investment.

By now, most of those flow-through shares are in the hands of investors willing to back mineral exploration, not investors simply looking for a quick tax credit. But the 5-year episode proved that flow-through is a system of tax-driven incentives that works without creating a new layer of government bureaucracy. It provided a direct relationship between the investor and the company, directed by the tax system without using any taxpayers’ money. With refinements to protect against abuses, it could work again.

Mining companies have always been able to deduct mineral exploration expenses from mining income because it was always recognized that ore reserves must constantly be replenished. Exploration for the mining industry is analogous to research and development for manufacturing — something the state must encourage for its industries to remain competitive in the future. Flow-through allowed that tax credit to be used by companies that had no income from mining — the junior exploration companies. It let the juniors “flow through” the credit to individual investors who could then apply it against income from other sources. What made the mechanism so attractive in the 1980s was the added depletion allowance that allowed investors to deduct a further 33% of the cost of their investment from any source of income. As a result, the proverbial dentist who invested $9,000 in a mineral exploration company could deduct 133% or $12,000 from his income.

That sweetener made flow-through a roaring success, not on the merits of the exploration projects, but on the merits of the tax credit. Alarmed at how much money was being channelled into flow-through simply as a tax dodge, the government did away with the depletion allowance. Popularity of flow-through suffered a precipitous decline even though the 100% tax credit is still available.

Problems with the 133% flow-through in the 1980s all stemmed from the flawed premise that the rich tax credit would go to investors as long as the money was spent on exploration. There was no effort to discriminate between success and failure.

With the prospect of Canada’s mining industry now facing decline because of dwindling mineral reserves, it is time the federal government reflect on the lessons of the past and consider ways of channelling investors’ money — not taxpayers’ — into mineral exploration. Flow-through, with refinements, could be the proven vehicle to reward success in exploration rather than to reward success at spending money.

The difficulty lies in trying to determine what is successful exploration. Relying on “experts,” such as those who adjudicate on companies’ prospects for stock exchanges and securities commissions, to determine who has conducted successful exploration is too subjective.

A better approach might be to judge how successful those projects that go into commercial production for a certain minimum length of time. That would establish a clear measure undistorted by government subsidies or assistance. By and large, rewarding projects that went into production would steer money into viable projects. For example, a junior company raises funds by issuing flow-through shares. The 100% tax deduction for mineral exploration shares goes immediately to the investor, just as it does now. If the company does achieve production on the property for which it raised the money to explore, the holders of those shares at the time production is achieved would receive the 33% depletion allowance that made the flow-through shares of the 1980s so attractive.

This way, shareholders would be more inclined to hold their stock rather than dump it after using the initial tax credit, companies would be able to raise money for properties of real merit and the tax system would reward success and encourage development of resources necessary to maintain a vital industry.