Charitable Donations of Flow-Through Shares
Flow-through shares are a financing tool available exclusively to corporations in the natural resources sector. Essentially they allow corporations within this sector that incur qualifying exploration and development expenditures to issue new shares (flow-through shares) to investors at a premium, because the persons subscribing to these shares are entitled to deduct for tax purposes certain expenditures made by the issuing corporation (in effect the corporation’s qualifying expenditures “flow through” to the investors). Flow-through shares are described in greater detail in the December 2010 Mining Review.
In simplified terms, where an investor pays $100 for a flow-through share, that investor will be entitled to claim deductions from income of $100. To reflect this tax benefit, the holder’s cost of the flow-through share for tax purposes is deemed to be zero, meaning that the holder immediately has a built-in accrued capital gain equal to its fair market value. When the share is sold, the entire sale proceeds will be treated as a capital gain whether or not the share has experienced any appreciation in value.
In order to encourage donations, an investor is exempted from tax on accrued capital gains on publicly-traded securities donated to a charity. This has led to some planning strategies whereby flow-through shares were issued to subscribers who thereafter donated them to charity in order to eliminate the built-in capital gain inherent in their shares ($100 in the example above) and to receive the benefit of a charitable donation tax credit for the value of the donated shares (the charity would typically then sell the shares to a third party for cash). As a result, the flow-through share subscriber could claim the benefit of the flow-through share deductions (plus potentially the mineral exploration tax credit described below), also claim a charitable donation tax credit for donating the shares, and use the charitable donation capital gains exemption to eliminate the built-in capital gain on the donated shares. This meant that charitable donations of flow-through shares could involve very little after-tax cost to the investor.
The Department of Finance has decided that using the charitable donation capital gains exemption to shelter the built-in capital gain on flow-through shares is inappropriate. The 2011 Federal Budget proposes to effectively restrict the charitable donation capital gains exemption for flow-through shares (or rights to such shares) donated to charity to the amount of the gain in excess of the subscription price originally paid for the donated flow-through shares. Using the earlier example, there would be no exemption of the first $100 of capital gain: only to the extent that the value of the donated shares exceeded $100 (the price originally paid) would the capital gains be exempted. The Department of Finance considers it necessary to tax the portion of any capital gain up to the original subscription price (e.g., $100) in order to recover some of the investor’s tax benefits associated with flow-through shares. This proposal applies to flow-through shares acquired pursuant to a binding flow-through share subscription agreement made on or after March 22, 2011 (Budget Date).
More particularly, when an investor acquires a particular class of flow-through shares pursuant to an agreement made on or after Budget Date, the subscription price paid for those shares is added to the “exemption threshold” of that class of flow-through shares. When the taxpayer disposes of shares of that class in a charitable donation, the charitable donation capital gains exemption is effectively available only to the extent that the capital gain exceeds the taxpayer’s “exemption threshold” at that time. The “exemption threshold” in respect of that class will be the amount by which (1) the sum of the taxpayer’s original cost of all flow-through shares of that class acquired pursuant to an agreement made on or after Budget Date exceeds (2) capital gains (up to the exemption threshold at that time) on previous dispositions of shares of that particular class on or after Budget Date. These rules are supported by anti-avoidance rules applicable to donations of property acquired by the donor in a tax-deferred transaction.
Mineral Exploration Tax Credit
Individuals (other than trusts) who invest in flow-through shares may be entitled to additional tax benefits above and beyond the renounced exploration expenses available on all flow-through shares. Where certain qualifying expenditures (essentially expenses incurred in mining exploration above or at ground level) are incurred and renounced to a holder of flow-through shares that is an individual (other than a trust), that holder is entitled to an investment tax credit equal to 15% of the renounced qualifying expenditures. This tax credit on “grass-roots” surface exploration expenditures is called the “mineral exploration tax credit.”
The Income Tax Act currently requires that in order to be eligible for the mineral exploration tax credit, qualifying expenditures must be incurred by the corporation by the end of 2011 and renounced to the investor under an agreement made before April 2011. The 2011 Federal Budget proposes to extend the 15% mineral exploration tax credit for another year, by (1) extending the date for incurring qualifying expenditures to the end of 2012, and (2) extending to March 31, 2012 the deadline for the corporation and the investor to enter into the flow-through share subscription agreement governing renunciation.