Much of the economic potential of Canada’s North lies beneath the ground, in the form of vast natural resources. Discovering and developing these resources in some of the world’s most challenging terrain is a daunting undertaking, requiring considerable investment of time, capital and expertise. Exploring for and developing natural resources is a risky activity where success often occurs (if at all) after many failures, and the costs involved (especially in Canada’s North) make financing this high-risk activity very difficult.
For many years the income tax system has provided a valuable incentive to Canadian mining companies engaged in what is commonly referred to as “pre-production mining” activities. Qualifying expenditures made by a company on these activities entitle it to an “investment tax credit” or “ITC”, which is very valuable because each dollar of ITC reduces the amount of the company’s income tax payable by $1. Thus, unlike an expenditure that is simply deductible in computing income (where $1 of expense saves perhaps 25 or 30 cents of tax, depending on the company’s applicable tax rate), ITCs reduce taxes owing dollar for dollar.
The pre-production mining expenditure ITC applies to qualifying expenditures made in Canada by a taxable Canadian corporation on activities relating to “qualifying minerals,” which are:
- Base or precious metal deposits; and
- Industrial minerals that (when refined) result in a base or precious metal.
Qualifying expenditures are those included in the taxpayer’s pool of Canadian exploration expenses by virtue of being incurred (before the mine is producing in reasonable commercial quantities) on:
- “Grass roots” exploration to determine the existence, location, extent or quality of a mineral deposit in Canada (exploration expenses); or
- Activities undertaken in order to bring a new mine in Canada into production (development expenses).
Expenditures on these activities (“pre-production expenses”) are added to a pool, and the corporation is entitled to claim an ITC equal to 10 percent of the pool balance for the year.
Unfortunately, in the March 29, 2012 Budget, the federal government announced the elimination of the pre-production mining expenditure ITC. For preproduction exploration expenditures, the ITC will continue to apply at the 10 percent rate for expenditures incurred in 2012, with the ITC rate dropping to 5 percent for expenditures incurred in 2013 and no ITC for expenditures in subsequent years.
For pre-production development expenses, the 10 percent rate would apply for expenditures incurred in 2012 and 2013, dropping to 7 percent for expenditures incurred in 2014, 4 percent for expenditures incurred in 2015, and no ITC in subsequent years. Transitional relief would be provided by maintaining the 10 percent rate for pre-production development expenditures incurred before 2016 under a written agreement entered into before March 29, 2012, or as part of a new mine the construction of which (or the engineering and design work for the construction of which) had commenced before March 29, 2012. For this purpose, activities such as obtaining permits or regulatory approvals, conducting environmental assessments, community consultations or impact benefit studies, and similar activities will not be considered construction or engineering and design work.
Elimination of the pre-production mining expenditure ITC is disappointing, particularly at a time when commodity prices are falling and funding for exploration and development becomes harder to find for mining companies. More expensive projects such as many of those in Canada’s North will likely be the first to suffer, as the loss of this important ITC considerably reduces the economic incentive for mid-tier and senior mining companies to conduct the sort of high-risk exploration and pre-production development activity that is needed to unlock the resources buried north of the 60th parallel. Economic development of the North is one of the key elements of Canada’s Northern Strategy, and foregoing tax revenues today to assist in the discovery of new resources that will generate taxes for many years in the future would be a wise investment. In the meantime, mining companies and their partners in Canada’s North should ensure that qualifying expenditures are incurred as quickly as necessary in order to obtain the maximum ITC during the phase-out period.