The flow-through share entered the Canadian tax code just over 25 years ago. Looking back, mining executives, lawyers, bankers and accountants believe this quirky Canadian tax innovation has generated billions for mining exploration and contributed to the development of some of the country’s most notable mines, such as the Ekati and Diavik diamond properties in the Northwest Territories.

Indeed, statistics compiled by Financial Post data show Canadian mining firms have raised $2.5-billion over the past five years using flow-through shares.

In 2012, Canadian companies raised $536.8-million through 94 deals, not far off the five-year annual average of $500-million and 93 deals a year. The peak year in that five-year period was 2011, when miners raised just under $698-million through 120 deals.

Kevin Wong, a chartered accountant who is regional leader of the tax practice in the Vancouver office of MNP LLP, says flow-through shares are an instrumental part of the Canadian junior mining industry. “Flow-through shares assist the companies that wouldn’t otherwise be able to raise the money to explore,” Mr. Wong says. “To the extent they hit pay dirt or find the gold, the benefit to the government is several-fold through the taxation on the [capital] gains and through the taxation on the production of the resource.”

Canada’s Income Tax Act allows issuers to agree that they will transfer or “renounce” their exploration expenses to individual investors. Companies that have revenue may not wish to do this, since they’ll want to apply those expenses against their income to reduce or eliminate their own tax liabilities. But a junior exploration mining company, which usually has no significant revenue, won’t need those expenses because they’re likely not profitable and won’t be facing any income tax. It therefore makes sense to pass on those expenses to individual investors, who will happily apply them against their personal incomes.
Flow-through shares keep a coterie of advisors across the country busy. Kevin Zimka, a partner in the Vancouver office of national Canadian law firm Blake, Cassels & Graydon LLP, says he works on at least a couple flow-through share deals each month.

“The flow-through share regime is designed to provide an incentive for financing qualifying exploration ventures in Canada and effectively shift the tax deduction from the company doing the exploration to the purchasers of the flow-through shares,” Mr. Zimka says.

A common misconception is that flow-through shares are a special class of equity. Not true. According to the Income Tax Act, they have to be ordinary common shares, lawyers say. The process of transferring the exploration expense to the investor is done by an agreement that is separate from the documentation that creates the shares.

“A flow-through share must be a ‘garden variety’ common share and the investor must be fully at risk for his or her investment,” says Nigel Johnston, a partner in the tax group of McCarthy Tétrault LLP in Toronto.

“It’s all done by agreement,” adds Leonard Glass, a partner with Lawson Lundell LLP in Vancouver. “The company agrees that if you give it the money, it will give you the shares. But it also agrees, on top of that, that it will give you these expenses.”

The devil, as they say, is in the details. Canadian rules require that a company renouncing an exploration expense must get out in the field and spend those exploration dollars within 24 months. Even then, a so-called “look-back” rule might shift that period backward in time to give investors the opportunity to claim the expenses on their prior year’s tax returns. That can force exploration companies to hit the dirt as fast as possible. “As soon as you renounce, the clock starts ticking,” Mr. Glass says.

Flow-through shares are also common in the oil and gas sector. Edmund Gill, partner in the Calgary office of Osler, Hoskin & Harcourt LLP, works on lots of flow-through share deals, most involving oil and gas companies.

Recently, business has been tough as the deal flow through Calgary has diminished. “The juniors are having a tough time raising money, even if they’re throwing in the perks of a flow-through,” Mr. Gill says.
A lot of Mr. Gill’s work is on a popular structured product known as a Limited Partnership. These are entities that assemble a portfolio of companies with flow-through shares. These companies agree to pass the exploration expense up to the partnership, which then distributes it to the unitholders.

Tax lawyers point out that the Limited Partnership helps make the whole flow-through share system tick. Once the partnerships are formed, they’re obligated to invest in flow through shares.

“It’s a huge amount of money. Historically you had these flow-through limited partnerships, which is the way most of the money is raised,” says Chuck Spector, a lawyer with FMC Law in Montreal. (The firm will be known as Dentons following a trans-Atlantic merger scheduled to close at the end of March.)

Mr. Spector adds that flow-through shares are also popular with provincial governments, particularly Quebec.

Indeed, according to tax rates analyzed by PDAC for 2011, the after-tax cost of a $1,000 investment under the “super flow-through” program would vary between a low of $284 in Quebec to a high of $519 in Alberta. “Super” flow-through includes the regular 100% deduction that’s available under the Income Tax Act, along with a federal program that provides another 15% non-refundable tax credit for grass roots exploration completed by Canadian companies. The temporary super flow-through program has been extended several times. The 2012 federal budget extended the expiry date to March 31, 2013.