What the alternative minimum tax could mean for investment in critical mineral exploration
Proposed legislative changes to Canada’s alternative minimum tax (AMT) could reduce the tax advantages associated with flow-through shares, including the critical mineral exploration tax credit (CMETC) recently introduced to stimulate investment in critical mineral exploration. The changes to the AMT are set to be effective in Jan. 2024.
Critical mineral exploration tax credit (CMETC)
Under current law, investors who subscribe to “flow-through shares” in a mining company may claim a tax deduction for certain mineral exploration expenditures incurred by the company in Canada and renounced to the investor. In certain cases, the investor may also claim an additional tax credit in respect of such expenditures, thereby enhancing the tax benefits associated with the flow-through share investment.
Announced in the 2022 federal budget, the CMETC is available to purchasers of flow-through shares where the issuer uses the proceeds to conduct qualifying grassroots exploration in Canada primarily targeting certain critical minerals. The CMETC is 30%, twice the amount of the regular 15% mineral exploration tax credit (METC) that applies to other (non-critical) minerals. The new tax credit was introduced as part of Canada’s critical minerals strategy to aid in the transition to a green and digital economy.
Proposed changes to the AMT
The 2023 federal budget proposed changes to the AMT. Although the minimum tax itself is not new, it had not been modified substantially since Canada first adopted it in 1986.
The AMT is an alternative tax calculation meant to ensure that high-income individuals and trusts do not pay a disproportionately small amount of tax relative to their income compared with other taxpayers. The AMT regime operates by applying a fixed rate of tax against a parallel income calculation that allows fewer deductions, exemptions, and tax credits than under the “regular” income tax rules. Individuals then pay the greater of their tax owing under the “regular” rules and the AMT.
The proposed changes aim to broaden the tax base used for the AMT such that it would be calculated by reference to a higher share of total income. For example, only 50% of non-refundable tax credits, such as the CMETC, will be allowed to reduce the AMT under the proposed rules. As well, the federal AMT tax rate would rise from 15% to 20.5% (which may also have consequential effects on the applicable rates of provincial AMT). However, there is also a relieving change proposed in that the amount of income that is excluded from the calculation for eligible taxpayers is proposed to be increased to $173,000 from the current $40,000.
Impact of the changes
In a September 2023 report, the parliamentary budget office (PBO) released its own analysis of the revenue expected from the AMT changes for both individuals and trusts. The PBO said the estimated net revenue from the proposed changes to the AMT is $2.6 billion over five years. Almost all of this will come from individuals, with the tax burden expected to shift to those earning higher incomes. Only $50 million of the expected $2.6 billion will come from trusts.
How AMT changes could affect flow-through shares’ investment
As most individuals who invest in flow-through shares are high-income earners, stakeholders are concerned that the new AMT rules will lead to a decrease in investment into flow-through shares by significantly reducing many investors’ participation capacity. Under the new AMT regime, a high-income individual would only be able to invest a lower amount in flow-through shares before becoming subject to AMT.
Furthermore, under the new rules, 30% of capital gains realized on the donation of flow-through shares would be included in determining the AMT. As many flow-through shares’ investors subscribe in connection with a donation strategy, the proposed AMT rules further disincentivize a major component of the flow-through share regime.
The proposed amendments to the AMT rules could reduce the tax incentives to invest in critical mineral exploration. Mineral exploration companies should be cognizant of these proposed legislative changes, and their potential dampening effect on the demand for flow-through shares once they come into effect. In the short-term, there may be increased demand for the remainder of 2023 while the current AMT rules remain in force.
ANDREW N. DISIPIO is a partner at Bennett Jones in Toronto. He practices securities and corporate law. PHILIP B. WARD is a partner at Bennett Jones in Toronto. He has a general corporate tax practice that focuses on domestic and international tax planning. ANDREW YOUNG is an associate at Bennett Jones in Toronto. He has a general tax practice.