The era of super flow-though financing for mineral exploration is scheduled to come to an end this month after a six-year run. But the jury is still out on whether the loss of the tax credit will deflate the general popularity of flow-through products, which are heading for another record-breaking year.

Flow-through shares are issued by Canadian companies and allow individual shareholders to deduct from their personal income the money junior mining companies spend on exploration in Canada. Regular flow-though financing allows a 100% deduction, while “super” flow-throughs give inves-tors an extra 15% tax credit. The SFT credit is set to expire on March 31.

The federal government introduced SFT financing in 2000 to help resuscitate the Canadian mineral exploration industry, which had been in decline for several years and was losing investment dollars to the high-tech sector. Several provinces have topped up the federal incentive by offering their own tax credits, ranging from 5% in Ontario to 20% in British Columbia.

After a sluggish start, SFT shares became a hit with high net-worth investors as metals prices rose, helping Canada become one of the world’s top destinations for exploration dollars. In 2006, Canada captured 19% of the record US$7.13 billion budgeted for mineral exploration worldwide, according to Halifax-based Metal Economics Group.

Flow-through financings in general also appear to be heading for a record, hitting $600 million by the end of October 2006. Since the tax credit was introduced, companies issuing flow-through shares for exploration have raised almost $1.9 billion and made hundreds of grassroots discoveries, according to the Prospectors and Developers Association of Canada.

For an investor in Ontario’s highest tax bracket, the after-tax cost of a common, non-registered $30,000 SFT investment is approximately $13,000. Using SFT shares, the investor gets a powerful tax shelter as well as the potential upside of a mineral discovery by the company. The tax deductions can be carried back three years or carried forward seven years.

But the extraordinary success of the SFT program, combined with record metals prices, may have rendered the tax credit obsolete. Although it has been renewed several times over the years, the federal Conservatives are expected to allow the credit to expire at the end of March despite intense lobbying by the PDAC to keep it alive. The provincial governments, with the exception of Quebec, will probably follow the federal lead.

“We are not an industry in cri-sis anymore,” says Gerald Har-per of Toronto-based Gamah International Ltd. , a consultancy that tracks financings in the global mining sector. “We have more money than we can spend. We are reaching the point at which we cannot efficiently spend the financing we do have available, not only in Canada but around the world.”

And any flow-through money left unspent within a year of the company renouncing exploration expenses to shareholders is not only subject to a 10% fee, but must also be returned to the investor as income, Harper points out. As shortages of labour and equipment required to do the work become increasingly acute, the probability of money sitting in the bank increases. So, too, does the chance that companies will spend the money just to get rid of it.

Such a situation happened two decades ago, when a similar program, the mineral exploration depletion allowance, was introduced as a stimulant. The program became so popular with investors that juniors flush with cash began throwing money at uneconomical prospects. Spending on mineral exploration in Canada reached $1.3 billion before the government withdrew the tax incentive in 1998.

Today — although restrictions on how flow-through money is used have helped quell abuse of the program — similar demand for flow-through shares and their associated tax benefits may signal that the SFT tax credit has outlived its usefulness again.

“We raised $15 million in 2006, the most to date, and 2007 promises to be double that,” says David Mason, chairman and managing director of Augen Capital Corp. , a Toronto-based investment firm that offers flow-through share funds. “The investment tax credit is nice, but it’s only a small portion of the total rate of return.”

Augen has had a 66% average after-tax rate of return on its limited partnership funds issued since 1999. For the past three years, the return has been 98%. In 2006, the LP portfolio included juniors involved in exploration for gold (35%), uranium (25%), base metals (21%), oil and gas (15%) and other minerals (4%).

@page_break@Mason “holds out some hope” Ottawa will renew the SFT credit.

MineralFields Group, another Toronto-based firm offering flow-through funds, has also had an excellent run. In just five months in 2005, one of the company’s funds doubled. An investor who put in $100,000 got back almost $200,000 in that time, on top of tax breaks worth about $60,000. And the company had a record amount of investor subscriptions in 2006, topping $105 million.

“Even without the tax credit, flow-through LPs are one of the very few legitimate, government-sanctioned tax breaks left,” says John David, a MineralFields analyst. “And because Canadian investors have a huge demand for tax-efficient products, the flow-through industry is in no jeopardy.”

There’s such a demand, in fact, that flow-through fund companies are putting pressure on junior companies to issue more flow-through shares to satisfy the funds’ growing investor base.

If the SFT tax credit is phased out, the mining industry will be on equal footing — and competing for investment dollars — with the oil and gas industry, which has long allowed investors a 100% tax deduction on exploration expenditures. But David says flow-through oil and gas shares trade at such a premium to their counterparts in the mining industry that mining will maintain a competitive advantage with or without the SFT credit.

The PDAC, which lobbied so hard for the SFT tax credit in the first place, is less sanguine about losing it. The organization has launched a letter-writing campaign to 90 members of Parliament who either have mining in their jurisdictions or a strong contingent of PDAC members, asking the MPs to push for a renewal of the SFT credit at the end of March.

The PDAC’s fear is that if the tax credit is phased out, Canada will lose its position as one of the top destinations for exploration dollars. Competition for those dollars is much fiercer now that many countries have revised their mining laws to attract foreign — mostly Canadian — investment.

“When we talk to financiers and small juniors, it’s still the No. 1 issue,” says MaryAnn Mihychuk, director of regulatory affairs at the PDAC. The organization would like to see the program extended in a series of rolling three-year extensions that include annual reviews of the program’s benefits.

Canada’s SFT program is the envy of the world and shouldn’t be toyed with, Mihychuk argues. Indeed, South Africa is considering introducing a similar program to boost exploration in that country.

Roger Baxter, chief economist of South Africa’s Chamber of Mines, which represents the majority of mining houses in South Africa, told his country’s parliament in February that the government should follow Canada’s example and introduce flow-through shares to provide incentives for venture-capital funding in the exploration sector.

It will be difficult to measure the impact revoking the SFT tax credit will have on flow-through financing for Canadian projects because there are so many factors — including metals prices, management and upside potential — that affect the attractiveness of a junior mining stock. But it’s difficult to make a case that the industry should continue to receive extra government subsidies while it’s so strong. IE