Explorers fear regulatory meddling over Canada's critical minerals tax credit

Canada's juicy 30% critical mineral exploration tax credit has caused some industry hype, but explorers are worried about how closely federal regulators will police the new scheme.

Canada launched the critical mineral exploration tax credit, or CMETC, in April 2022 amid a broader government push to beef up the country's energy-transition supply chain. The country already has a general 15% mineral exploration tax credit. However, in a bid to bolster discoveries of critical minerals, it created the heftier tax benefit for domestic exploration of 15 critical minerals needed to decarbonize the economy, including copper, nickel and lithium.

The CMETC, outlined in legislation passed in December 2022, is drawing strong interest from investors, exploration executives told S&P Global Commodity Insights. But explorers and investors have the jitters because the Canada Revenue Agency, or CRA, has not released detailed guidelines on how the government will oversee the new tax credit. An explorer could set out to target metals covered by the CMETC, but the government might demand its money back if the specific minerals are not discovered out in the field.

This creates a conundrum for an explorer. It will have raised money from investors, advertising expectations of using the tax credit, and then spent that cash. But subsequent exploration results may call into question whether the expenditures will qualify for the tax credit. That is giving investors cold feet — the opposite of the law's intent.

"It's really challenged our confidence in knowing whether things are going to qualify," said John-Mark Staude, president and CEO of Riverside Resources Inc. "It is a big gamble."

Investors hold back

Canadian mining companies pass on the tax benefits to investors through the country's flow-through share system, which allows investors to claim tax deductions and credits related to domestic exploration spending instead of the companies doing the work. The CMETC applies to flow-through share agreements signed from April 7, 2022, to March 31, 2027, according to the Canadian government.

Canada was the top country for exploration in 2022, accounting for $2.68 billion, or 20.6% of global exploration budgets, according to Commodity Insights' Corporate Exploration Strategies studies. The flow-through share system and related tax benefits are a significant draw for investors.

The initial excitement over the CMETC helped generate a flurry of deals. That includes Benz Mining Corp., which raised C$11.9 million in September 2022, largely targeting the new tax credit, and Tashota Resources Inc., which in August 2022 announced a CMETC-related offering worth up to C$1.0 million in units.

Uncertainty over the final rules may be holding back some investments, according to Kai Hoffmann, CEO of Oreninc, which tracks mining sector financings.

"The CMETC is still a new construct, and we hear that investors are not willing to take the risk of higher premiums yet, as definitions are still murky," Hoffmann said in an email.

To qualify for the critical minerals credit, a professional engineer or geoscientist must verify that a company's exploration plans primarily target the government-specified critical minerals. The CRA has published a certifying form for a professional engineer or geologist to fill out and justify a project under the tax scheme.

However, if a company fails to find a critical mineral after getting a certification from an engineer and claiming the credit, it might have to return the money.

"It's something that I'm sure is crossing a lot of people's minds right now," said John Burzynski, executive chair and CEO of Osisko Mining Inc., a junior explorer that has run some of Canada's largest exploration programs.

Staude said the government should clarify how it will approach these kinds of situations and give some leeway to explorers if they do not end up primarily finding critical minerals. Staude said the CRA should not necessarily disqualify expenses in these kinds of cases: "It's too drastic."

Such a disqualification would be a double whammy for explorers, as the government has said that if an explorer fails to qualify for the CMETC, it cannot fall back on the more general 15% exploration tax credit, which is not tied to specific metals.

The CRA could not respond to a request for comment by publication time.

Exploration scruples

A more flexible rule that accounts for the possibility of failure could also lead to abuse of the credit. A less scrupulous company might try to exaggerate the critical minerals potential of an asset in order to qualify for the beefier tax credit. The system will likely have to rely on professional ethics to ensure abuses like this do not happen.

"I think those cases would stand out like beacons," Burzynski said. "But they're not going to really be fooling anybody. So it comes down to 'investor beware.' Make sure that who you put your money into is actually somebody reputable."

The Prospectors and Developers Association of Canada, an industry group representing the interests of the country's mineral explorers, raised questions about how the CRA would scrutinize the certification of spending plans, responding to the proposed rules in 2022. The association noted that proposed legislation outlining the critical minerals tax credit, since passed, stated that a professional engineer or geoscientist is to have "acted reasonably" in justifying expenditures in a declaration to the CRA.

The association worries this could require CRA auditors to police the conduct of a professional geologist or engineer.

"Our view is the determination of whether a professional engineer or geologist 'acted reasonably' is the exclusive prerogative of the professional associations ... and the current phrasing invites CRA auditors to second-guess the professional and/or ethical conduct of the qualified engineer or geoscientist," the organization said Sept. 30, 2022, in a letter to the government.

While uncertainty hangs over how federal officials will police the CMETC, industry and analysts say the tax credit is proving popular as investors flock to critical minerals.

"There's this voracious demand for it," Burzynski said.

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