Does a critical minerals push make this tax strategy more attractive?

The shift in Canada’s economic focus and tone since the rise of Mark Carney as Prime Minister can have some feeling like everything old is new again. Some of the sectors most maligned under the previous government, such as energy and mining, have become critical priorities for this new government. A desire to restart a sluggish economy and global demand for critical minerals has a number of mining projects attracting new flows of capital, backed by tax incentives.

For certain retail investors, there may be new attraction in an older investment vehicle as well. Flow-through limited partnerships providing exposure to critical minerals projects can offer both exposure to this key priority sector in Canadian economic growth alongside some significant tax benefits. Robert Anton, President and Founding Partner at Next Edge Capital Corp. (“Next Edge”, outlined the prospects for critical mineral projects in Canada and emphasized how tax savings built into flow through limited partnerships can help certain clients.

“There have always been tax incentives in Canada for investments into exploration and development by Canadian resource companies, with the hopes that they can find something and eventually produce a mine to create jobs and tax revenue. What many investors and advisors are still not aware of are some new extra tax credits towards critical minerals in particular,” Anton says. “In 2022 the government implemented an extra 30 per cent tax credit on exploration and development towards critical minerals (“Critical Mineral Exploration Tax Credit” or “CMETC”), on top of the 100 per cent core Canadian Exploration Expense (“CEE”) tax deduction. That’s quite key.”

The case for critical minerals

Aside from their near constant presence in the headlines and remarks made by world leaders, critical minerals represent a growing opportunity for Canada, in Anton’s view. While Canadian production can’t compete with other markets, notably China, on price, Anton explains that certain key markets have shown a preference for “friendshoring” the supply of minerals they can’t produce themselves. The European defence industry, for example, is looking closely at Canadian critical mineral supplies to avoid a critical reliance on China.

Canada also has what capital markets like, strong property rights laws, a strong rule of law, safety regulations, an experienced workforce, and strong environmental standards. The new tailwinds blowing from Ottawa incentivizing capital and new project development further add to this positivity. Under the 2022 CMETC tax incentive, 32 specific minerals have been identified as “critical.”

The utility of flow-through limited partnerships

All that positivity behind critical minerals might invite investors to make the more textbook move: buy mining equities. While Anton believes there can be a strong case for mining stocks right now, he argues that investors in a certain tax bracket can be better served by an investment in a flow-through limited partnership model. Returns from flow-through limited partnerships, he says, are typically not positive on an absolute basis, that is until you look at those returns on a tax-adjusted basis. The tax incentives behind exploration and production endeavours, as well as the additional tax credits incurred when the investment focuses on critical minerals. The Canadian resource company flow-through limited partnerships being offered by Next Edge, Anton explains, are explicitly weighted to critical rather than precious minerals, at a ratio of 75 per cent critical to 25 per cent precious.

Because the primary source of returns from these limited partnerships, over longer periods of time, is in their tax savings, Anton says that they can help investors who want exposure to critical minerals but are concerned that prices are currently elevated. While he believes macro demand for critical minerals driven by defence, technology, clean energy initiatives, and other infrastructure investments should ensure a strong lasting demand for these metals and minerals and potentially  drive prices higher, he notes that tax-based returns should keep overall returns extremely attractive.

While the tax incentives and macro tailwinds may invite interest from advisors, Anton insists that client education is a vital step in any investment decision. The investment vehicle is quite different from what most clients would be used to, and explaining that most flow-through funds lose money before tax is factored in can be challenging. However, for the right client Anton believes that these limited partnerships can provide real value, so long as they understand what they’re getting and why.

“There’s a whole generation of people, when you include the bear market that we had that lasted for over a decade in resources, who have never purchased a flow-through limited partnership before, or if they have, they haven’t done so in 15 to 20 years,” Anton says. “It’s important now to educate them  on some of the new tax incentives available that make the break-even investment point vastly lower. Meaning that even losing 25 or 30% on an absolute basis, could still result in a really good experience for your client if they’re in the highest marginal tax bracket.”