CHAPTER 13 TAXES AND THE STRUCTURING OF INVESTMENTS IN INTERNATIONAL MINING VENTURES

• Jurisdiction: United States

Mineral Development in Latin America
(Nov 1997)
CHAPTER 13
TAXES AND THE STRUCTURING OF INVESTMENTS IN INTERNATIONAL MINING VENTURES
Richard G. Tremblay ^*
Osler, Hoskin & Harcourt
Toronto, Ontario, Canada
Rodrigo Valenzuela ^**
Langton Clarke y Cia, Ltda./Coopers & Lybrand
Santiago, Chile

I. INTRODUCTION

The purpose of this paper is to outline, in a non-technical manner, many of the tax issues that arise in the structuring of an international mining operation. In large part, the discussion will focus on the Canadian and Chilean tax consequences associated with Canadian-based mining companies doing business in Chile. Following the Introduction (Part I), this paper is divided into three major parts. Part II of the paper provides a general discussion of many of the principal Canadian tax considerations to be addressed in planning an offshore mining project. Part III of the paper will examine the Chilean tax implications of companies doing business in Chile. Finally, various structuring alternatives will be analyzed (Part IV). It will become evident that depending on the method chosen to do business abroad, there can be very different tax consequences.

In choosing the best means to structure an offshore investment, consideration must also be given to many non-tax related factors such as: political climate, restrictions in the jurisdiction on foreign investment, legal requirements of the foreign country, start up and operating costs, available infrastructure, environmental and other liability issues, and employment considerations to name but a few. While this paper does not propose to deal with non-tax related issues, they are nevertheless a key element in planning a mining

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project. Similar to tax issues, many of these non-tax factors can best be resolved through the combined input and assistance of professional advisors from Canada and the foreign jurisdiction.

A. Canada Recognizes the Global Nature of the Mining Business

In recent years, Canadian-based companies have actively pursued business opportunities in mining ventures outside of North America. Some of the reasons that Canadian companies have looked to global expansion include the opportunity for significant financial returns, the enormity of mining prospects around the world and the need to expand, replenish reserves and remain competitive in today's global economy.

Moreover, foreign promoters of public mining companies often choose to list on one of the Canadian Stock Exchanges as they can generally realize greater values by listing in Canada. Canada has a reputation as one of the world's preeminent markets for shares of mining companies. There is a long history of Canadian involvement in the mining field with the result that mining investors are both knowledgeable and experienced in the industry. Moreover, Canadian investors have traditionally been prepared to invest more in mining companies than investors in other jurisdictions. Public offerings by mining companies have historically been very successful in Canada.

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For shares to be attractive as an investment and marketable in Canada, they must not constitute "foreign property"¹ under the Income Tax Act (Canada).² There is a limit on the amount of foreign property that can be held by registered retirement funds, deferred profit sharing funds and pension plans in Canada. Basically, the rules limit the cost of foreign property assets which the above investors can hold to 20% of the aggregate cost of all assets held by the investor. In the event that the limit is exceeded, the investor is subject to a 1% penalty per month on the excess amount. Moreover, Canadian mutual funds often have restrictions on foreign property to enhance the marketability of their units.

There are proposed amendments to modify the definition of "foreign property" in the Act, which include among other things, that shares or debt issued by a Canadian corporation with a "substantial presence" in Canada will not qualify as foreign property (regardless of whether the shares derive their value primarily from foreign property). The test to determine "substantial presence" is set out in proposed subsection 206(1.1) of the Act and in very general terms includes a Canadian corporation (or a corporation controlled by the Canadian corporation) which employs more than five people on a full-time basis in Canada (otherwise than in connection with certain specified activities). The "substantial presence" test might also be met where a Canadian corporation (or a corporation controlled by the Canadian corporation) incurs more than $250,000 for the services (other than for services related to investment activity) rendered by its employees or others in any calendar year that

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ended in the last fifteen months.³ The foreign property rules are complex, technical and may yield surprising results. Therefore, when looking to list in Canada, careful consideration must be given to this issue.

To some extent, the trend in Canada of investing in offshore mining ventures has come to a temporary halt in light of the recent scandal involving Bre-X Minerals Ltd. and the tampering of gold samples from the Busang mines in Indonesia. However, steps are now being taken to prevent similar problems from occurring in the future. For example, the Toronto Stock Exchange and the Ontario Securities Commission have formed a joint Mining Standards Task Force to consider whether there is a need to revise standards for public mining. The Task Force will examine, among other things, how exploration projects should be operated, the need for full disclosure by mining companies, and how to avoid tampering by improving the security of samples.⁴ It is widely anticipated that as these issues are resolved, attitudes towards international mining ventures will once again bring excitement and enthusiasm from Canadian investors.

B. Canadian Investment in Chile — A Wealth of Opportunity

Chile has become an investment magnet for Canadian companies in search of business opportunities in Latin America. To date, Canadians have invested approximately $7 billion in Chile and Canada is the second largest foreign investor in the country, occupying 15% of Chile's total authorized foreign investment. While foreigners are investing in a variety of industries in Chile, there has been a general focus on the agriculture, telecommunications, electricity and gas, and mining sectors. There are many reasons why Chile has become an attractive market for foreign investment. The country has had strong economic growth

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during the last 10 years. The Chilean government has welcomed and encouraged foreign investment, removed the majority of entry barriers for foreign business, and applauded entrepreneurship. Responsible fiscal policy, controlled inflation and reasonably low unemployment rates have attracted investors to Chile from around the globe.

Other recent efforts by the Chilean government would suggest that Canadian investment interest in Chile will continue to grow. Trade between Canada and Chile amounts to approximately $600 million a year. To assist in the open movement of goods between the countries, representatives from the Canadian and Chilean governments negotiated a bilateral free trade agreement (the "Canada-Chile FTA") which came into force on July 5, 1997. To some extent, the Canada-Chile FTA will serve as an interim agreement until Chile joins the North American Free Trade Agreement ("NAFTA"). Negotiations in this regard have already commenced and the likelihood of Chile joining NAFTA has only heightened the interest of North Americans in Chilean business prospects. Furthermore, within one month of the Chilean Congress approving the Canada-Chile FTA, Chilean and Canadian negotiators met in Ottawa to discuss the possible signing of a Canada-Chile tax treaty. The next round of tax treaty negotiations are scheduled for November 1997 in Chile and a tax treaty between the two countries appears eminent. The effect of a tax treaty between Canada and Chile should serve to increase the amount of business conducted between the two countries.

II. PRINCIPAL CANADIAN TAX STRUCTURING CONSIDERATIONS

Set forth below is a discussion of many of the Canadian tax considerations to be addressed in the planning of an international mining venture. While this paper is not intended to be

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exhaustive, it will provide a general overview and understanding of many of the potentially relevant tax issues associated with offshore mining projects.⁵

A. Carrying on Business Abroad — Establishing a Foreign Branch of a Canadian Corporation vs. a Foreign Corporation

A Canadian company will experience very different tax consequences from an overseas mining investment depending on whether it choose to carry on its business through a foreign branch or a foreign corporation.

1. Branch of Canadian Corporation

A Canadian company carrying on business abroad may choose to do so through a foreign branch operation provided that the foreign jurisdiction authorizes branches to be established and directly own and work a mining property. Chile authorizes direct investment in mining projects by foreign branches, but some other countries do not.

A foreign branch of a Canadian company is not considered to be a separate entity from that company for purposes of the Income Tax Act (Canada).⁶ Therefore, income earned by the foreign branch, measured under Canadian rules, would be included in computing the income of the Canadian company in the year it is considered income under Canadian tax principles. The

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branch will also be subject to foreign tax on its income earned in the foreign jurisdiction. Relief from this double taxation may be provided in whole or in part by the foreign tax credit system. A foreign tax credit⁷ is a deduction from Canadian tax otherwise payable that may be claimed in respect of "income or profits tax"...