Exploration Financing Fares Well In Federal Budget
Authors: Parsons R.B. 
Published: March 2010

Although the downstream end of Canada's oil and gas industry is somewhat dismayed with the proposed cut-backs of investment tax credits, the upstream segment applauds a number of measures in the February 26, 1986 federal budget. Financing exploration programs is made easier by proposals to fix up the flow-through share rules, and by keeping limited partnerships available for investors who wish to participate in oil and gas exploration. Tax Topics examines these aspects of the federal budget as well as other important budget proposals.

Introduction

With oil and gas prices at devastatingly low levels, the oil patch needs all the encouragement it can get these days. On the fiscal scene, although Finance Minister Michael Wilson's February 26, 1986 budget received a mixed reaction from business and labour leaders, the budget was mainly "good news" to the oil and gas industry. Limited partnerships will apparently be able to continue to serve a useful role in financing exploration programs, a long-standing bugaboo in the flow-through share rules will be cleared up, corporations will be allowed a $10,000 deduction in computing production revenue for PGRT purposes, and a permanent set of rules will be installed for the tax treatment of Northern allowances.

Flow-Through Shares

The present rules which apply to an investment in flow-through shares are structured in such a way that the relevant Canadian exploration expense ("CEE") must be incurred by the investor, and not by the issuing corporation. Obviously, in the case of most flow-through share issues, this requirement that the investor incur the CEE poses a practical problem – the investor typically does not have the expertise or organization to incur the CEE. As a result an integral part of most flow-through arrangements is an agreement whereby the investor appoints another party (usually the issuing corporation) as his agent to spend the flow-through funds on CEE on his behalf- Although the issuing corporation might consequently be the party which actually spends the flow-tluough share funds on CEE, nevertheless the legal structure is such that the investor is the "principal" who is incurring the CEE. As such, the investor is legally responsible for any third party claims with respect to the exploration program. Third-party liability might arise, for example, in the case of property damage, personal injury, environmental infractions, and so on.

In order to provide some degree of protection for the investor in connection with possible third-party liability, a flow-through share arrangement generally requires the exploration corporation to acquire and pay for third-party liability insurance on behalf of the investor. In addition, or alternatively, the issuing corporation may indemnify the investor with respect to possible third-party claims resulting from the exploration program. However, these efforts to protect the investor have not always been acceptable or appropriate. Some companies who would have liked to issue flow-through shares have found the cost of necessary insurance coverage to be prohibitive. In certain instances, too, the issuing company's indemnity has not been acceptable as sufficient protection.