INBOUND FINANCING AND INVESTMENTS 2010 MINING TAXATION UPDATE ACUMEN INFORMATION MAY 10, 2012

1. INBOUND FINANCING AND INVESTMENTS2010 MINING TAXATION UPDATEACUMEN INFORMATIONMAY 10, 2012 Steve Suarez Borden Ladner Gervais (Toronto)

2. OVERVIEW OF PRESENTATION • Financing & Inbound Investment • Debt Financing • Equity Financing • Alternative Investments • Non-Resident Acquisitions of Canadian Mining Companies • Exit Strategies • Taxable Canadian property • Tax treaty protection • s.116 issues • Cross-Border Canada – U.S. Issues • Limitation on benefits under the Canada-U.S. Treaty • Using hybrid entities in inbound transactions

3. Financing & Inbound Investment Non-residents making Canadian mining investments (new projects in Canada, acquiring interests in existing projects or acquiring interests in existing Canadian entities) must consider: • Canadian income tax • Canadian withholding tax • home-county taxes • limited legal liability • day-to-day functionality In most cases other than straightforward lending or royalties, this will involve using a Canadian corporation (directly or indirectly) as the investment vehicle

4. Financing & Inbound Investment Debt Financing: non-residents have a number of important considerations to balance • where to locate interest expense • thin capitalization limitations on Canadian interest deductibility • possibilities for double-dip financing • Canadian interest withholding tax • Other considerations

5. Financing & Inbound Investment: Debt On simple loans to arm’s length borrowers, a non-resident will typically be worried only about home country taxation of interest income • no Canadian withholding tax on interest paid to a non-resident creditor dealing at arm’s length with Canadian borrower, unless interest is “participating” (e.g., variable based on profit, cash flow, etc.) Otherwise, if non-resident is debt-financing a Canadian investment, need to consider whether • interest expense deductions are most useful in Canada or the non- resident’s home country (effective tax rate, where sufficient taxable income exists, etc.); • withholding tax costs of lending to Canada; and • is there any scope for multiple deductions?

6. Financing & Inbound Investment: Debt Thin capitalization restrictions (s.18(4)ITA) Canadian corporations are restricted on the amount of interest expense they can deduct on debt owing to “specified non-residents”: non-residents who own, or deal non-arm’s length with someone who owns, 25%+ of Canco’s equity (by votes or value) No interest deduction on debt owing by Canco to specified non-residents, to the extent it exceeds 2x Canco’s “equity”, being the sum of • Canco’s start-of year unconsolidated retained earnings; • Canco’s contributed surplus received from specified non-resident shareholders; and • paid-up capital of Canco shares owned by specified non-resident shareholders

7. Financing & Inbound Investment: Debt Thin capitalization restrictions are being tightened under the March 2012 federal budget • debt/equity limit being reduced to 1.5:1 (effective 2013) • rules now capture debt of partnerships that have Canadian corporations as partners • disallowed interest expense with be treated as a dividend (not interest) for withholding tax purposes See “Canadian 2012 Federal Budget: Tightening the Screws,” included with materials

8. Financing & Inbound Investment: Debt Foreign Parent Foreign Finance Co $50M equity $100M loan Canco • Starting in 2013, Canco can only deduct interest on $75M of the debt • owing to Foreign Finance Co • no deduction for interest on the remaining $25M, which is treated • as a dividend and subject to dividend withholding tax

9. Financing & Inbound Investment: Debt Double-Dip Structures Where U.S. parent is lending to Canadian subsidiary, consider whether a “double dip” hybrid structure can be used to create an instrument that is debt for Canadian purposes (deductible interest expense for Canco) but equity for U.S. purposes (no interest income for U.S. parent)

10. US Co Third-party debt 3. Support Agreement 1. Loan 4. Guarantee 2. Forward Subscription Agreement Canco LLC Financing & Inbound Investment: Debt • Summary • 1. US Co uses proceeds of 3rd party debt to make a loan to Canco • 2. Simultaneously, LLC enters into a forward subscription agreement with Canco to purchase Canco shares for cash equal to the principal amount of the loan on the maturity date • Simultaneously, US Co enters into a support agreement with LLC to purchase shares for cash in order that LLC can fund its obligation under the forward subscription agreement • Simultaneously US Co provides Canco with a guarantee of LLC’s performance under the FSA

11. US Co 3. Support Agreement 4. Guarantee 1. Loan LLC 2. Forward Subscription Agreement Canco Financing & Inbound Investment: Debt • Summary • 1. Loan from US Co to Canco • 2. Forward subscription agreement between LLC and Canco • Support agreement between US Co and LLC • Guarantee from US Co to Canco

12. Financing & Inbound Investment: Debt Interest Withholding Tax Under Part XIII, Canada no longer levies withholding tax on interest (other than participating interest) paid to a creditor dealing at arm’s length with the debtor “participating debt interest” means interest (other than interest described in any of paragraphs (b) to (d) of the definition “fully exempt interest”) that is paid or payable on an obligation, other than a prescribed obligation, all or any portion of which interest is contingent or dependent on the use of or production from property in Canada or is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation.

13. Financing & Inbound Investment: Debt Interest Withholding Tax: other relevant provisions s.214(6): deemed payment of accrued interest on transfer of bond, etc. by a non-resident to a Canadian resident, if bond issued by Canadian resident s.214(7): deemed payment of interest on transfer of bond, etc. by a non-resident to a Canadian resident, if issued by Canadian resident and transfer price exceeds issue price of the bond s.214(8): “excluded obligations”, carved out of s.214(7) and partially carved out of s. 214(6) (former 5/25 debt or shallow discount debt issued for not less than 97% of principal amount)

14. Financing & Inbound Investment: Debt Interest Withholding Tax: convertible debentures There is considerable uncertainty as to the tax treatment of holders of convertible debentures who are non-residents • not clear whether the value of shares received on conversion over principal amount is “participating interest” (if so Canadian withholding tax applies on sale or conversion of debenture) • not clear whether “regular” interest is tainted by the conversion premium CRA administrative position has been “under development” for almost 4 years, and remains in progress

15. Financing & Inbound Investment: Debt Interest Withholding Tax: Tax treaty structuring While most of Canada’s tax treaties reduce the 25% rate of Part XIII interest withholding tax to 10%, the rate under the Canada-U.S. Treaty for U.S. residents entitled to Treaty benefits is 0%, even if dealing non-arm’s length with the debtor ➙ This creates an incentive for non-residents outside the U.S. to consider financing into Canada through a U.S. group member, in order to get 0% interest withholding Issues to watch for • limitation on benefits under the Canada-U.S. Treaty • anti-hybrid rules in Canada-U.S. Treaty • anti-avoidance mechanisms (discussed below)

16. Financing & Inbound Investment: Debt Interest Withholding Tax: Financing Through the U.S.

17. Financing & Inbound Investment: Debt s.78: Accrued and Unpaid Interest: Deductible amounts owing to a non-arm’s length person and which remain unpaid at the end of the second taxation year following the year it was incurred, are added back to income in the third following year, unless the parties jointly elect to deem the amount to have been paid

18. Financing & Inbound Investment: Debt Foreign Exchange Issues When lending into Canada, consider the F/X implications of the loan • Canadian debtor borrowing non-Cdn. $ will realize income/gain/loss on maturity, with any loss probably denied recognition if incurred on debt from a non-arm’s length lender • Canadian debtor should not assume any gain will be a capital gain: need to consider capital/income treatment • Canco may want to consider making the s.261 foreign currency election in appropriate circumstances For more on the tax treatment of F/X gains and losses, see “Canadian Taxation of Foreign Exchange Gains and Losses” at www.miningtaxcanada/about/

19. Financing & Inbound Investment: Equity Equity Financing: principal Canadian tax considerations for non-residents making an equity investment in Canada: • tax recognition of cost of investment • maximizing cross-border paid-up capital (PUC) • minimizing Canadian dividend withholding tax • minimizing Canadian taxation of gains on exit • managing s.116 obligations on sale

20. Financing & Inbound Investment: Equity Paid-up Capital • Tax equivalent of corporate law share capital • Basic concept is that shareholders should be able to extract PUC without being treated as receiving a dividend (but reduces shareholder’s cost in the share) • Each share of the same class or series has the same PUC (PUC of class divided by # of shares)

21. Before X Y FMV = $200Cost/PUC = $100 $200 CanCo Financing & Inbound Investment: Equity Paid-up Capital: pooled within each class After Y X FMV = $200Cost = $100PUC = $150 Cost/FMV = $200PUC = $150 CanCo $200

22. Financing & Inbound Investment: Equity Paid-up Capital: non-residents Especially important for non-resident purchasers • PUC can be extracted out of Canada without dividend withholding tax • PUC increases how much debt Canco can incur from related non-residents on an interest-deductible basis • 2012 federal budget targets PUC increases where foreign-controlled Canco makes an “investment” in a foreign affiliate that does not satisfy a business purpose test (see “Canadian 2012 Federal Budget: Tightening the Screws”)

23. Vendor Non-ResidentBuyer FMV = $10MPUC = $2M $10M Canco Financing & Inbound Investment: Equity Paid-up Capital: non-resident acquisition

24. Incorrect Non-ResidentBuyer Vendor $10M FMV/Cost = $10MPUC = $2M Canco Financing & Inbound Investment: Equity Correct Non-ResidentBuyer Vendor $10M FMV/Cost/PUC = $10M New Canco FMV/Cost = $10MPUC = $2M Canco

25. Financing & Inbound Investment: Equity Equity Distributions A Canadian corporation can choose to make a distribution to shareholders either as (1) a dividend, or (2) a return of capital (to the extent of the stated capital of its shares) • unlike the U.S., there is no rule treating all distributions as dividends for tax purposes to the extent the corporation has earnings & profits (E & P) A dividend triggers dividend withholding tax but does not reduce the holder’s basis in the share A return of capital reduces basis in the share and is not treated as a dividend to the extent of PUC (except where s.84(4.1) applies)

26. Financing & Inbound Investment: Equity Equity Distributions In a mining investment, the prospect of dividends is often remote unless the Canadian corporation is a producer of significant size (mining is very capital-intensive) • dividend-paying mining corporations tend to be large public companies, which are severely limited in their ability to make capital reductions for tax purposes due to s.84(4.1) As a result, choice of jurisdiction to hold Canadian mining shares is usually driven by (1) recipient-country taxation, and (2) managing Canadian taxation of gains on dispositions, (see Exit Strategies)

27. Financing & Inbound Investment: Periodic Repatriations

28. Financing & Inbound Investment: Royalties It is relatively unusual for foreigners to invest in a Canadian mining project in the form of a royalty, as these tend to be tax-inefficient • effectively no cost recognition for Canadian purposes, as CDE pool rarely of use to a non-resident • royalties subject to 25% withholding tax under Part XIII • Canada’s tax treaties tend to offer little or no relief from Canadian taxation of Canadian-source mining royalties

29. Financing & Inbound Investment: Metal Streams Metal stream transactions are a particular form of mining transaction that typically sees a producer sell secondary output (e.g., silver from a gold mine) to an arm’s length purchaser, usually on the basis of an upfront payment plus a relatively low price per unit delivered (considerably less than spot) • structured so as not to be a royalty • up-front payment often set up as a deposit While possible to effect directly into Canada, (especially where the mine is located in Canada) metal stream transactions are typically set up with a foreign subsidiary of the Canadian mining company

30. Income Tax Results: Vendor: payments from Vendor Subco included in income when received Vendor Subco: upfront payment included into income when received; s. 12(1)(m) reserve claimed for goods to be delivered in future. Sales income from Purchaser included into income as received. Financing & Inbound Investment: Metal Streams

31. Financing & Inbound Investment: Acquisitions Acquisitions of Canadian mining companies: see B. Sinclair’s presentation • form of transaction • form and amount of consideration • process • structuring considerations purchaser (s.116 issues, s.88(1)(d) bump, exit strategy) vendor (tax minimization, deferral, s.116 issues) • pre-and-post transaction planning

32. Financing & Inbound Investment: Acquisitions Points of particular relevance to non-resident purchasers • maximizing cross-border PUC (to maximize Canadian interest deductibility under thin capitalization rules and the ability to effect distributions as PUC returns) • s.88(1)(d) bump • limited to using cash consideration • especially useful to extract Target’s foreign subsidiaries out of Canada • limited ability to offer tax deferral to Target shareholders who are taxable in Canada on gains (unless using exchangeable shares) • special considerations when planning for sale of investment (minimizing Canadian tax on gains)

33. Financing & Inbound Investment: Acquisitions Illustration of Inbound Acquisition Planning Pre-Acquisition

34. Financing & Inbound Investment: Acquisitions Post-Acquisition

35. Financing & Inbound Investment: Acquisitions For more on acquisitions of Canadian mining corporations see: • www.miningtaxcanada.com/mergers-acquisitions/ • “Using Exchangeable Shares in Inbound Canadian Transactions” (About page of website) • “Canada’s Tax Cost Step-Up: What Foreign Purchasers Should Know” (About page of website) • “Canada’s Section 116 System for Non-Resident Vendors of Taxable Canadian Property” (included with materials)

36. Exit Strategies The time to plan for how to exit an investment in Canadian mining is before making the investment, especially for non-residents. Careful planning can help minimize: • Canadian capital gains tax • Canadian s.116 obligations • home-country taxation (direct and CFC) Taxpayers are invariably more successful with planning that is put in place at the time the investment is made as opposed to planning done near the time of sale

37. Exit Strategies: Debt Unless somehow convertible into or exchangeable for another property, a debt investment into Canada will generally not constitute “taxable Canadian property” so as to be subject to Canadian capital gains tax or s.116 obligations • simply lending to a Canadian mining company does not create TCP But consider the potential for s.214(7) to create Part XIII tax on sale or redemption if proceeds exceed issue price and debt is not an “excluded obligation”

38. Exit Strategies: Equity When making an equity investment in Canada, the three principal Canadian tax considerations are: • will the investment constitute TCP, so as to be subject to Canadian capital gains tax • if so, can protection from Canadian capital gains tax be found in a relevant tax treaty • if the investment constitutes TCP, do the parties have obligations under the s.116 system governing dispositions of TCP by non-resident vendors

39. Exit Strategies: Equity Taxable Canadian Property • includes interest in Canadian real property or Canadian resource property (which includes most mining royalties) • property used or held in a business carried on in Canada • share not listed on a designated stock exchange (other than of a mutual fund corporation) or partnership interest or trust interest (other than of a mutual fund trust), that derives its value (directly or indirectly) primarily from Canadian real/resource properties anytime in the preceding 60 months (other than through a corporation, partnership or trust whose shares/interests are not TCP) • share that is listed on a designated stock exchange, or of a mutual fund corporation, or interest in a mutual fund trust, if at any time in the preceding 60 months both: • more than 50% of the share’s/interest’s FMV was derived (directly or indirectly/ from Canadian real/resource properties; and • taxpayer (together with non-arm’s length persons) owned 25%+ of corporation’s shares or MFT’s units

40. Exit Strategies: Equity Summary: TCP Status

41. Exit Strategies: Equity Determination of taxable Canadian property status for shares 2010 Budget narrowed TCP status for shares: only TCP if shares derive value primarily from Canadian real property in past 5 years (directly or indirectly) Previously, CRA had allowed taxpayers to make “value primarily derived” determination based on (1) corporation’s gross assets, or (2) corporation’s net assets, allocating liabilities on a reasonable basis

42. Exit Strategies: Equity At 2011 CTF Round Table, CRA announced a change in its administrative policy • For property held by the taxpayer any time during 2011 and disposed of before 2013, old policy applies • For all other property, the CRA will make “value primarily derived” determination based on gross assets Q: shouldn’t the value of a share be based on the value of the corporation’s assets less all claims ranking ahead of the shares, i.e., on a net assets basis?

43. Exit Strategies: Equity Tax Treaties: where the Canadian equity investment will (or may in the future) constitute TCP, it is essential to consider whether tax on sale could be reduced either by • structuring the exit as a dividend for Canadian tax purposes (if dividend withholding tax is less than Canadian capital gains tax), or • using a tax treaty to achieve a more favourable result, taking into account (1) Canadian taxation of the gain, (2) taxation of the gain in the shareholder’s jurisdiction, (3) costs of distributing the sale proceeds out of the shareholder’s jurisdiction (whenever this occurs) and (4) taxation of that distribution in the jurisdiction of the ultimate parent

44. Exit Strategies: Equity Tax Treaties: there is a very wide range of protection from Canadian capital gains taxation on a sale of shares in Canada’s tax treaties (see “Canadian Taxation of Mining,” included with materials) – for example: No relief (e.g., Chile. ,Argentina, Brazil, Australia, Japan, India) Taxation if share value derived primarily from Canadian real property (e.g., China, Singapore, Korea, Ireland) As above, but operating mines excluded from “real property” (e.g., Netherlands, Germany, South Africa, Luxembourg, Switzerland, U.K.) Taxation limited to Canadian corporations (Netherlands, Russia, Switzerland, U.S., Germany) Publicly-listed shares excluded (Luxembourg, Netherlands, U.K., Germany, Switzerland) Minimum ownership threshold, usually 10% (South Africa, U.K., Netherlands, Luxembourg, Switzerland)

45. Exit Strategies: Equity

46. Exit Strategies: Equity s.116 System: applicable to dispositions of TCP by a non-resident (whether or not any tax is owing or any gain exists), unless an exception applies; consists of • vendor notification obligation • purchaser remittance obligation • vendor tax return filing obligation See “Canada’s Section 116 System for Non-Resident Vendors of Taxable Canadian Property” (included with materials)

47. Exit Strategies: Equity s.116 System: Excluded Property Generally no s. 116 system obligations arise to the extent the TCP is “excluded property,” which includes: • shares listed on a recognized stock exchange • deemed TCP (e.g., shares received on a tax-deferred rollover) • bonds, debentures, mortgages and similar obligations • options/interests in respect of the foregoing • “treaty-exempt property” (which requires the purchaser to notify the CRA within 30 days of sale if the purchaser and vendor are related)

48. Exit Strategies: Equity s.116 System: Vendor notification obligation Vendor is required to notify the CRA within 10 days of the disposition, unless the TCP is (1) excluded property, or (2) property described in s.116(5.2), viz., property that may yield income on disposition s.116 System: Vendor Tax Return Obligation Vendor is required to file a Canadian tax return, unless all TCP dispositions in the year are (1) of excluded property, or (2) ones in respect of which the CRA issued a certificate of compliance

49. Exit Strategies: Equity s.116 System: Purchaser remittance obligation Purchaser is liable to remit to the CRA (and may withhold from the purchase price) 25% of the purchase price, unless • property is excluded property; • purchaser reasonably believes that vendor is not a non-resident, after making reasonable inquiry; • requirements for s.116(5.01) “treaty protected property” exception are met; or • CRA has issued a certificate of compliance

50. Exit Strategies: Equity s.116 Withholding: Treaty-protected property exception Where a non-resident vendor is claiming to be exempt from tax on a disposition of TCP due to a treaty exemption, purchaser can 1. withhold and remit; 2. demand a certificate of compliance; or 3. file Form T2062C within 30 days of sale under s. 116(5.01) Problem with 3. was that s.116(5.01), which was introduced in 2008, does not exempt the purchaser from liability if treaty exemption does not in fact apply (e.g., due to valuation uncertainty, chattel/fixture uncertainty, former residence, limitation on benefits, anti-avoidance, etc.) ➙ Result: Purchasers often unwilling to rely on 3.