BRIEF FROM THE SMALL EXPLORERS &
PRODUCERS ASSOCIATION OF CANADA
The Small Explorer’s and Producers Association of Canada (“SEPAC”)
with a membership of approximately 350 companies is the voice of the junior oil
and gas producers in Canada. The junior
sector invests in the neighbourhood of $8 billion dollars each year in
Canada drilling thousands of oil and gas wells and constructing related pipeline
and processing facilities. Junior oil and gas producers are active across the country
from Newfoundland and Labrador to British Columbia and our members’ capital
investment in Canada creates tens of thousands of well- paying jobs, mostly in
rural areas of Canada where such jobs would
otherwise be few.
Executive Summary
1) First recommendation: permanently improve the “flow through”
share regime
In the first six months of 2011 $212 million in flow through
equity was raised in Canada out of approximately $7 billion in total equity
financings (source: Sayer Energy Advisors, Calgary). Flow through share
offerings are disproportionately relied on by the junior oil and gas sector to attract Canadian investors to higher risk
opportunities, particularly
exploration directed spending.
Support from Canada’s tax framework via flow through shares has
contributed to creating in Canada a world leading public equity market for
junior oil and gas companies. Toronto and Calgary have become global centres
for oil and gas finance and, according to the TSX, Canada is home to a
remarkable population of over one third of the world’s publicly listed oil and gas companies, the majority of whom are junior
and mid-cap companies who look to
flow through shares as a source of financing .
Lower overall corporate tax rates, while a laudable goal of the
government, do not address the unique financing requirements of junior oil and
gas companies to compete for investment
capital because the majority of these companies are not in a taxable position.
The flow-through of eligible expenses to investors is a deferral of
tax only and the capital invested creates jobs, mostly in rural Canada, and
generates corporate and personal income. Junior producers, having passed on
their deductible expenses to investors, will be in a taxable position sooner,
all other factors being equal.
There are two aspects to our recommendations on how to improve the
existing flow-through share regime:
a) Increase the
annual limit of Canadian Development Expense (“CDE”) convertible to Canadian
Exploration Expense (“CEE”) from $1 million to $3 million.
b) Increase
the corporate taxable capital ceiling for eligibility to access the annual CDE to CEE conversion from $15 million to
$50 million.
2) Second recommendation: natural gas completion and development
costs be deducted at a 50% straight line
rate for a time limited 24 months
Natural gas production in Canada, and exports to the US, are
enormous contributors to Canada’s economy. However,
North American capital flows are favouring development of cheaper US
domestic gas sources. This is aggravated by more favourable tax treatment in the US of expenses related to developing
natural gas reserves.
A 24 month time limited accelerated deduction at 50% straight line
for completion and development expenses for natural gas wells would improve
cash flow for Canadian producers and encourage investment on this side of the
border at a critical time necessary to slow the decline of Canadian production
and maintain our share of North American markets. This period would also allow
time for our industry to make progress in increasing
natural gas demand in Canada and develop Asian market access infrastructure.
SEPAC endorses the proposal of
the Canadian Association of Petroleum Producers in this regard and we invite you to review CAPP‟s
submission to the 2012 Parliamentary PreBudget Consultation for further
details.
Details of SEPAC Recommendations
1) Flow through shares
The importance of encouraging flow through share investment by
Canadians in Canadian energy exploration and development is reflected in the
June 2009 Report of the House of Commons
Standing Committee on Industry, Science & Technology which recommended:
That the Government
of Canada examine the flow-through share regime with a view
to stimulating greater access to capital for exploration activities in the
junior oil and gas and mining sectors.
a) Permanently increase the $1 million CDE to CEE conversion limit to $3 million
Currently, the Income Tax Act (the “Act”) allows for the conversion
of only $1 million of CDE to CEE in any particular calendar year, subject to
certain other limitations. The beneficiaries of this provision are junior oil
and gas companies who raise much of their
investment capital in the equity markets. The flexibility allowed by this conversion
feature was introduced to enable junior oil and gas companies to spend a portion
of the capital raised from investors on less risky „development‟ drilling
rather than high risk „exploration‟ drilling thus facilitating greater
financial stability for investors. Because of increasing complexity in the type
of wells being drilled and inflation, the
costs to drill and complete oil or gas wells has substantially increased since 1996, when the convertible feature of CDE to CEE
was set at $1 million.
b) Permanently increase the taxable capital limitation for CDE to CEE conversion
This recommendation is linked to
the above CDE to CEE conversion limit proposal. The current ceiling for
companies able to access the conversion from CDE to CEE is a taxable capital
test (as defined in the Income Tax Act) of $15 million in the preceding year.
The amount of capital needed even by start-up companies today is much larger
than in the past and this limitation is too
low even for the “small” producers of Canada. We submit the taxable capital base ceiling be increased immediately to $50
million.
SEPAC believes increasing the
CDE annual conversion limit will result in modest tax expenditure for Canada
yet stimulate significant investment and economic growth. These conversions of
CDE to CEE represent a small percentage of all oil and gas flow-through share financings.
2) Natural gas completion and development costs be deducted at a 50% straight line rate for a time limited 24 months
Details on this proposal will be submitted by the Canadian
Association of Petroleum Producers with
additional supporting data. SEPAC endorses the proposal as submitted by
CAPP.