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Biotech lobbies for flow-through shares

Proponents hope tax provision would be boon for clean-tech companies
|Written By Julius Melnitzer
Biotech lobbies for flow-through shares
Extending flow-through shares would ‘create a gargantuan opportunity,’ says Rick Sutin.

After years of talking about it, Canada’s biotechnology industry has mounted a serious lobby to extend flow-through shares to the sector.

A flow-through share is a type of share that allows corporations to transfer exploration and development expenses to investors who can then use them as deductions against personal income tax.
Eligible corporations are those involved in the exploration, production, and processing of certain commodities such as minerals, oil and gas, and renewable energy.

According to Rick Sutin of Ogilvy Renault LLP’s Toronto office and a leader in the flow-through movement, the current lobby to extend flow-through shares is based on a new approach.

“We’ve reframed the issue,” Sutin says. “Our argument used to be based on the fact that the industry was dying and needed help, but ultimately we concluded that there’s no justification for what we want just because our industry is in trouble.”

Instead, BIOTECanada is focusing on the fact that the sector’s innovative potential presents a tremendous social and economic opportunity.

“If we could translate the success of flow-through shares from the resource sector to the biotech section, it would create a gargantuan opportunity for the country,” Sutin says. “That’s a message that’s starting to resonate and that’s the reason why we’re finally getting some traction in our efforts.”

BIOTECanada’s efforts on the flow-through share issue include a submission to the 2011 federal budget consultations by the standing committee on finance and an offer to give input to the upcoming work of the federal research and development review panel headed by Thomas Jenkins, executive chairman of OpenText Corp.

“Flow-through shares can become the path to leadership in the clean innovation economy by meeting the need for risk capital required to commercialize the discoveries generated by our world-class, government-supported research and development,” Sutin says. 

“They are only attractive to industries that require significant capital to make expenditures that are not needed to offset revenues because revenues are uncertain and remote.”

Flow-through shares for Canadian resource exploration and development found their way into the Income Tax Act about 20 years ago. About 10 years ago, the government extended them to certain renewable energy technologies, particularly wind power. 

“The program has had spectacular success in the resource sector and was a significant factor in kick-starting our wind-power build-out,” Sutin says.

As he points out, since the creation of flow-through shares, Canada’s capital markets have become the global leader in resource finance. It has also become home to more resource companies than any other country in the world. 

At the same time, Canadian companies are engaged in more global exploration and development than businesses from any other country, allowing Canada to attract the top talent in the field.

“Flow-through shares act as an incentive to private-sector investment like no other government incentive program as they are only triggered by private-sector investment, resulting in significantly more capital invested and deployed than is the case with any other government incentive program,” Sutin says.

The biotechnology sector’s contribution to the Canadian economy is estimated at $84 billion, which amounts to 6.9 per cent of GDP and is more than the automotive and aerospace sectors combined. 

Although Canada represents only 1.8 per cent of the global economy, it provides nearly four per cent of the biotechnology sector’s global revenues. On a per-capita basis, Canada’s biotech sector ranks second only to the United States.

Of the 663 biotech firms across the country, some 40 per cent of them are working on industrial and environmental solutions to make production more efficient and the environment cleaner. 

For a host of reasons, however, biotech companies rarely get funding through traditional financial institutions such as banks.

Unlike mining, oil, gas, and the automotive sector, 90 per cent of the biotech industry involves small- and medium-sized enterprises. Although 50 per cent of the companies in the sector have less than 20 employees, the industry as a whole employs more than one million workers. 

According to the Organisation for Economic Co-operation and Development’s science, technology, and industry scoreboard for 2009, the biotechnology sector accounts for 11 per cent of research and development spending by Canadian businesses.

The sector is also different from other technology-based industries. It involves pure science; has a high level of risk associated with scientific development; tends to be highly regulated; and has long development cycles requiring patient capital.

As a result, raising the $1 billion in capital the sector needs every year is a perennial problem. Since 2007, venture financing for it has fallen by 56 per cent.

“In any case, Canada’s venture capital industry is too small to completely fund our needs,” Sutin says. “Flow-through shares can fill the gap as they did for resource exploration by providing venture capital at premium valuations through the public markets.”

According to a recent study produced by PricewaterhouseCoopers LLP, extending flow-through shares to the sector would add $558 million to GDP along with $336 million to wages and salaries; create almost 8,000 jobs; and boost tax revenues by more than $80 million.

Sutin also believes extending flow-through shares to the innovation sector would produce other benefits. “A flow-through program would attract hard equity from investors outside of Canada. 

The hard financings would promote global endeavours despite the fact that expenditures from flow-through shares are earmarked for Canada, and this country will become a global leader in an important sector,” Sutin tells Law Times. 

“Facilitating all this is the fact that Canada, led by the Toronto Stock Exchange and the TSX Venture Exchange, already has world-class capital markets with global leadership in the resource sector.”

In addition, Sutin believes that if Canada becomes a place where risk capital for innovation is available, it will draw innovators, entrepreneurs, and investors who in turn will draw talent and intellectual capital to become a self-reinforcing cluster.

“Enhanced clusters lead to enhanced prospects for success,” he says. “That’s exactly what happened in Silicon Valley.”

Last but certainly not least, Sutin points out that successful innovation in the green economy will have significant social and economic benefits for Canada.

Despite the optimism, Stephen Fyfe of Borden Ladner Gervais LLP’s Toronto office warns that the success of the flow-through lobby is far from a guarantee. He notes that in the late 1990s, the federal government amended the definition of Canadian exploration expense to add a subcategory called Canadian renewable conservation expense.

“They did that with the idea of extending flow-through financing to the renewable energy sector,” Fyfe explains.

But the uptake on the renewable energy side has been disappointing. “Unless you’re dealing with wind farms or geothermal projects, the development costs tend to be very small,” he says. “The upshot is that there are few renewable projects that justify embarking on a flow-through program.”

For his part, Fyfe believes that the partnership flip approach that exists in the United States could be a more useful financing tool for the innovative clean-tech industry than flow-through shares. 

The flip structure involves the formation of a tax partnership between a developer and tax equity investors. 

The tax equity investors get the bulk of the various tax credits that are available. If the partnership meets certain requirements in the Internal Revenue Code, the Internal Revenue Service won’t challenge the allocation of these credits.

  • Roger Loomis
    I think this could be a great idea - let's extend these sorts of shares to a whole set of favored industries. The problem with flow through shares in this respect is that typically they mandate a two year cash-in period. For an oil drilling company, that's enough time to know if there's oil in the ground or not. It might not be enough time to have such a substantial "payoff" in other industries such as hitting a new discovery in the clean tech or, say, biotech fields. Those discoveries usually come after 4-7 years of research and testing.