Tax Due Diligence Issues. 3. Other local considerations, e.g. regulatory or exchange controls

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1 AMERICAN BAR ASSOCIATION BUSINESS LAW SECTION SPRING MEETING 2013 PROJECT FINANCE AND DEVELOPMENT COMMITTEE MEETING FRIDAY APRIL 5, :30 P.M. THE MINING PROJECT: GETTING IT RIGHT DUE DILIGENCE AND DEAL STRUCTURING Linda E. Carlisle White & Case LLP (202) A. Tax Issues in Financing the Project 1. Sources of financing debt v. equity 2. Host country tax considerations Tax Due Diligence Issues a. Interest deductibility/thin capitalization b. Withholding tax on interest and/or dividends 3. Other local considerations, e.g. regulatory or exchange controls 4. Will returns be repatriated or left outside U.S.? B. Holding Structure Tax Issues 1. Potential holding structures a. Host country branch of U.S. corporation b. Host country subsidiary of U.S. corporation c. Host country branch of foreign subsidiary of U.S. corporation

2 - 2 - d. Host country subsidiary of foreign holding company subsidiary of U.S. corporation e. Two-tier foreign holding company structure 2. PFIC/CFC implications 3. Cost of future restructuring C. Host country tax issues 1. Host country tax on earnings a. Can start-up expenses and exploration costs be carried forward? b. Any incentives for investment? c. Can U.S. parent expenses be pushed down to project? i. Financing expenses ii. Salaries of management employees iii. Stewardship expenses d. How stable is tax regime? 2. Host country tax on outbound returns on investment a. Dividends b. Interest c. Other d. Is there a tax treaty that will impact tax on investment returns? i. If no direct treaty, is there an intermediate country that could house a holding company for investment? ii. Is there a limitation on benefits article in the treaty? iii. Is there an intermediate tax haven country that could house a holding company? 3. Personnel issues: a. Employees vs. independent contractors

3 - 3 - b. Permanent establishment and taxable presence 4. Tax on exit D. Tax Issues in Inbound Investments assume not engaged in a U.S. trade or business 1. How does U.S. tax investment? a. Accelerated depreciation? b. Credits or other incentives for business activity? c. State tax incentives? 2. How does U.S. tax outbound returns on investment? a. 30% withholding on dividends, not interest b. Capital gains generally not taxed c. FIRPTA imposes tax on gains from U.S. real property interests 3. Possible impact of U.S, Tax Reform

4 Radu Costinescu Duncan & Allen Five often-neglected due diligence issues Foreign Corrupt Practices Act (FCPA) o In relevant part, prohibits payment of money or anything of value to a foreign official in order to obtain or retain business. o Mining industry is fertile territory for FCPA issues. o FCPA is not intuitive; it is deemed to be written confusingly and applied vigorously (The Economist). o Foreign officials include executives of State-Owned Enterprises (SOEs). o Anything of value includes gray areas, even for sophisticated parties. o You are responsible for acts of third parties on your behalf; no actual knowledge required, no willful blindness. o Consider legacy FCPA issues in mining M&A context. o Consider similar issues under U.K. Bribery Act o Mitigation: understand scope of FCPA enough to spot red flags (see DOJ/SEC Resource Guide to the U.S. FCPA); know your local partners (including local counsel); include appropriate representations, warranties, covenants and indemnification provisions in agreements with local partners/m&a agreements. Importance of local language skills on investor team. Section 1502 of Dodd-Frank Act (Wall Street Reform and Consumer Protection Act) o Requires some public companies to disclose use of conflict minerals originating in the Democratic Republic of the Congo (DRC) and neighboring countries (Republic of the Congo, Central African Republic, South Sudan, Uganda, Rwanda, Burundi, Tanzania, Zambia and Angola). o Covers a large swathe of resource-rich Sub-Saharan Africa. o Conflict minerals are tin, tantalum, tungsten and gold (3T and G) and their derivatives.

5 - 5 - o Enhanced due diligence requirements if minerals in question may have originated in the covered countries; further due diligence and disclosure requirements (including Conflict Minerals Report, which will eventually have to be independently audited) if company determines that minerals are from the covered countries (see SEC Flow Chart). o Applies to manufacturers, not miners. o Nonetheless, miners (and their lenders) should understand supply chain implications. Optics of offshore special-purpose investment vehicles o Investors should understand host-country perceptions of offshore jurisdictions. o Also consider international arbitration tribunal jurisdiction. Conflicting maps and overlapping remits o Some countries lack a central geology service or a full-fledged mining cadastre; beware of inconsistent/unreliable maps and records. o Example: map used by environmental agency shows national park covering significant part of mining concession shown as open to mining by cadastre map. o Mitigation: understand institutional structure; thoroughly examine all possible sources of competing claims. Political turf wars o Mining licenses and projects are often the apple of discord among competing political interests in the host country (e.g. central v. local government; Prime Minister v. President; Minister of Environment v. Minister of Mines, etc.). o Investors could be caught in the cross-fire and should be prepared to mitigate. o Mitigation: understand institutional structure, host-country politics and how the project fits in; examine the Mining Code and Regulations to establish how much government discretion is involved in moving from one stage of the project to the next (e.g. exploration to exploitation); provide for and emphasize local development benefits; consider contractual protection against political risk (see below). Local counsel is important in these efforts, but so is international counsel with in-country experience and comparative mining law expertise.

6 Dealing with Political Risk Resource nationalism is trending o Governments demand greater share of perceived windfall profits accruing to investors as a result of the commodities boom. o Host countries believe they have greater negotiation leverage in current market environment. o Recent examples: renegotiation of existing mining contracts; revision of Mining Codes and Regulations; imposition of windfall taxes. How to mitigate? o Stabilization provisions Fiscal, customs, exchange, regulatory regime applicable to project protected from negative changes in generally applicable law. Who gets the upside? Role of equilibrium clauses. o Contractual protection of property rights Beware of creeping/constructive expropriation. o International arbitration Consider jurisdictional issues. o Political risk insurance Offered by public and private insurers. Policies may cover expropriation/nationalization, cancellation of licences/concessions, selective discrimination, forced divestiture, business interruption, inconvertibility, political violence, arbitration award default, etc. Cost-benefit analysis on a case-by-case basis 3. Other Security Risks Violence, riots, labor unrest are all too common. Initial security risk assessment is essential and may be a deal breaker. Force majeure clauses should be broad enough to account for such risks. Insurance might help.

7 Alison R. Manzer Cassels Brock & Blackwell LLP (416) FINANCING THE MINING PROJECT 1. A Synthetic Structure for Lease Based Finance That "Works" The transaction is structured as an equipment acquisition for lease or equipment sale and leaseback facility, preferably to a special purpose vehicle. The leasing vehicle provides a back to back availability contract with the mining developer and operator. The transaction is structured to satisfy off balance sheet financing requirements and in a manner to provide equipment usage flexibility for the mining operator. The structure works best for off balance sheet treatment using a third party service provider for fleet management, repair, maintenance and compliance with return conditions using a fleet management contract entered into with the special purpose vehicle (the special purpose vehicle does not have servicing capabilities) Guarantees are generally required from the mining operator and from the service provider for performance obligations. Special purpose vehicle as lessee will generally give supporting security. The transaction proceeds as follows: (a) the equipment is acquired or in a sale and leaseback transaction, the mining operator sells the equipment to the lessor; (b) the special purpose vehicle enters into an operating lease with the lessor as to the equipment acquired; (c) special purpose vehicle enters into fleet availability contracts with the mining operator; (d) a servicer is identified and will be responsible for the equipment fleet management, repair, maintenance and compliance with return conditions in a management services contract is entered into between the servicer and the special purpose vehicle; (e) annual equipment reviews are generally undertaken, and equipment portfolio rebalancing may be made available in the larger transaction; (f) on maturity the equipment may be returned to the lessors, or acquired from the lessors, if it is returned early then there is payment requirement

8 - 8 - based on the present value of the remaining rental payments, subject to agreed upon caps, equipment return is generally dealt with using residual assurances and remarketing; Payments being made by the special purpose vehicle in these structures are generally subject to a cash flow waterfall which will place the lease payments at the top, and generally ahead of the service payments; Caps are generally included as to equipment that can be returned using minimum projected collateral coverage covenants; The equipment will be required to be returned in a pre-agreed return condition which will generally meet the requirements of the residual assurer; In Canada there are limitations under the Bank Act which limits the amount of residual value risk that a bank can take on leased assets limiting it to 25% of the purchase price in a single transaction or 10% on a portfolio basis, this can be divested using payment returns or residual value assurance; a similar limitation does not exist for United States banks; The leases are structured as operating leases under IFRS or GAAP generally the structure is a fair market value operating lease, with specified terms and rental payments, The source of revenue for the special purpose vehicle is the back to back arrangement with the operating company, the operating company is under those terms obliged to make monthly usage or rental payments on a back to back basis in an amount which will cover the rental payments due under the lease; Structuring is in the transaction outline indicated, the operating leases are standard format operating leases 2. Accessing the Canadian Debt Markets Why consider a topic on accessing the Canadian Debt Markets - the Canadian public markets are the world's mining specialists; while heavily oriented to equity the Canadian public markets raise funds for a huge percentage of mining projects, globally (70% in recent years), and in raising funds, whether debt or equity, familiarity of the market place with the type of project is a key benefit; while Canadian markets have been evolving and growing rapidly in recent years, they remain markets available for the smaller transaction as a consequence of the nature of the listing requirement for the public deal and the stability, size and sophistication of fixed income institutional investors in Canada; Structuring a debt issuance for the Canadian market is relatively straightforward and includes the following features:

9 - 9 - (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n) (o) There is no withholding tax on cross border payments of interest between Canada and the United States (by tax treaty) Documentation, usually a trust indenture is used, outlines the issuer's obligation to the debt holders, sets out the remedies available if the issuer fails to make a payment or satisfy covenants, the indenture trustee will be responsible for administering the trust indenture on behalf of the debt holders Secured debt includes security documentation that outlines the secured party's rights against the collateral Credit rating agencies may be involved to assign ratings of credit worthiness Most debt security is structured by using a trust indenture, with indenture trustee Secured debt will use a supplemental package of security documentation The timetable for offering debt securities is similar to that of a follow on equity security offering but generally shorter than that of initial public offering of equities While interest paid on plain vanilla debt security is without Canadian withholding tax, interest which is contingent or dependent on the use or production from property may be subject to withholding tax No other Canadian taxes are payable by non-resident holders who do not carry on business in Canada Most expenses incurred in the issuance of debt securities are deductible over a 5 year period for tax purposes The majority of debt securities are issued in Canadian dollars but some are issued in United States dollars and there is no prohibition Continuing obligations including periodic financial reporting and disclosure obligations exist with debt securities in similar manner to that of equity securities The same exemptions from continuous disclosure for foreign issuers is available for debt securities as for equity securities The same penalties as are applicable for debt securities as for equity securities for breaching continuing obligations The settlement cycle for debt is generally T plus 3; bonds with the remaining term to maturity of three years or less including mortgage backed securities, federal, corporate, and municipal, provincial bonds and others have been allowed to settle on T plus 2

10 (p) (q) (r) (s) (t) (u) (v) Debt securities, like equity securities, generally settle through the Canadian Depository for securities CDSX system, on a real time gross settlement platform Participant ledger positions at CDS are adjusted book entry in the same manner as for equities Physical securities must be medallion signature guaranteed Registration typically takes two weeks for bonds if the agent is local, out of town or cross-border can take several weeks Canada is a full member to Financial Action Task Force on Money- Laundering and accordingly transactions will be required to comply with anti-money laundering requirements this requires verification of the existence of corporate and institutional account owners There are repurchase restrictions, based upon daily and monthly repurchase restrictions Repurchase will need to comply with the issuer bid requirements, the debt substantial issuer bid and normal course issuer bids applied to debt purchases Listing of debt securities in Canada has lower fees and lower listing requirements than many of the major US exchanges, these include: (a) The minimum listing requirement and the annual listing fees are generally similar between debt and equity securities: (1) net tangible assets of at least Cdn 7.5 million (2) tax and pre-extraordinary items earning from operation in the last fiscal year of Cdn $300,000 (3) pre-tax cash flow from ongoing operations in the last fiscal year of at least Cdn $700,000 (4) average pre-tax cash flow from ongoing operations from the past two fiscal years of Cdn $500,000 (5) a suitable capital structure and adequate working capital carry on the business (b) (c) Annual listing fees are generally the same for debt securities as for debt securities, see Policy 1.3 Schedule of Fees, TMX and TSX Venture Exchange The TSX will give consideration to the listing debt securities that do not meet the minimum listing requirements where suitable

11 (d) (e) (f) (g) (h) (i) (j) Debt securities are issued using a prospectus in similar fashion to that used for equity securities There is a medium term note program available, this allows for continuous distribution of debt securities where only specific variable terms are determined at distribution including price, interest rate, maturity, method of distribution, these employ a base shelf system similar to that available for equities A short form prospectus or base shelf prospectus with pricing supplement can met the prospectus requirements in a manner similar to those for the offering of equity securities Exemptions from prospectus requirements for debt issuances are similar to those for equity Non-convertible debt securities with approved credit rating, on a term to maturity of less than 1 year, commercial paper, are exempt from prospectus requirements The prospectus is prepared in a similar manner to that for equity securities, liability for misrepresentation or omission is generally the same as that in the offering of equity securities If a credit supporter guarantees the obligations of an issuer of debt securities it must make disclosures in the prospectus and sign the prospectus, the guarantor is liable for misrepresentations contained in the prospectus There is no withholding tax on arm's length cross border payments of interest between Canada and the United States, the documentation used in Canadian transactions is virtually identical to that used in the United States; If a transaction is being placed on a private placement basis, the exemptions from registration and prospectus requirements are similar to those of the United States including the accredited investors exemption 3. Mining Credit Agreements - Specialized Clauses A mining project finance debt deal is simply that, a project finance debt deal, and the documentation will be essentially identical to the documentation for essentially any other project finance transaction, however, there are some specialized terms and considerations unique to the mining deal to be considered Matters that are critical to mining project financing include insuring there is a bankable project using a bankable feasibility study; the use of special purpose vehicle structure, examination of a life of mine plan, financial model and development plan, suitable hedging arrangements, due diligence which will

12 include title to the project but also sponsor reputation and management team reputation and quality, equity contribution and contingent support, appropriate insurance coverage, completion testing and a comprehensive panel of security; The primary perceived risks in the mining finance transaction include, and are borne by parties to the transactions as follows: (a) (b) (c) (d) (e) (f) reserve risk is generally borne by the lenders; completion risk is generally borne by the sponsor using completion guarantee techniques; construction risk is generally borne by the construction contractor; insufficient mineral demand risk is generally borne by the off taker on a take or pay basis; permit and concession risk is generally borne by the mine operator; political risk is generally offloaded using sovereign guarantees, these have export credit agencies or by private market political risk insurance; The representations and warranties which are unique to the mining project finance include authorizations for the project, a status of mining claims, feasibility study status, life of mine plan, financial model and development plan, project information specific to the mine and its development, title to the project and project assets which are frequently complicated in the mining project and compliance with environmental laws; The financial covenants which are generally included in mining project finance are: (a) (b) (c) (d) a debt service coverage ratio which is the ratio of cash flow available for debt service to the interest and principal payments under the facility; loan life coverage ratio (this is unique to the depleting nature of the asset in mining) which is the ratio of aggregate discounted cash flow available for debt service over the remaining life of the loan for the amounts outstanding under the facility; project life coverage ratio (again unique to the depleting nature of the mining asset) which is the ratio of project life discounted cash flow available for debt service to the amounts outstanding under the facility; reserve tail ratio which is the ratio of the metal contained in the ore reserves remaining to be mined at the scheduled maturity of the facility to the total metal contained in the life of mine ore reserves

13 The completion testing differs somewhat for the mining project and will generally encompass completion of physical facilities, production tests such as mining, milling, recovery, unit cost and concentrate quality tests, and legal compliance; Security in the mining project will include security over deposits, mine output, mine licenses, permits and concessions, project contracts in addition to the usual project finance collateral, the nature of the collateral and security needs to be examined early in the mining project finance process because many of the jurisdictions in which mines are located do not allow the creation of effective security interests over many of these types of assets or the foreign investment legislation may prevent strategic assets such as the mineral deposits or the land in which the deposits are located from being mortgaged to foreign lenders; Insurance is a common requirement of project finance but the jurisdictions in which mines are frequently located creates practical difficulties may occur in that many of those jurisdictions require that the insurance be provided by a local insurance company which raises performance and credit risk issues; Care must be taken in mining project finance to examine this law around the off take, many countries require certain of their metals to be sold locally or to a federal agency or authorized entity which can result in price control and quantity restrictions; The list force majeure events in the mining finance world, outside of North America, should frequently include political force majeure events which are events involving expropriation actions, political violence, or government actions in contravention of mining conventions that could deprive the project proponents of the right to construct, own or operate the mine, export its products, retain the proceeds of product sales offshore or distribute the project proceeds; Hedging arrangements for mining project finance should include commodity hedging which is an eligible financial contract for the making or taking of delivery of a commodity, a commodity swap agreement, floor, cap or collar agreement or commodity future or option where the subject matter of the agreement is any commodity or price, value or amount payable thereunder which is dependent or based upon the price of a commodity or fluctuations in the price of a commodity; Permitted encumbrances will need to consider the requirements of mining development which will frequently require cash deposits or securities to be posted for the contracts related to the development or operation of the mine, mining concession or environmental operations; Rights and interests in highways and related means of access and egress need to be more carefully considered than with other types of projects because the mining project is generally remotely located; In the mining project the related mineral rights and the requirements for the maintenance of the mineral rights will need to be considered and covenants

14 included that the mineral rights are to be maintained in a commercially viable manner, defended in accordance with applicable law, covenants should insure that there are no agreements, commitments, third party held options or third party rights to the mineral rights that are not being controlled and satisfied, that there are no unpaid taxes, debts, fees or overdue royalty payments pending in relation to the mineral rights, and that all steps and actions required to maintain the mineral rights will be timely undertaken; The security taken will generally include a pledge of the mineral rights and a pledge of the production arising from the mining activity