North·In Depth

Tax breaks may have been at the heart of dead deal for Ekati mine

A proposed deal to purchase the Ekati diamond mine could have been more about tax savings for its U.S. billionaire owner than diamonds.

New COVID-19 stimulus bill in U.S. turned Dominion Diamond Mines into lucrative tax break

An aerial view of the Ekati mine, 300 kilometres northeast of Yellowknife. The mine had been producing diamonds for almost 22 years when its owner shut down production in March. (Dominion Diamond Corporation)

An offer to purchase the Ekati diamond mine was likely more about the taxes of a billionaire owner than diamonds.

The offer was to be argued in a Calgary courtroom on Wednesday but collapsed late last week. According to Dominion Diamond Mines, the insolvent company that owns the mine, the buyers failed to reach a key agreement with three insurance companies that hold reclamation security bonds for the mine.

The offer to purchase was made by affiliates of The Washington Companies, a conglomerate owned by U.S. billionaire Dennis Washington. It would have been the second time Washington bought the mine. Three years ago, Ekati was the main asset in his $1.2 billion US purchase of the Dominion Diamond Corporation, a publicly-traded company that owned both Ekati and a 40 per cent stake in the nearby Diavik diamond mine.

In a move that surprised many, last April, Dominion sought creditor protection. It claimed the COVID-19 pandemic had shut down diamond sales and it was unable to pay its bills, despite its billionaire owner. Details of the company's profits and losses are scant because it is no longer subject to the disclosure requirements that apply to publicly traded companies.

Even Dominion's biggest creditors said they received no advance warning that Dominion would seek creditor protection. Typically, companies in financial trouble will approach creditors with requests for payment extensions or other accommodations before taking the drastic — and very public — step of applying for creditor protection.

That was the second surprise from Dominion in as many months. In March, it suspended operations at Ekati, saying it did so to protect its workers during the COVID-19 pandemic. The two other diamond mines in the N.W.T. have remained open through the pandemic with only two confirmed cases between them.

COVID-19 tax breaks

Less than a month before Dominion filed for creditor protection, the Coronavirus Aid, Relief, and Economic Security (CARES) Act came into effect in the United States. It included significant changes to tax laws aimed at providing relief to companies facing financial pressures as a result of the pandemic.

The CARES Act allows businesses to apply losses incurred this year to taxes already paid in the past, known as a carry back.

"Typically owners are allowed to carry excess losses to years ahead," explains Georgetown University professor Brian Galle, who specializes in tax law. "So if you lost a million dollars this year and anticipate making two million next year, you can use this year's losses to reduce taxes payable next year."

Gallle says the CARES Act permits carrybacks.

"That is, even though your loss of a million dollars might have happened in 2020, for tax purposes you can pretend that it happened in 2017 or 2018," he said.

The CARES Act allows losses to be applied to taxes paid up to five years ago.

Matt Sooy, an assistant professor at the Ivey Business School at the University of Western Ontario, said the CARES Act also doubles the amount of taxes that can be refunded. He said if the deal had gone through it would have been a tax windfall for Washington and his companies.

"In the case of the Ekati mine, a one billion dollar loss — if you take the $1.2 billion purchase price three years ago, and the sort of fire sale price of a little less than $200 million now —  a $1 billion loss would enable the new ownership group to claim between 200 and 300 million dollars of these refunded taxes."

Sooy said the proposed deal was an example of one of the flaws in tax laws: that something can be legal but not just.

"If I was in Yellowknife I'd be wondering if we got robbed twice on the same deal, by having an important employer purchased then shut down, and then watching a bankruptcy court sell the company for pennies on the dollar to an ownership group with same owner that took the debt out that forced it into bankruptcy."

Heavy haulers move rock out of the Diavik diamond mine pit on the shore of Lac de Gras, approximately 300 kilometres northeast of Yellowknife, N.W.T. In a move that surprised many, last April, Dominion sought creditor protection. (Adrian Wyld/The Canadian Press)

In court documents, a group of Dominion's creditors have criticized the process used to sell off Dominion's assets, saying it is too rushed and forcing a sale at a time when the global pandemic has depressed the price of Dominion's assets and made it difficult for prospective buyers to arrange financing.

Galle said there is some urgency for businesses hoping to take advantage of the ability to use losses to recoup taxes paid in the past.

"This special CARES Act provision is not going to last for long, and so that might be an important motive for someone to complete a transaction before the end of this year if they're hoping to generate losses in the transaction."

According to an analysis done by an affiliate of Ernst and Young corporate tax advisors, the Act also allows more business owners to apply losses from one of their businesses to offset taxable profits in others. Previously only those earning less than $500,000 annually were allowed to do that.

According to Galle, depending on the tax structure of The Washington Companies, some of the expanded tax benefits under the CARES Act could be used to reduce Dennis Washington's taxes.

"For a business with only a few owners, it's quite common that the business doesn't pay any taxes itself. Instead, the businesses' profits and losses are divided up amongst its owners...if there are three owners, each gets one third of the taxable profits of the business."

Biggest lenders opposed deal

The deal to repurchase Ekati was also opposed by Dominion's biggest creditors, a group of firms that loaned Washington more than half a billion dollars to purchase Dominion in 2017. They argued the deal Washington proposed to repurchase Ekati would have cancelled most of that debt.

A critical part of escaping any tax penalties from cancelling debt is the ownership structure of the purchaser. If it was simply The Washington Companies repurchasing Ekati, the debt written off would be treated as a taxable benefit.

"The amount of prior obligation they've escaped is treated as taxable income," said Galle. "But there are exceptions."

Galle said one of those exceptions hinges on Washington's stake in the repurchase of the mine. If it has less than a 50 per cent interest, it would pay no taxes on the cancellation of that outstanding debt.

As Dominion's creditors pointed out, neither Dominion nor Washington has identified the structure of the ownership group behind the offer or who is financing the deal.

Washington would have had to disclose that to the insurance companies posting the reclamation security bonds and the N.W.T. government, which had to be satisfied that the new owners of the mine had the financial capacity to assume the environmental liabilities associated with Ekati.

In July, Ekati senior managers advised employees Dominion was aiming to bring Ekati back into operation by the end of this year. On Friday, after advising employees the deal to purchase the mine had fallen through, the company told workers the mine operations are suspended indefinitely.

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