In accordance with the Government’s election promise, the 2014 Budget introduced the Exploration Development Incentive (EDI), a program designed to increase grass roots exploration expenditure with a goal of “discovering the mines of tomorrow.”
With the EDI formally launched by Minister for Industry, Ian Macfarlane, at the AMEC Convention in Perth, operational details of the EDI design have now been released and, subject to the proposed amendments to the Income Tax Assessment Act 1997 (Cth) (ITAA) passage through the legislative process, will come into being with effect from 1 July 2014.
What is the EDI?
The EDI is a tax incentive provided directly to shareholders of eligible companies in the form of a tax credit, operating in a similar fashion to a dividend imputation credit where the credit is deductible against tax payable by the shareholder in respect of its taxable income. The EDI will be distributed to shareholders by eligible companies that have successfully applied to participate in the EDI pool. There are $100 million of tax credits available under the EDI over the next three financial years, equating to $350 million in eligible exploration expenditure. EDI credits each year will be capped at $25 million for 2014-15, $35 million for 2015-16 and $40 million for 2016-17.
Which companies are eligible to apply for the EDI?
To be eligible to apply for the EDI, the applicant company must:
- be an Australian resident company that is a “disclosing entity” under section 111AC of the Corporations Act1;
- incur “eligible expenditure” in respect of exploration for minerals in Australia; and
- satisfy a “no taxable income” test and a “no mining activities” test.
Participation in the scheme is voluntary – companies may choose to retain exploration expenditures as accumulated losses to set off against future assessable income.
What is “eligible expenditure” for the purposes of the EDI?
The EDI will apply to eligible “greenfields” expenditure undertaken in Australia. Under the ITAA, exploration includes:
“geological mapping, geophysical surveys, systematic search for areas containing minerals (except petroleum) or quarry materials2, and search by drilling or other means for such minerals or materials within those areas.”
Under the EDI, eligible exploration expenditures would be those incurred on activities that are deployed for the purpose of determining the existence, location, extent or quality of a new mineral resource in Australia. However, exploration expenditure in relation to oil and gas, quarry materials and geothermal energy are specifically excluded from eligibility.
Any expense related to mineralisation that has been classified as an Inferred Mineral Resource or higher under the JORC Code, or to a potential or actual extension of a mine, is excluded from eligibility for the EDI.
Who will be eligible to receive the EDI?
Companies participating in the EDI and providing exploration credits to shareholders will need to make an irrevocable choice whether to provide exploration credits to all shareholders, or only to holders of shares issued after 30 June 2014. If the latter option is chosen, shares issued by listed companies after 30 June 2014 will trade as a separate class.
Shareholders (as at the record date) of an eligible company that has successfully applied for the EDI will be entitled to an EDI tax credit proportionate to their shareholdings. However, the EDI is effectively restricted to Australian resident taxpayers (foreign shareholders and exempt entities will receive EDI credits but will be unable to use them).
How will it work?
Eligible companies filing tax returns will identify “EDI eligible expenditure” for the purpose of participation in the EDI scheme. Assuming the “after tax cost”3 of total EDI eligible expenditure for all participating companies exceeds the caps set out above, the ATO will calculate an appropriate modulation factor (so that the cap is not exceeded). The ATO will then advise participating companies of the proportion of their “eligible losses” they will be entitled to provide to shareholders as EDI credits.
In practice, this means that tax credits in respect of eligible exploration expenditure incurred in the 2015 tax year will be available for utilisation by shareholders for their 2016 tax year.
Key issues for listed companies – disclosure of intentions in respect of the EDI
The EDI policy is targeted directly at junior exploration companies and is designed to encourage investment in, and greenfields exploration activity in Australia by, those companies.
Directors of eligible companies will need to decide whether or not the company should participate in the EDI scheme and, if so, whether the EDI credit will be available to all shareholders or only in respect of fresh capital. These decisions will be material to shareholders and will require careful consideration of the pros and cons of participation (essentially the only “con” is that losses “recovered” by way the EDI tax credit will not be available for deduction against future assessable income – this may have particular relevance for companies with a significant proportion of foreign shareholders on the register).
Communication with shareholders in respect of the directors’ intentions will require careful attention. Given the uncertainty of the quantum of a company’s available EDI credits until after the ATO’s modulation process has been completed, and applicants notified of available credits for distribution to shareholders, directors should take care not to make any forward looking statements in respect of the likely benefits to be derived by shareholders in the form of EDI tax credits. Directors of eligible companies should of course make reference to:
- their intention to participate in the EDI scheme;
- their reasonably-held belief that a proportion of the Company’s expenditure will include “eligible expenditure”;
- an estimate of that proposed or expended “eligible expenditure” (as the case may be); and
- their reasonable expectation that shareholders will receive an EDI tax credit, the amount of which to be subject to the Company’s actual quantum of eligible expenditure and the impact of the ATO’s modulation process.
Further details in relation to the EDI will become available when the draft bill is released.
- In general terms, a “disclosing entity” is a company or a managed investment scheme with 100 or more security/unit holders.
- Notwithstanding the definition, quarrying activities are specifically excluded from access to the EDI.
- The EDI tax credit will be at the company tax rate e.g. $1,000,000 of eligible expenditure will equate to EDI tax credits of $285,000.