Draft legislation has been released that contains details of the Exploration Development Incentive announced as part of the 2014-15 Federal Budget. The scheme is designed to encourage equity investment in greenfield explorers, by enabling explorers to issue 'exploration credits' to its investors. Partner Martin Fry (view CV) and Senior Associate Jennifer Richards report.

HOW DOES IT AFFECT YOU?

  • Small exploration companies often have high amounts of deductible exploration expenditure but little or no income and, as a result, accumulate tax losses they cannot utilise until many years later, if at all. Due to the time value of money, the present value of the tax deduction is diminished. By contrast, established mining companies that also undertake exploration often have income from mining operations and can therefore use exploration deductions in the year in which they are incurred. '
  • To address this imbalance, the Exploration Development Incentive enables greenfields exploration companies to transfer the tax value of eligible exploration expenditure to investors, by issuing 'exploration credits', which confer an entitlement to franking credits (for equity holders that are corporations) or tax offsets (for other equity investors). It is hoped that this acceleration in the utilisation of an explorers' tax losses will attract new equity investment to the explorer.
  • The scheme is only available to an entity if it qualifies as a 'greenfields minerals explorer'.
  • Companies will not qualify if they carry on mining operations (or have an affiliate or connected entity that has such operations); petroleum, oil shale and quarry material exploration is not eligible; and exploration expenditure will generally need to relate to establishing the existence (rather than the viability/feasibility of) a mineral resource or ore reserve.
  • Exploration credits must be distributed to equity holders in proportion to their equity interests and therefore, generally, cannot be streamed. As an exception, exploration companies can make an irrevocable election, before first issuing any credits, with the result that exploration credits will only be distributed to holders of equity interests issued on or after 1 July 2014. It is hoped that this will encourage new equity investment.
  • At this stage, the scheme will only apply to expenditure incurred in the 2014-15 through 2016-17 years. Exploration companies will therefore need to act quickly if they are to take full advantage of the scheme.
  • Comments or submissions on the exposure draft must be submitted by Friday, 24 October 2014.

WHICH ENTITIES, AND WHAT EXPLORATION, IS ELIGIBLE TO GENERATE EXPLORATION CREDITS?

The tax incentive is designed to encourage equity investment in small mineral exploration companies undertaking greenfields mineral exploration in Australia. The draft legislation therefore contains prescriptive rules in relation to the type of entity that will qualify (a 'greenfields minerals explorer') and the type of expenditure that will qualify ('greenfields minerals expenditure'). Details are set out in the table below:

Click here to view table.

HOW ARE CREDITS CREATED?

Under the scheme, exploration credits are able to be created based on the previous year's greenfields minerals expenditure. Therefore, an entity that was a greenfields minerals explorer in the 2014-15 year can issue credits referable to their 2014/15 greenfields minerals expenditure in the 2015-16 year. (There is no ability to carry forward unissued credits to later years).

A global cap has been imposed on the value of credits that can be issued under the scheme: namely, $25 million, $35 million and $40 million for expenditure in 2014-15, 2015-16 and 2016-17 respectively 2. To enable the cap to be enforced, entities that wish to create credits must report estimated greenfields minerals expenditure, and estimated tax losses for the previous income year, by 30 September the following income year. This is to enable the Commissioner of Taxation to calculate and publish a 'modulation factor', which operates as an effective cap on the total credits that can be issued by each participating entity. Credits can only be issued after the modulation factor has been published.

The maximum amount of exploration credits a company can create in an income year is calculated by applying the corporate tax rate to the smaller of its tax losses and its greenfields minerals expenditure for the previous year. This ensures that an entity cannot create credits where it has itself been able to utilise the tax deductions. Also, if estimated expenditure/losses is lower than actual expenditure/losses, estimated amounts must be used.

Example: Assume an entity has estimated tax losses of $1 million, actual tax losses of $1.1 million, and estimated and actual exploration expenditure of $1.2 million. Assume also that the published modulation factor is 0.20. The value of exploration credits an entity could issue would be $60,000 (ie $1 million x 30 per cent of the corporate tax rate x 0.2). If the entity creates credits of $60,000 (by issuing them to investors), it would reduce its tax losses by a corresponding amount ($1 million).  

HOW DO EQUITY INVESTORS BENEFIT?

Equity investors who are issued with exploration credits may be eligible to receive either a tax offset or a franking credit, depending on their entity type. The following table summarises the consequences for the different entity types.

Click here to view table.

INTEGRITY MEASURES

The new rules also contain a number of specific integrity measures, including:

  • An 'excess exploration credit tax' that is imposed on the issuing entity, if they issue exploration credits in excess of the maximum number they are entitled to issue for a year. One circumstance where this could apply is where actual tax losses for a year are subsequently adjusted as a result of a tax audit. Where excess exploration tax is imposed, the Commissioner has a discretion to determine that the entity is no longer eligible to participate in the scheme.
  • Expansion of the general anti-avoidance rules in Part IVA to cover schemes with a dominant purpose of accessing exploration credits.

CONCLUSION

The proposed exploration incentive is a welcome measure, albeit limited. 

As the incentive is only proposed to apply to expenditure incurred in the 2014/15 to 2016-17 years, exploration companies will need to act quickly and ensure that they have the systems in place to take full advantage of the scheme.

Comments or submissions on the exposure draft must be submitted by Friday, 24 October 2014.