On 3 September 2013, the then Shadow Minister for Energy and Resources announced the Coalition's intention to introduce an Exploration Development Incentive ("EDI") that would allow investors in small to mid-tier exploration businesses to offset a proportion of the business' expenditure on certain green fields exploration against the investors' taxable income ("exploration credits").
The announcement was outlined in the Coalition's Policy for Resources and Energy 2013. This document stated that final implementation details would be determined in consultation with peak industry representative bodies.
On 13 March 2014, Treasury and the Department of Industry released a Discussion Paper setting out options for implementing the proposed EDI scheme.
The release of the Discussion Paper and the EDI proposal is a positive step towards enhancing investment in junior mineral exploration companies. Further details of the key points raised in the Discussion Paper (including details on who is eligible and how it will operate) are set out below.
JUNIOR MINERALS EXPLORERS TARGETED
The Government intends that the EDI will provide incentives for new "green fields" mineral exploration activity. Noting that much of this exploration is conducted by small to mid-tier explorers, the EDI will be targeted to that sector.
Specifically, to ensure appropriate targeting and integrity of the EDI scheme, it is proposed that:
- eligibility to participate in the scheme could be confined to Australian resident companies that are listed, or companies with over 50 members and which have dispersed ownership (ie "widely held companies" as defined in s 995-1 of the Income Tax Assessment Act 1997);
- a related entity test may also be used to ensure large entities cannot access the scheme through a relatively smaller interposed subsidiary; and
- an eligible company will only be able to distribute exploration credits to its members if that company has "no taxable income" in the year in which the relevant expenditure to generate the credits was incurred (ie "expenditure year") and does not derive assessable income from mining activities in that year. Alternatively, any assessable income from mining activities could reduce the exploration expenditure eligible for the scheme.
Comment: Restricting the EDI to listed entities and widely held entities assists with protecting the integrity of the incentive (as generally these entities that are required to prepare and lodge audited financial accounts and comply with Corporations Law disclosure requirements). However, adopting this requirement would mean that investors in closely held, smaller exploration companies could not benefit from the EDI.
WHICH INVESTORS WILL BE ABLE TO RECEIVE EXPLORATION CREDITS?
It is proposed that eligible companies will be able to distribute exploration credits to their members which have "equity interests" in the company when the credits are distributed.
While the Discussion Paper acknowledges that providing the exploration credits to all equity interest holders would be the simplest option to implement, confining eligibility for the credits to holders of "new shares" (eg holders of shares issued in the expenditure year) would increase the incentive for additional investment in exploration activity. However, this limitation may also increase the administrative burden associated with the EDI scheme.
Comment: The timing elements in relation to the eligible investors could become very complex to administer, especially where the administration of the benefit is determined by the investee company (eg where they are required to provide a report to the ATO about which investor received the tax offset - similar to what currently occurs with dividends, employee share schemes, etc). Therefore, this administrative burden will need to be considered in the context of the decision to incentivise all shareholders, or just new investor shareholders.
ELIGIBLE "GREENFIELDS" EXPLORATION EXPENDITURE
The EDI will only apply to eligible exploration expenditure and therefore this definition is very important. There are two aspects to this being:
- what is included in "green fields" exploration; and
- what is eligible exploration and what activities does it include?
Targeting the EDI to these two aspects is designed to funnel investment into expenditure on exploration leading to new discoveries.
Limiting the EDI to exploration in "green fields" areas is intended to focus the incentive on the search for new discoveries. The Discussion Paper indicates that this will only include the exploration of unexplored or incompletely explored areas. Rather than focussing on the relevant area (and defining this as a green fields area) the preference is to use an activity based approach, whereby the activities are important in determining the eligibility of the expenditure.
Accordingly, it is proposed that eligible exploration expenditures would be limited to activities that are for determining the existence, location, extent or quality of a new mineral resource in Australia. The EDI would exclude expenses incurred in relation to a mine that has come into production, an extension of a mine or a mineralisation that has been classified as an Inferred Mineral Resource or higher under the Joint Ore Reserves Committee Code, being activities associated with "brown fields" exploration.
In terms of the definition of "exploration expenditure", the Discussion Paper proposes that a practical starting point could be to adopt the current definition of "exploration and prospecting" at subparagraph 40-730(4)(a)(i) of the Income Tax Assessment Act 1997, with certain adjustments. The current definition includes:
"geological mapping, geophysical surveys, systematic search for areas containing minerals (except petroleum) or quarry materials, and search by drilling or other means for such minerals or materials within those areas."
However, it is proposed that eligible exploration expenditure will exclude:
- searching for petroleum (per the definition);
- exploration for geothermal energy resources;
- to ensure the expenditure is limited to exploring "green fields", other aspects of the definition in subsection 40-730(4) - eg expenditure on activities normally associated with feasibility activities aimed at determining whether it is economically and technically feasible or commercially viable to proceed to development, or how to best develop a known mineralisation would be excluded.
Comment: A key issue for consultation will be in relation to activities connected to an exploration company, but not directly related to exploration (eg administration, overhead and compliance costs associated with setting up and running a widely held or listed entity). Where the EDI is only available in relation to the relevant exploration activities, investors will want to understand how much of their investment will go towards these activities, as opposed to the other costs of running the company.
HOW THE EDI SCHEME IS PROPOSED TO WORK
A company that wishes to provide exploration credits to its shareholders will:
- elect to reduce the loss it may carry forward from the expenditure year by the amount it wishes to provide to shareholders (its "renounced loss");
- calculate the total exploration credit by multiplying its "renounced loss" by the corporate tax rate; and
- notify its shareholders of their individual entitlement to a tax offset.
The "renounced loss" cannot exceed the company's "eligible loss", which will be the lesser of a company's eligible exploration expenditure and its total tax loss from the expenditure year.
Shareholders would claim their tax offset in their tax returns for the year they receive the exploration credits. However, to ensure that a distribution of exploration credits does not put shareholders in a better position than if the company elected to carry forward its tax losses and subsequently distributed an unfranked dividend, shareholders may need to include the amount of the credit in their assessable income. This would be consistent with the treatment of franking credits under the imputation system.
The Discussion Paper also states that: "Exploration credits will flow through trusts and partnerships. Corporate shareholders would also receive a benefit, but as with the imputation system, this may not be an offset. Individuals who are not required to lodge tax returns would be able to claim a refund of the exploration credits."
EXPLORATION CAPS AND MODULATION
The EDI Scheme is proposed to be limited by exploration caps and a "modulation" process. This is because the exploration credits that can arise under the EDI scheme will be capped at $100 million over the forward estimates period, as follows:
Click here to view table.
The existence of a cap will require special "modulation" rules, to ensure the cap is not breached. Under these rules, it is proposed that companies wishing to participate in the EDI scheme would need to calculate and report their "eligible losses" for the previous income year (ie the expenditure year), and lodge their tax-return by a cut-off date (eg 1 March following the expenditure year). The ATO would then calculate the total "eligible losses" reported for the expenditure year.
If the total exploration credits that would result from the total "eligible losses" exceed the cap for the particular year, the ATO would calculate an appropriate modulation factor (so that the cap is not exceeded) and advise eligible companies of the proportion of their "eligible losses" they will be entitled to provide to shareholders as exploration credits.
The ATO also suggests alternative rules whereby the modulation process may be partially based on "eligible losses" estimated at the start of the expenditure year, rather than just "eligible losses" based on actual eligible exploration expenditure which is known and reported after the end of the expenditure year.
Comment: The modulation process could have the effect of reducing certainty for investors as at the time that they make an investment, they will not be able to determine whether or not a tax offset is available, or the amount applicable to that investment. Therefore, rather than being able to calculate the amount of the EDI when making an investment, the investor will need to understand that they may get the EDI because they have invested in a specific company.
There are a number of issues which need to be worked through in relation to the EDI. In particular, the definition of eligible exploration expenditure, the timing of which investors can participate and the possible uncertainty around the modulation process.
However, the fact the fact that investors may receive the EDI in relation to a particular investment should, of itself, direct more investment into this area and on this basis, is a positive step.