Providing tax relief for shareholders of companies who contribute to the development of Australia’s next generation of mines.

In the lead up to the 2013 Federal Election, the Liberal Party and National Party Coalition released its policy for Resources and Energy. Central to this was the announcement of an ‘Exploration Development Incentive’ (EDI), a proposal to boost exploration for new mineral deposits, specifically targeting the junior exploration companies.

Six months on and Treasury has now released a discussion paper (the Paper) in relation to the EDI which is proposed to apply from 1 July 2014.

Treasury is seeking feedback on the design of the EDI, with submissions on the paper due by 4 April 2014.

How will the EDI work?

The EDI would allow Australian resident shareholders to obtain a refundable tax offset for ‘greenfield’ exploration undertaken by Australian junior exploration companies that do not derive any taxable income. The purpose of the incentive is to give shareholders the economic benefit of tax losses attributable to exploration activities undertaken by a company. In return for distributing the exploration credits to shareholders, companies will reduce the amount of tax losses they can carry forward.

Exploration credits would flow through trusts and partnerships, with corporate shareholders also receiving a benefit. Taxpayers subject to marginal tax rates lower than the corporate tax rate should also receive a refund. Although foreign resident shareholders will receive exploration credits, they will not be able to use them.

It is important to note that the EDI is proposed to be a voluntary incentive, with companies having the choice to elect to carry forward tax losses as opposed to distributing exploration credits to shareholders under the EDI.

Who is eligible?

The purpose of the EDI is to provide an incentive for shareholders who invest in junior mineral exploration companies, that is, companies that engage in exploration for new mineral discoveries that meet the no ‘taxable income’ test. Eligible exploration credits can only be distributed by a company which has a tax loss for the year in which exploration expenditure is incurred. Further, the Government are considering the preclusion of companies (either entirely or through a reduction in eligible exploration credits) who already derive some assessable income from ‘mining activities.’

In addition to the two qualifying tests, a further qualification is that the EDI is limited only to Australian resident companies that are widely held (i.e. listed or with greater than 50 shareholders).

What exploration expenditure is eligible?

As currently planned, the EDI would apply to eligible ‘greenfields’ exploration expenditure incurred in Australia from 1 July 2014. However, two questions arise in the determination of what should constitute eligible ‘greenfields’ exploration expenditure.

  • What is eligible exploration expenditure?
  • What is meant by ‘greenfields’?

What is eligible exploration expenditure?

It is envisaged that the definition of exploration expenditure for the purposes of the EDI will mirror the definition of ‘exploration or prospecting’1 contained within the Income Tax Assessment Act 1997 Cth (ITAA 1997), which states that ‘exploration or prospecting’ includes:

“geological mapping, geophysical surveys, systematic search for areas containing minerals….and search by drilling or other means for such minerals….”

Notably however, the EDI does not include exploration expenditure in relation to petroleum as being eligible for the EDI.

What is meant by ‘greenfields’?

Those in the mining industry understand greenfields exploration to be ‘exploration of unexplored or incompletely explored areas directed at discovering new resources.’

Treasury are currently in consultation as to the definition of ‘greenfields’ noting they may seek to adopt a similar definition used in Canada’s ‘flow through’ share scheme. Under this approach, greenfields exploration expenditure would be defined as those activities incurred for ‘the purpose of determining the existence, location, extent or quality of a new mineral resource in Australia’; in essence, ‘grass roots’ exploration.

Benefits for shareholders

The paper considers whether exploration credits should be provided to all (i.e. existing) shareholders, or confined to holders of ‘new shares.’

Allowing all shareholders access to the EDI would be the simplest outcome for companies as the latter approach mentioned above, narrows the application of the incentive only to additional investment in junior exploration companies (i.e. investment by new shareholders). Under the narrow approach, exploration credits would only be available to holders of shares issued from a point/period in time (i.e. the expenditure year). This would prove difficult for companies to monitor.

Modulation

As announced in the Coalition’s policy for Resources and Energy released just before the 2013 election, the EDI is to be capped at $100 million over the 2015, 2016 and 2017 income years. Further, this will be capped (and modulated) at $25 million for exploration expenditure incurred in 2014-15, $35 million in 2015-16 and $40 million in 2016-17. It is proposed that where total exploration credits are less than the cap, leftover amounts are lost and will not be available in subsequent years.

A modulation process would occur on either an ex-post (relying on reported ‘eligible losses’ after the expenditure year) or an ex-ante (relying on the company’s expectations of their ‘eligible losses’) as well as their reported ‘eligible losses’ after the expenditure year.

In broad terms, an ex-post modulation would require companies to notify the Australian Taxation Office (ATO) of their ‘eligible loss’, with the ATO calculating a modulation factor advising companies of the proportion of their ‘eligible losses’ they will be entitled to provide to shareholders as exploration credits. This would minimise regulatory burden, ensure the cap is fully utilised, and apply to expenditure incurred after 1 July 2014.

This does however create ambiguity for shareholders, with an inability to determine the quantum of exploration credits receivable as a result of their investment.

The ex-ante modulation process differs in that a company would notify the ATO of their expected ‘eligible losses’ at the beginning of the year (modulated to the extent the cap is exceeded). This provides shareholders with greater certainty as they could estimate the company’s ‘eligible loss’ to obtain an idea of exploration credits they may receive. However, as exploration credits are dependent on actual ‘eligible losses’ (and the choice by the company to distribute the credits), there is still some degree of uncertainty for shareholders.

Finally, a combined ex-post and ex-ante modulation process is discussed in the paper which could provide further certainty for shareholders as it provides a minimum modulation factor (and thus exploration credits) at the beginning of the year.