Since announcing the proposed implementation of the Exploration Development Incentive (EDI) in 2013 the Government has been working to finalise the nature and scope of the EDI and released a paper containing the operational details for the scheme on 2 July 2014. As always, there are still questions that haven’t been answered and will await the release of the legislation.
Broadly, the aim of the EDI is to encourage investment in junior explorers undertaking “greenfields” exploration in Australia from 1 July 2014 by allowing investors to deduct the expense of mineral exploration against their taxable income. Under the scheme, a proportion of expenses will be claimable as exploration credits by investors. These exploration credits will entitle investors to a refundable tax offset.
Which explorers will be eligible to participate?
The EDI scheme aims to target junior explorers. This is to be achieved by imposing a “no income test” as well as a “no mining test”. Companies which are ‘disclosing entities’ under the Corporations Act 2001 and have no taxable income in an income year will be eligible to participate in the EDI scheme for that year. Companies that have commenced production, and companies connected or affiliated with an entity that has commenced production, will be excluded from the scheme. For tax consolidated groups, the group will be treated as a single entity with eligibility determined taking into account the activities of the group as a whole.
What expenditure is eligible?
The EDI will only apply to eligible ‘greenfields’ exploration expenditure within an Australian onshore exploration tenement.
Following the existing definition in the Income Tax Assessment Act 1997, exploration for the purposes of the EDI will include geological mapping, geophysical surveys, systematic search for areas containing minerals, except petroleum and quarry minerals, and search for minerals by drilling or other means. Expenditure on studies to evaluate the economic feasibility of mining minerals once they have been discovered will be excluded.
The ‘greenfields’ aspect is achieved by limiting exploration expenditure to expenditure incurred on activities for the purpose of determining the “existence, location, extent or quality of a new mineral resource in Australia”. It will exclude any expense related to a mineralisation classified as an Inferred Mineral Resource or higher under the JORC Code 2012, and will also exclude expenditure related to a potential or actual mine extension.
The scheme does not apply to expenditure on exploration for quarry materials, shale oil, petroleum (including coal seam gas) and geothermal energy resources.
Caps and modulation
As previously reported, the cost of the scheme will be capped at $100 million with exploration credits being capped at $25 million in 2014/15, $35 million in 2015/16 and $40 million in 2016/17.
The Government has now decided on an ex-post modulation approach. Participating companies will need to notify the Australian Tax Office (ATO) of the lesser of their exploration expenditure and their tax loss from the financial year. The ATO will then advise eligible companies of the proportion of this amount they will be entitled to provide to shareholders as exploration credits. Provided they do not exceed the amount advised by the ATO, companies will be entitled to choose the tax losses they wish to convert into exploration credits at the company tax rate. Exploration credits must be distributed by the end of the year in which modulation occurs. Further details on this modulation process will only become available when the draft legislation is released.
Which investors will be eligible to participate?
At the company’s election, exploration credits can be issued to all shareholders or only to holders of shares issued after 30 June 2014. Once this election has been made it will be irrevocable.
While electing to issue exploration credits only to holders of shares issued after 30 June 2014 may encourage the sought after investment, this election will have a number of broader consequences as it requires such shares to be traded as a separate class of shares. This will require careful consideration of the company’s constitution and Corporations Act 2001 and Listing Rule implications as well as creating complications for takeovers and schemes of arrangements and generally increasing compliance costs. In most cases, we would expect the participating companies to elect to issue exploration credits to all shareholders.
Shareholders who receive exploration credits will be entitled to refundable tax offsets equal to their exploration credits, provided they are Australian resident shareholders. These offsets will be claimed in the shareholders’ tax returns for the year they receive the credits. Similar rules that apply to franking credits will apply to exploration credits.
For those interested in the EDI, it is likely that we will gain further clarity in relation to the scheme with the release of the draft legislation and explanatory materials expected in the coming months.