The Federal Government has released an operational details paper on the exploration development incentive.  This paper sets out operational details concerning the incentive in order to provide assistance and certainty to small mineral exploration companies and their investors.  Given the start date of 1 July 2014 for the incentive, the release of the paper is timely.

The operational details paper follows on from a discussion paper released by the Federal Government earlier this year which sought industry consultation on a number of specific policy matters regarding the incentive.  McCullough Robertson along with a number of other stakeholders responded to that discussion paper.  McCullough Robertson’s concerns centred around a number of specific policy matters, particularly those concerning the limited availability of accessing the incentive due to the proposed ‘no taxable income’ and ‘no mining activities’ eligibility threshold tests.

Operational details addressed

The paper addresses operational details concerning:

  • which explorers will be eligible to access the incentive
  • how exploration credits can be provided to investors in these companies
  • what expenditure will be eligible
  • how the incentive will be capped, and
  • the treatment of exploration credits.

Eligibility requirements

Unfortunately the paper confirms the Federal Government’s intention to persist with heavily restricting the overall eligibility to access the incentive.  Consistent with prior announcements, the paper confirms that:

  • only companies with no taxable income in an income year will be able to participate in that year
  • only explorers for minerals that have not commenced production may apply
  • a consolidated approach has been taken with respect to corporate groups in that the eligibility of an entire corporate group will be tested and not just a single corporate member of the group.  That is, if another entity within the corporate group has taxable income or conducts mining activities then no one in that corporate group can participate, and
  • only disclosing entities can apply.  This would require that the applicant company be listed or have on issue widely held managed investment securities.

These requirements are likely to be problematic for the very companies which the incentive should have been designed to target and are likely to give rise to the adoption of some unusual compliance strategies.  For instance:

  • a requirement that a company (or its consolidated tax group) has no taxable income will encourage the use of inefficient structures such as a stand alone exploration company which is not connected to the group’s other activities.  This is in contrast to the more sensible and conventional practice of consolidating companies into one tax consolidated group enabling all of the group’s income and expenditure to be netted off
  • listing a company which has no taxable income while its activities and assets remain highly speculative is not likely to be attractive to both the company’s sponsors and the market itself.  To require a company to do this to access this incentive is likely to encourage poor exploration expenditure decisions or have the consequence of setting the company up for ultimate failure, and
  • unnecessary ongoing restructures and reorganisations will be required to move tenements out of the exploration company and into another vehicle as those tenements move from exploration and into production as the failure to do so will result in the exploration company ceasing to satisfy the eligibility requirements for the incentive.

Other practical considerations

Eligible exploration expenditure is that incurred on activities strictly for the purposes of the existence, location, extent or quality of a new mineral resource in Australia but not anything that has been classified as inferred mineral resource or higher under the JORC Code. 

Those exploration activities can include geological mapping, geophysical surveys, systematic searching for areas containing minerals except petroleum or quarry materials and searching for minerals by drilling or other means for such minerals within those areas but cannot include any exploration for quarry materials, shale oil, petroleum including coal seam gas and any naturally occurring hydrocarbon or naturally occurring mixture of hydrocarbons whether in a gaseous liquid or solid state, or geothermal energy resources.  In addition, expenditure incurred to evaluate the economic feasibility of mining minerals once they have been discovered is not eligible. 

In other procedural matters the paper confirms that the incentive is voluntary but the choice to participate is irrevocable.  Companies must choose whether to provide the credits to all of their shareholders or restrict availability only to new shareholdings issued after 30 June 2014, noting that, if the second alternative is selected, then those shares issued after 30 June 2014 would need to be traded as a separate class for corporations law purposes.

Timing and capping issues

The previously announced overall cap of $100 million for the incentive scheme will still apply and exploration credits for the current year will be capped at $25 million, with caps of $35 million and $40 million to apply for the following two years.  The paper confirms that companies wishing to provide exploration credits to their shareholders will reduce the tax loss that they can carry forward by the amount provided to shareholders. The resulting exploration credits must be distributed by the end of the financial year in which those exploration credits have been calculated and determined.  Finally, exploration credits will still flow through trust and partnership shareholders in a manner consistent with the rules applying to franking credits.

Next steps

Further details of the draft legislation explanatory memorandum are still to be released.  We will provide commentary on those details once they are available.  Interested stakeholders will still have an opportunity to provide further input on the design of the incentive through public consultation once the draft legislation and explanatory materials have been released.