Tax Industry Insight:

Junior Miners welcome new Exploration Incentive and begin preparing for applications

29 November 2017

On 19 October 2017, the Government introduced Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017 into Parliament which proposed to introduce a new Junior Minerals Exploration Incentive (JMEI), to replace the Exploration Development Incentive (EDI), which expired this year.

The JMEI is designed to attract and encourage investment in small exploration companies undertaking greenfields mineral exploration in Australia at a time when global competition for capital remains fierce. The JMEI allows eligible companies to ‘give up’ their exploration tax losses to investors in the form of a refundable tax offset and will attach to newly issued shares.

Exploration credits can be obtained via application to the ATO between 1 June and 30 June in the preceding financial year that corresponds to the income year for which the allocation is requested. This provides exploration companies with certainty regarding the amount of credits they have available for the following income year which may also be prior to an eligible capital raising.

Expiry of the EDI

The EDI was introduced for three years in mid-2014 by a newly elected Government.  However, the current Government decided not to renew the EDI, with final applications due by 30 September 2017.  The Government cited poor take-up of the EDI and a failure to encourage exploration.  However, industry claims that the EDI was overly complicated and poorly targeted, and has been pushing for a replacement (or at least an extension) of the EDI.  Industry’s lobbying has paid off. Two of the main issues being the ‘modulation factor’ (which caused the EDI credit to be a fraction of the greenfields exploration actually incurred by the explorer) and dilution of tax credits due to legacy shareholders have been rectified under the JMEI.

The JMEI is a welcomed improvement on the previous EDI as it provides more timely certainty to investors and exploration companies when compared with the EDCI. Mineral exploration is a highly risky venture. Without the EDI, investors into unsuccessful mineral exploration companies will generally only realise a tax benefit from their losses in the form of a capital loss – sometimes many years after the initial investment is made. This should make the JMEI more successful than the EDI in encouraging investment in Australia’s mining industry. The JMEI may encourage interest from superannuation funds who traditionally avoided risky junior explorer companies. However, it is suggested that all investors, particularly superannuation funds, obtain advice from a licensed investment advisor.

Which explorers are eligible?

A greenfield mineral explorer is eligible if it is undertaking a new capital raising and has not carried on any mining operations during the income year or over the immediately preceding income year; and no mining operations have been carried out during the period by another entity that is ‘connected with’ or an ‘affiliate’ of the greenfield mineral explorer. Generally, an entity is ‘connected with’ another entity if either entity controls the other or both entities being controlled by the same third party and control refers to holding 40% of the rights to any distributions of income or capital, or the voting power, in the second entity. This ‘see through’ test means that a group is aggregated together with all entities in which the 40% test is passed.  An entity is affiliated with another entity if the second entity acts or could reasonably be expected to act in accordance with the first entity’s directions or wishes, or in concert with each other. In order to claim the JMEI, existing mining groups may seek to form incorporated joint ventures in which existing miners will own less than 40% of the shareholdings (to ensure the ‘connected with’ and ‘affiliate’ tests are not breached).

When does it apply?

The JMEI will apply for four years, starting from the 2017-18 year. A transitional rule will apply for the 2017-18 income year, which will require an application for an allocation of credits by an eligible exploration company to be made on or after 1 February 2018 but before 1 March 2018. The ATO is allocating exploration credits on a first come, first serve basis until the annual cap is reached.

Therefore, we encourage small exploration companies that are interested in applying to start planning to ensure readiness by February 2018. This will provide exploration companies and investors with increased certainty in relation to the likely tax offset available when raising capital and undertaking greenfields exploration. As the exploration credits are provided when the new shares are issued which is prior to the incurring of the relevant expenditure, a downside may be that companies which are allocated the maximum 5% (of the annual cap which is $15 million in 2017/2018 and $25 million in 2018/2019) may not utilise all of the exploration credits issued to them for the relevant year, which may be at the cost to companies which missed out on this basis, and yet have undertaken the relevant exploration activities during the year.

How will the credit work?

After being allocated with credits an eligible company must then choose to renounce a portion of its exploration expenditure losses in an income year, up to its maximum exploration credit amount. The credit will be available to investors in the income year following the one in which eligible expenditure is incurred by the company (similar to the franking system). Company investors will be entitled to a franking credit equal to the amount of JMEI they receive.  The franking credit must be claimed in the year of issue and is non-transferable (these concepts are currently unclear and will require clarification by the Government or the ATO). Other investors will be entitled to a tax offset equivalent to the amount of the JMEI.  The offset can be applied on the same basis as franking credits.  This may result in a refund of cash to superannuation funds, taxpayers with low marginal rates and certain not-for-profit entities. The amount of the credits a mineral explorer chooses to create must not exceed its maximum exploration credit amount.  This is the smallest of its tax loss or greenfields mineral expenditure for the prior income year, multiplied by the corporate tax rate for the prior income year.

Issuing credits to investors

Exploration companies that are allocated credits by the ATO can issue those credits to eligible investors that make an investment after the time the credits are allocated by the ATO, but before the end of the income year in which the credits are allocated. Credits can however be issued by the exploration company in that income year, or the year after. The credit is limited to the lesser of the company’s eligible greenfields expenditure for the income year, and the company’s tax loss for that year. An exploration company with credits is likely to determine the issuing of credits after year end, but those credits will be issued to investors in respect of the income year in which the exploration activity occurred. If a company over allocates credits, or has allocated them inappropriately, the company (not the investor) may be subject to excess exploration credit tax.

Outstanding issues

The mechanism to facilitate the offset has yet to be developed. No details have been announced regarding how the credits will interact with a company’s franking account. A franking account type mechanism is a possibility, however, significant administrative complexities remain to be overcome. It is anticipated that the JMEI would ‘flow through’ trusts in a similar fashion to franking credits, although investors should check their trust deeds to ensure credits can be streamed.  It is likely amendments will be required to ensure credits can flow without corresponding income.

Investment outlook

At the time of unveiling the JMEI back on 2 September in Perth, Prime Minister Turnbull said in this media release that the scheme would encourage the “investment and risk-taking” needed to unlock new deposits. He said “These tax incentives will encourage ‘junior explorers’ to take risks and to have a go at discovering the next large-scale mineral deposit … we want to back enterprise. We want to turnaround the greenfields minerals exploration expenditure that have declined by almost 70% over the past five years.” Australia’s junior resources sector has already started to crank up its spending as it continues to shake off the post-downturn funk and capitalise on the increased amounts of cash available to it. BDO’s latest quarterly analysis of the financial health of the country’s listed exploration companies by accounting and advisory firm BDO released in September shows a big increase in the amount spent by the nation’s small-caps on investing and exploration as well as doubling in the number of $10 million-plus capital raisings. Sherif Andrawes, the national leader of natural resources at BDO, said optimism that had been building in the sector was now translating into actual spending and deals.

The JMEI was developed in close consultation with industry after seeing Canada benefit from a similar tax credit model for more than 30 years. The Canadian system has generated more than $12 billion in exploration funding that has fuelled the prosperity of junior miners and helped propel Canada’s industry to the top due to the exploration funding and equity investment it commands. Australian mining exploration will hope to soon follow suit.

BDO Comment

Outside of the first transitional year of 2017-18, the application by the exploration company needs to be made in advance, between 1 June and 30 June in the preceding financial year that corresponds to the income year for which the allocation is requested. The applicant process is the same for entities that have substituted accounting periods. As noted earlier, for the 2017-18 income year, the application will need to be made on or after 1 February 2018 but before 1 March 2018. Exploration companies who are interested in applying for the incentive for 2017/18 should therefore make sure they are adequately prepared to submit an application in February 2018. An application needs to be submitted online to the ATO. The application needs to include an estimate of the company’s greenfields minerals expenditure, tax loss and corporate tax rate for the income year.