Treasury has just released a discussion paper outlining the policy design for the EDI which was proposed by the Coalition Government in September 2013.

Treasury has just released a discussion paper outlining the policy design for the EDI which was proposed by the Coalition Government in September 2013. Treasury are seeking feedback and comments from industry participants by 4 April 2014.

The introduction of the EDI would be a positive step in encouraging investment into junior explorers, who have been badly impacted by the global financial crisis and declining commodity prices. Grant Thornton’s survey of junior miners and explorers confirms that junior miners and explorers are crying out for government support. Operating in a volatile commodity market with limited funding options and low cash balances is putting a severe competitive strain on the industry. We are delighted to see Treasury has made a bold submission to support the market and believe that the policy design is a good starting point. However, there are obviously a number of areas that require consultation and refinement. The most problematic area will be the modulation to ensure the cap is not breached, which we discuss in detail below. This will impact on the timing of the exploration credits flowing to shareholders and the level of certainty for investors regarding the extent of credits likely to become available should this proposal be adopted.

The paper addresses five key questions which are summarised below.

How to ensure junior mineral explorers benefit from the EDI?
The intention of the scheme outlined in the paper is to provide an incentive for investment in junior mineral exploration companies. The incentive is proposed to be limited to Australian resident, widely held companies, although Treasury have acknowledged that rules may be needed in relation to subsidiaries and joint ventures. A ‘no taxable income test’ and a ‘no mining activities test’ for the income year in which the exploration expenditure is incurred is proposed, along with related entity tests to prevent exploitation.

Which investors will be able to receive exploration credits?
There are two proposals for the distribution of exploration credits. The first is for the distribution to be to all equity holders at the distribution time, thus reducing red tape.  The alternative is to restrict the distribution to the new shares issued in either the exploration year only or those issued in the exploration year and the preceding year.

How will ‘eligible expenditure’ and ‘greenfields’ be defined?
The EDI will apply to eligible ‘greenfields’ exploration expenditure incurred in Australia from 1 July 2014 and it is therefore necessary to look at how this will be defined.  The proposal is to use the current definition of exploration and prospecting in subparagraph 40-730(4)(a)(i)  of the Income Tax Assessment Act 1997  as this is familiar to the industry.  In this context, ‘minerals’ will exclude petroleum and geothermal energy resources.  By restricting the definition to that used in this definition, expenditure on activities normally associated with feasibility studies will also be excluded.

Greenfield exploration is exploration of unexplored or incompletely explored areas directed at discovering new resources. Any expense related to a mine that has come into production or extensions thereto or a mineralisation that has a JORC (Joint Ore Reserves Committee) code of inferred mineral resource or higher is generally excluded from the definition of eligible exploration expenditure..

How will the modulation process work?
The scheme is proposed to be capped at $100 million in exploration credits over the forward estimates period, being $25 million in respect of exploration expenditure incurred in 2014/15, $35 million in 2015/16 and $40 million in 2016/17.  As it is impossible to determine the total amount of eligible exploration expenditure to be incurred in any of these years, it will be necessary to introduce a modulation process to determine the extent to which exploration companies can provide the exploration credits to their shareholders in periods subsequent to the year in which the expenditure is incurred.  This would effectively restrict the eligible credits to the percentage resulting from the company’s share of eligible exploration expenditure to total eligible expenditure multiplied by the cap.

But how and at what stage should the percentage of eligible exploration expenditure be determined? The paper proposes three possible options, being ex-post. ex-ante  or a combination of the two. Essentially this means that the percentage would be based on either post lodgement of the company tax return, forward estimates or a combination of the two.

How will the exploration credit system work?
The incentive would allow companies with exploration expenditure and tax losses in the same income year to provide exploration credits to their shareholders. This would give the shareholders an entitlement to a refundable tax offset. Companies that choose to do this could base their credits on the lesser of the eligible exploration expenditure for the year or the tax loss for the year. The company would then reduce the loss they carry forward by the amount it chooses to give to shareholders.

The system will work in a fairly similar manner to the current imputation system, insofar as the exploration credits will be claimed by the individual shareholders in their income tax return for the year. The credits will flow through trusts and partnerships, but foreign resident shareholders will not be able to use them. There will be a similar disincentive for companies that distribute excess exploration credits and possible penalties.