After much anticipation by the exploration industry, the Government has introduced a bill for the new Junior Minerals Exploration Incentive (JMEI, previously referred to as the JMETC, which we reported on when the Prime Minister first announced the incentive). The JMEI allows greenfields minerals explorers to attract new capital investment by passing on a portion of their exploration deductions to the investors in the form of a tax offset. However, the devil is in the detail, and explorers (and investors) may find that the program’s strict timeframes, yearly requirements and caps limit the program’s usefulness.
Who is this for?
“Greenfield minerals explorers” (explorers) who are planning to undertake a capital raise to carry out exploration or prospecting. Broadly, explorers must be Australian resident companies who:
- will be incurring expenditure on exploration or prospecting for minerals in Australia; and
- are not undertaking extraction activities of minerals (excluding petroleum), and are not connected with or affiliated with an entity who is undertaking such activities (you are connected with an entity if either of you have at least 40% of the voting, capital or income rights of the other entity).
It is important to note that the incentive is driven by the tax deduction available for the exploration expenditure under specific exploration provisions in the tax law. To get the biggest bang for buck, explorers will need to understand where best to spend their exploration dollars.
The JMEI converts tax losses in an exploration company that has no present need for them into either a franking credit for corporate investors (which can then be used to pay franked dividends) or a refundable tax offset for other investors that can reduce their tax liability or be returned as a cash tax refund.
JMEI works on a pre-approval basis. This provides a significant advantage for explorers who are allocated credits by the Commissioner of Taxation (Commissioner) to go into a capital raise stating that they have the ability to distribute those credits to investors. Investors only qualify if they are issued new shares after the Commissioner has allocated credits to an explorer, within the income year in which the exploration expenditure will be incurred.
The refundable nature of the JMEI may encourage interest from superannuation funds who traditionally avoided risky junior explorer companies.
Exploration credits should “flow through” trusts in a similar fashion to franking credits, although investors should check their trust deeds to ensure credits can be streamed.
The credits are personal to the investor who subscribes for the shares and do not attach to the shares, and therefore are not transferrable. This does require the explorer to keep track of the original subscribers as the traditional share register is unlikely to be enough to reflect who should receive the credits. Unfortunately, this also has the potential to deflate the share price of explorers as investors invest to receive the credits but then sell quickly and perhaps cheaply.
Although the concept of the JMEI is simple, there are many “caps” prescribed under the bill in order to work out the exploration credits that can be allocated to explorers and then distributed to investors.
Allocation to explorers
First there are the “program wide” caps per year over the program’s four year life that restrict how much can be allocated to explorers:
Base yearly cap
These caps are allocated on a first come first serve basis, so well prepared explorers are more likely to receive an allocation. Applications are made in a one month period before the start of he relevant income year (except for 2017-2018), making the whole process quite tight.
Fortunately, unused amounts from a prior year cap can roll forward to future years. This is going to be particularly relevant to the cap for the 2017-18 income year as applications for allocations cannot be made until February 2018, giving explorers just 3 to 4 months within which to raise capital and incur exploration expenditure!
There is also a “cap on the cap”, such that no single explorer is entitled to more than 5% of the yearly cap. Ironically, because of the carrying forward of unused caps, explorers seeking to claim the incentive in future years may find the 5% is actually more valuable because the actual cap has increased above base cap for the year.
Explorers can only apply for the amount of exploration credits which corresponds to the tax deduction available for expected greenfield exploration expenditure in the first year following the application (that is, being the year of the capital raise, not the life of the project). Practically, to access the exploration credits over the four years of the JMEI program, explorers must go to market more than once during those four years, instead of raising capital once to cover an exploration schedule that runs over several years.
If an explorer does not distribute all of its allocated exploration credits in the first year, it is able to distribute the unallocated credits in the second income year following the allocation. However, it cannot “top up” on the credits available for distribution. Explorers also cannot “over-estimate” their first year credits (so as to increase their allocation) as the Commissioner may deny applications that are not reasonable or cannot be proven.
Distribution to investors
Then, after the income year has ended, explorers are further capped on the credits they can pass on to their investors based on the lower of the following amounts: the approved allocation, the tax deductions for the explorer’s minerals expenditure in the year, and actual tax losses of the explorer for the year.
What’s the process?
A summary of the process is below (in respect of the 2017-18 and 2018-19 income years only). A detailed table is included in the Appendix.
The key takeaway: there are quite a few deadlines, and explorers only have a very limited time to apply under the JMEI, raise capital, and then spend the money, for investors to be eligible for exploration credits.
See Appendix for more information.
What’s in a year?
Our concern is timing. Mineral exploration does not operate based on an income year. Projects can take years to get up and running, and can be very “lumpy” in terms of exploration expenditure. As an explorer, it is hard to know what is going to happen until you start exploring, and even then, plans can change.
Ideally, the Government would have abolished all references to “income years” and merely opened applications until the $100 million total cap was exhausted (but even then, why have a cap like this in the first place – the point of incentives is to take loss making activities and turn them into profitable activities that return tax dollars to the Government). Explorers could then create exploration credits over the life of their projects in a commercially rational way, and raise capital when it suited them (and the market). The administrative burden of the program on explorers would be reduced heavily as a result.
The JMEI bill does not appreciate this. Investors are only eligible for exploration credits based on an estimate of the first income year’s greenfield exploration expenditure only. Explorers are bound by very tight timeframes, and are expected to predict project expenditure from the outset, raise capital at certain times of the year, spend money very quickly (otherwise, the credits will expire), and change commercial behaviour for tax benefits to accrue. The market will likely see a lot of capital raises at the same time to suit the JMEI. This could mean a lot of “supply”, and a limited amount of “demand”, for investments in explorers at certain times.
We believe these issues could have been resolved if a proper consultation process took place as part of drafting the law.
What should I do?
The new bill should prompt explorers and investors to start planning out their next capital raise. As the bill is subject to the parliamentary process, it may change (we certainly hope so for the better).
Explorers and investors should start seeking legal and tax advice soon to establish a plan forward.
Appendix: Detailed timeline