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Tax credits for shareholders of explorers: one step closer to a mine
The Prime Minister, Malcolm Turnbull, announced today (2 September 2017) that the Junior Mineral Exploration Tax Credit (JMETC) will replace the Exploration Development Incentive (EDI) with effect from the current 2017/2018 income year. The announcement has been welcomed by the industry, which has been pushing for such a credit (otherwise referred to as a “flow-through share”) for over a decade. A similar type of scheme has operated successfully in Canada and has been attributed with facilitating significant exploration activity in that country.
Tax and economic benefits
The concept of a flow-through comes from the ability of the company undertaking the exploration to renounce the deductions for exploration, passing on the benefit of those deductions to shareholders.
This important tax benefit takes deductions from an exploration company (which is likely to have no income for many years until (if ever) it turns a profit from a successful mine, and therefore does not benefit from those deductions until that occurs) and passes them to investors as a credit against tax payable on other income.
The economic benefit of the JMETC is that it will encourage non-mining investors to invest in exploration companies, opening up the pool of funds available to fund exploration activity and potentially find the next figurative (or even literal) gold mine! According to some reports, exploration activity in Western Australia alone has dropped 70% in the last 5 years, and the industry hopes this trend will be reversed by the JMETC.
Which explorers are eligible?
A greenfield mineral explorer is eligible if it is undertaking a new capital raising and:
a) has not carried on any mining operations during the income year or over the immediately preceding income year; and
b) 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 the first entity holds at least 40% of the rights to any distributions of income or capital, or the voting power, in the second entity. The test is a “see through” test, meaning 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 JMETCs, 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).
Which investors are eligible?
Investors who are eligible for franking credits are expected to be eligible for the JMETCs. Investors must be Australian tax residents for the whole income year in which the credits are received.
JMETCs will be administered on a first-in, first-served basis, subject to integrity measures applied by the Australian Taxation Office (ATO). The Government will implement a cap of $100 million over four years, starting from the current income year (although it is not clear whether this cap will be applied on a pro rata basis over the four years). Given the ATO’s oversight of the program, we anticipate the program will be administered under an application-based system.
This system is a welcome change from the EDI “modulation factor” system, although the $100 million cap may still create uncertainty in the market. Under the EDI, if the scheme had been oversubscribed, the value of the tax credit would have been reduced, thereby removing the incentive to invest. Under the proposed JMETC, eligible investors will have certainty that they will receive 100% of their credit until the cap is reached. This begs the question – what happens if the $100 million cap is reached in, say, the middle of the third year of the program? There are no details in respect of this, yet.
How will the credit work?
An eligible company must first 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).
It is anticipated that the credit will apply as follows:
- Private company investors: Private companies will be entitled to a franking credit equal to the amount of JMETC credit received. The 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). No details have been announced regarding how the credits will interact with a company’s franking account.
- Other investors: Investors will be entitled to a tax offset equivalent to the amount of the JMETC credit. Theoffset 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.
It is anticipated that the JMETCs 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.
The JMETCs may encourage interest from superannuation funds who traditionally avoided risky junior explorer companies.
The amount of the credits an entity chooses to create must not exceed its maximum exploration credit amount. This is the smallest of its tax loss or greenfields mineral expenditure forthe prior income year, multiplied by the corporate tax rate for the prior income year.
What happened to 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 persistence has paid off!
Two of the main grievances regarding the EDI – being the “modulation factor” and the dilution of tax credits due to legacy shareholders – have been rectified under the JMETC.
The mining market in Canada has strong support for its flow-through share system. In Canada, flow-through shares have assisted companies raise money to explore which otherwise may not have been invested. Further, to the extent exploration is successful, the Government benefits through tax on the production of the resource. The Canadian experience is about 30 years in, generating $12 billion in exploration funding and fuelling the prosperity of junior miners. Here is hoping Australian mining exploration will follow suit.