Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)
Chapter 6 - Exploration development incentive
Outline of chapter
6.1 Schedule 6 to this Bill and the Excess Exploration Credit Tax Bill 2014 introduce an exploration development incentive by amending the Income Tax Assessment Act 1997 (ITAA 1997) and other tax legislation to provide a tax incentive to encourage investment in small mineral exploration companies undertaking greenfields minerals exploration in Australia. Australian resident investors of these companies will receive a tax incentive where the companies choose to give up a portion of their losses relating to their exploration expenditure in an income year.
6.2 The total value of the tax incentives available to taxpayers in respect of expenditure in an income year is restricted to $25 million for greenfields minerals expenditure incurred by eligible companies in 2014-15, $35 million for greenfields minerals expenditure incurred in 2015-16 and $40 million for greenfields minerals expenditure incurred in 2016-17.
6.3 The incentive is not available for expenditure incurred in income years after 2016-17.
Context of amendments
Mineral exploration in Australia
6.4 A significant part of the Australian economy is based on the extraction and sale of its mineral resources. Ongoing exploration and the discovery of new mineral resources is vital to the longer term future of the resources sector.
6.5 Exploration for minerals often involves significant expenditure and risks. While larger, established mining companies are generally in a position to fund such activities from their own profits, smaller companies focused solely on exploration are dependent on attracting investment to fund their activities. Such smaller companies are also more likely to engage in more speculative mineral exploration in greenfields areas rather than focusing on the development of their existing resources.
6.6 Over recent years there has been a noticeable decline in exploration, particularly greenfields exploration.
6.7 The Government made a commitment in the 2013 election campaign to provide a tax incentive to Australian resident shareholders of small mineral exploration companies to support greenfields minerals exploration undertaken by these companies in Australia. The Government proposed that the incentive would be available for expenditure on greenfields minerals exploration incurred in 2014-15, 2015-16 and 2016-17. This proposal was confirmed in the 2014-15 Budget.
6.8 The Department of Industry will monitor greenfields exploration and the scheme throughout its operation, with a review of the scheme in 2016 and, subject to these review outcomes, the Government may decide to extend the programme for a further period.
Income tax and mineral exploration expenditure
6.9 Generally, mineral exploration expenditure is likely to be capital in nature and would not be deductible by taxpayers under the general deduction rules in the income tax law. However, specific provisions allow taxpayers to immediately deduct most expenditure incurred in the course of exploration or prospecting for minerals.
6.10 Section 40-80 of the ITAA 1997 generally allows an immediate deduction of the full value of any depreciating asset (broadly an asset with a limited useful life) when it is first used for exploration or prospecting for minerals and the taxpayer carries on mining operations, proposes to carry on such an operation, or incurred the expenditure in the course of a business of exploration or prospecting for minerals.
6.11 Section 40-730 of the ITAA 1997 allows an immediate deduction for other expenditure (both capital or revenue) incurred in exploration or prospecting for minerals where the taxpayer carries on mining operations, proposes to carry on such an operation, or incurred the expenditure in the course of a business of exploration and prospecting for minerals.
6.12 Most expenditure incurred in relation to exploration for mineral resources is likely to be deductible.
6.13 The benefit this provides differs significantly between different types of explorers.
6.14 Large mining companies undertaking minerals exploration obtain an immediate benefit from the deduction, as it can be immediately offset against the assessable income from their ongoing mining activities in the relevant income year.
6.15 On the other hand, smaller companies engaged solely in exploration for minerals may earn less assessable income in a given income year than they outlay on exploration or prospecting. Such companies therefore will generally have a tax loss for the income year. This tax loss will not provide any benefit unless a company earns sufficient assessable income in a future income year against which the loss can be deducted.
Summary of new law
6.16 Schedule 6 to this Bill creates an exploration development incentive (EDI) for Australian resident investors in small mineral exploration companies. Investors may be entitled to a refundable tax offset or additional franking credits where the company in which they have invested issues them an exploration credit (a conversion of a tax loss from exploration or prospecting into an immediately distributable tax benefit).
6.17 Companies may issue exploration credits to their shareholders up to a capped amount. A company's cap for an income year is based on its exploration or prospecting expenditure and tax loss for the previous income year, adjusted by a modulation factor to ensure that the total value of all credits provided in respect of expenditure in an income year does not exceed $25 million for expenditure incurred in 2014-15, $35 million for expenditure incurred in 2015-16 and $40 million for expenditure incurred in 2016-17.
6.18 To give effect to these caps, Schedule 6 to this Bill and the Excess Exploration Credit Tax Bill 2014 require companies that issue exploration credits in excess of their maximum entitlement to pay excess exploration credit tax on the amount of the excess.
Comparison of key features of new law and current law
|New law||Current law|
|Eligible mineral exploration companies can utilise their tax losses:
|Mineral exploration companies can generally only utilise tax losses to reduce their taxable income in later income years.|
|Australian resident taxpayers that are not corporate tax entities and receive exploration credits are entitled to a tax offset equal to the amount of the credit.
For individuals, superannuation funds and certain trustees, this offset will be a refundable tax offset.
|No equivalent provisions.|
|Australian resident trusts and partnerships that receive exploration credits may be able to provide their members with a share of the exploration credit so that their members may obtain the tax offset.||No equivalent provisions.|
|Australian resident corporate tax entities receiving exploration credits are entitled to a franking credit equal to the amount of the exploration credit.||No equivalent provisions.|
|Entities that create exploration credits in excess of their maximum exploration credit entitlement will be subject to excess exploration credit tax, and potentially, shortfall penalties in respect of that amount.||No equivalent provisions.|
Detailed explanation of new law
6.19 Schedule 6 to this Bill amends the tax law to establish the EDI. There are three key components of the incentive.
6.20 First, this Schedule creates an EDI by way of:
- a tax offset (the EDI tax offset) which is available to certain Australian resident investors that receive exploration credits; and
- additional franking credits for corporate tax entities that receive exploration credits.
6.21 Secondly, it establishes a framework for eligible companies to give up a portion of their tax losses from greenfields minerals exploration to create and issue exploration credits to their shareholders.
6.22 Finally, it introduces the excess exploration credit tax to apply to companies that issue exploration credits in excess of their maximum entitlements.
6.23 Overall, the incentive will allow eligible exploration companies to convert a portion of their tax loss to exploration credits which can be provided to shareholders to entitle the shareholders to a tax benefit.
Exploration development incentive tax offset
Exploration development incentive tax offset - general case
6.24 Schedule 6 amends the ITAA 1997 to introduce a tax offset available to Australian resident taxpayers that receive exploration credits, provided that the taxpayers are not corporate tax entities. [Schedule 6, item 2, section 418-10 of the ITAA 1997]
6.25 The tax offset is generally not available to entities that do not generally pay tax - trusts, partnerships and exempt entities. However, exempt entities that are entitled to a refund of franking credits will also be entitled to the EDI tax offset. Additionally, the EDI tax offset will also be available to certain trusts to the extent that the trustee is subject to income tax as an Australian resident individual, for example, where an Australian resident beneficiary of the trust estate who is under a legal disability and is presently entitled to an amount of the income of the trust (see subsections 98(1), 98(2), 99(2) and 99(3) of the Income Tax Assessment Act 1936 (ITAA 1936)). [Schedule 6, item 2, paragraph 418-10(b) of the ITAA 1997]
6.26 Consistent with the rules for the tax offset for franking credits, the EDI tax offset is only available to taxpayers that are resident in Australia for the whole of the relevant income year. This addresses integrity concerns around providing offsets to foreign residents who may have no other association with the Australian tax system and who generally do not interact with the Australian tax system on the same basis as Australian resident taxpayers.
6.27 The amount of the offset in an income year for a particular taxpayer is the value of the exploration credits the taxpayer has received in that income year. The offset will generally be available to the taxpayer in respect of the year following the year in which the company undertaking the exploration incurred its exploration or prospecting expenditure. [Schedule 6, item 2, section 418-25 of the ITAA 1997]
6.28 The offset is refundable to taxpayers with no basic income tax liability that are individuals, superannuation funds and certain charities and not-for-profit entities that are eligible for refunds of franking credits (referred to in the tax law as exempt entities eligible for a refund see Subdivision 207-E of the ITAA 1997). [Schedule 6, item 1, item 27 in the table in section 67-23 of the ITAA 1997]
6.29 As entitlement to the EDI tax offset is likely to vary significantly between income years, the offset will not be taken into account in determining taxpayers' pay-as-you-go instalments. [Schedule 6, items 27 to 30, paragraph (h) at the end of step 1 of the method statement in section 45-340 and paragraph (g) at the end of step 1 of the method statement in section 45-375 of the ITAA 1997]
6.30 This Schedule also amends the general anti-avoidance rules in Part IVA of the ITAA 1936 to apply to the EDI. This will ensure that taxpayers who enter into tax avoidance schemes with the predominant purpose of accessing the EDI will not benefit from the incentive. [Schedule 6, items 3 to 15, definitions of 'exploration credit' and 'exploration development tax offset' in subsection 6(1), paragraphs 177C(1)(bba), 177C(1)(fa) and 177C(2A)(c), subsection 177C(3) and paragraphs 177C(3)(cb) and (h), 177CB(1)(da), 177F(1)(d), 177F(1)(e) and 177F(3)(d) to (f) of the ITAA 36]
Exploration development incentive tax offset - life insurers
6.31 Consistent with the imputation system and the income tax law more generally, these amendments include special rules for corporate tax entities that are life insurance companies. [Schedule 6, item 2, section 418-15 of the ITAA 1997]
6.32 Life insurance companies are eligible to receive the EDI tax offset in relation to some of their exploration credits. Specifically, life insurers hold assets wholly on behalf of their policy-holders rather than for the benefit of their shareholders.
6.33 For the purposes of the income tax law and the imputation system, these assets held on behalf of policy holders are taxed and eligible for refundable imputation credits consistent with the treatment these assets would receive if they were held in comparable investment arrangements such as superannuation funds or managed investment trusts.
6.34 These amendments provide that life insurance companies will be eligible to obtain the EDI tax offset in the same circumstances they would be eligible to obtain a refundable tax offset under the imputation system. That is, they can obtain the EDI tax offset for that portion of exploration credits they receive in respect of investments they hold on behalf of policy-holders, provided the offset is applied wholly for the benefit of policy-holders. [Schedule 6, item 2, paragraph 418-15(1)(d) and subsection 418-15(2) of the ITAA 1997]
Exploration development incentive tax offset - trusts and partnerships
General rules for trusts and partnerships
6.35 Schedule 6 also provides special rules for trusts and partnerships that are neither corporate tax entities nor exempt entities entitled to a refund. [Schedule 6, item 2, section 418-20 of the ITAA 1997]
6.36 While trusts and partnerships are entities for income tax purposes, they generally do not have income tax liabilities or entitlements of their own. Instead, trusts and partnerships are generally flow-through entities for income tax purposes, with the tax consequences of their entitlements being passed on to their members.
6.37 As a result, trusts and partnerships generally cannot obtain any direct benefit from exploration credits they receive. Instead, where a trust or partnership is issued with an exploration credit or credits in an income year, they may be able to provide a member of the trust or partnership with a statement entitling that member to a share of the exploration credit or credits the trust has received. This statement does not need to accompany the passing along of an amount by the trust or partnership; unlike franking credits exploration credits have no link to a distribution from profits and do not need to follow the benefit of such a distribution. [Schedule 6, item 2, subsections 418-20(1) and (4) of the ITAA 1997]
6.38 The member who received the statement is then entitled to benefit from the EDI themselves as if they had been issued with an exploration credit or credits of that amount directly in that income year.
6.39 If the member is an individual they will be able to obtain the EDI tax offset. If they are a corporate tax entity they will be able to obtain a franking credit. If the member is itself a trust or partnership they will then be able to further pass on the benefit of the credit they have received to their own members.
6.40 The offset is not available to the trust or partnership to the extent a member has been made entitled to part of the tax offset. This ensures that there can be no double benefit from the tax offset in a situation in which the trustee can access a tax offset themselves. [Schedule 6, item 2, sections 418-25 and 418-30 of the ITAA 1997]
Restrictions on providing the benefit of the offset to members
6.41 There are however, a number of restrictions that apply to the transfer of the benefit of an exploration credit to the member of a trust or partnership. A trust or partnership must have regard to the terms of the trust instrument or partnership agreement as they would apply to an equivalent franked distribution when received in the same circumstances when determining shares of exploration credits that can be made available to particular beneficiaries or partners. [Schedule 6, item 2, subsection 418-20(2) of the ITAA 1997]
6.42 For trusts, this means that a beneficiary's share of the exploration credits received by a trust must be the same as the share the beneficiary would be entitled to receive of an equivalent franked distribution from the same source.
6.43 This means that, for example, a beneficiary of a fixed trust who would be entitled to 50 per cent of the income of the trust must receive a 50 per cent share of any exploration credits the trust receives. Equally, a beneficiary of a trust who is only entitled to receive distributions of capital or specific trust income that would not include an equivalent franked distribution cannot be made entitled to any share of the exploration credits the trust has received.
6.44 Where the terms of a trust would allow the trustee discretion as the recipient of an amount of income from an equivalent franked distribution, the trustee would have the same discretion about the distribution of an exploration credit. It is not relevant in exercising this discretion how the trustee has distributed specific amounts of income the trustee may receive, or even that the trustee has not distributed any income from the trust in relation to the relevant income year. However, if the trustee has made a general resolution about how the income of the trust or the income of the trust from franked distributions will be distributed, then this does affect how exploration credits can be passed along.
6.45 For example, if a trustee has resolved to distribute a specific amount to a beneficiary, this will not limit how they may subsequently distribute exploration credits - in this case the resolution is only about a specific amount. However, if the trustee resolved instead that 50 per cent of all franked distribution would be distributed to a specific beneficiary, this would limit how any exploration credits could be distributed - a distribution would only be consistent with the terms and conditions of the trust where it complied with the general rule. Similarly, if the trust had only resolved to distribute specific amounts but had also resolved that a particular beneficiary was the remainder beneficiary, as the remainder beneficiary would be entitled to the whole amount of the hypothetical franked distribution, the trustee would also be required to provide all exploration credits they wish to provide to beneficiaries to the remainder beneficiary (the same outcome would arise if the trust deed established a default beneficiary).
6.46 For partnerships, the share of exploration credits provided to a partner must also be the same as the share the partners would be entitled to receive of an equivalent franked distribution from the same source. [Schedule 6, item 2, subsection 418-20(2) of the ITAA 1997]
6.47 Where a trust or partnership purports to issue a member with a share that would not be consistent with what a member could receive if the exploration credits were instead a franked distribution, the member will not be able to benefit from the share of the exploration credits.
Example 6.1 Rob is an Australian-resident beneficiary of RK Family Trust, a discretionary trust that has made a family trust election under section 272-80 in Schedule 2F to the ITAA 1936 (with Rob's mother as the eligible individual).In May 2016, RK Family Trust is issued with exploration credits with a value of $100, by GME Co, a greenfields minerals explorer, in which the trustee of RK Family Trust, Trustee Co, holds ordinary shares on trust.In June 2016, Trustee Co resolves to determine that Rob is entitled to $50 of the exploration credits it has received from GME Co. It makes a determination that Rob should be entitled to this amount and provides Rob with a statement to this effect in the form approved by the Commissioner of Taxation (Commissioner) (see paragraph 6.67). Trustee Co must provide the statement to Rob by the time Trustee Co must lodge the income tax return for RK Family Trust for the 2015-16 income year.As a result, Rob is now taken to have been issued with $50 of the exploration credits that were issued to the trust in the 2015-16 income year. As an individual resident in Australia for the relevant income year (the 2015-16 income year) he is entitled to a $50 tax offset in respect of these credits, which he may claim in his tax return for that year.If the amount of income tax Rob must otherwise pay for the 2015-16 income year is less than the $50 of exploration credits he has received, he will be entitled to a refund of the difference.To the extent Rob is entitled to this $50 of exploration credits, neither the trust nor any other beneficiary of the trust can benefit from these credits.As a discretionary trust, the deed of the RK Family Trust places no restrictions on what entitlements can be provided to particular beneficiaries, so there is no restriction of the share of the exploration credits issued to the trust that Rob can receive.However, if the terms of deed for RK Family Trust did restrict the amount that Rob could receive of a comparable franked distribution from the same source, Rob would not be entitled to the benefit of the exploration credit unless his share of the exploration credit was consistent with the share he could receive of a comparable franked distribution.
6.48 Further, beneficiaries and partners will also not be able to benefit from a share of any exploration credits to the extent that they would not be entitled to obtain a tax offset in respect of a franking credit that relates to a distribution by the trust or partnership of an amount of a franked distribution received by the trust from the same entity or entities, in the same circumstances and in respect of the same interests. [Schedule 6, item 2, subsection 418-20(3) of the ITAA 1997]
6.49 This means that, amongst other things, partners and beneficiaries will need to be able to demonstrate that they have had a sufficiently certain interest in the entity issuing the exploration credits for a long enough period to meet the test to be a qualified person in relation to the hypothetical equivalent franked distribution (see sections 207-145 and 207-150 of the ITAA 1997).
6.50 As a result, the benefit of the EDI will generally not be available to beneficiaries or objects of discretionary trusts as these beneficiaries are not able to demonstrate such an interest. However, a specific exception applies for the beneficiaries of trusts that are the subject of a family trust election; special rules apply that allow such beneficiaries to be treated as qualified persons (see former section 160APHT of the ITAA 1936). An exemption also applies in certain circumstances for certain small shareholders (see former sections 160APHT and 160APHU of the ITAA 1936).
6.51 Beneficiaries will also not receive the benefit of the EDI to the extent they would be exempt from income tax on the amount of the hypothetical franked distribution, or if they have engaged in conduct that would amount to dividend washing (see section 207-157 of the ITAA 1997).
Example 6.2 Continuing from Example 6.1, as RK Family Trust has made a valid family trust election, Rob would be a qualified person in respect of a hypothetical equivalent dividend and so is be taken to be entitled to a share of the exploration credits.However, if RK Family Trust had not made a family trust election he may not have been entitled to a tax offset in relation to an equivalent franked distribution that flowed indirectly to him through RK Family Trust as a result of the integrity rules in Division 207 of the ITAA 1997 and therefore he would not have been entitled to any share of the exploration credits.
6.52 Trusts or partnerships that pass on the benefit of exploration credits they receive to their members must report this to the Commissioner in the approved form. This allows the Commissioner to ensure compliance with the EDI rules through data matching. It also provides the Commissioner with information about taxpayers potentially receiving the offset so that the Commissioner may provide targeted assistance should this be considered necessary (for example, it could be used to pre-fill individual income tax returns with entitlements to the EDI should the Commissioner consider this feasible, practical and appropriate). [Schedule 6, item 2, subsection 418-20(5) of the ITAA 1997]
Trusts that are taxed on income in the trust but are not corporate tax entities
6.53 In certain circumstances trusts (or more specifically, the trustee of the trust) may be obliged to pay tax on the income of the trust rather than, or in addition to, the income being attributed to beneficiaries. This can include, for example, cases where the beneficiary is under a legal disability.
6.54 To the extent that the income of the trust is income of this sort, the trust is entitled to a relevant proportion of the EDI tax offset as a refundable tax offset. [Schedule 6, item 2, subparagraph 418-10(1)(b)(ii) and section 418-30 of the ITAA 1997)]
6.55 However, the offset is not available to the trust to the extent a member has been made entitled to a share of the exploration credit, as outlined in paragraph 6.37.
6.56 The offset is only available in cases where the trustee is taxed on this income as if the trustee were an Australian resident individual and the beneficiary is also an Australian resident individual.
Exploration development incentive tax offset - tax treatment
6.57 Unlike franking credits, no amount is included in a taxpayer's assessable income due to the receipt of the EDI tax offset or the exploration credit.
Exploration development incentive - corporate tax entities
6.58 Corporate tax entities are generally not entitled to the EDI tax offset even where they receive exploration credits.
6.59 Unlike trusts or partnerships, corporate tax entities are not flow-through entities and are subject to tax on their own behalf. However, to reduce double taxation of corporate profits, corporate tax entities are entitled to franking credits where they pay tax or receive franking credits from investments in other corporate tax entities, which they can pass on to their members.
6.60 Due to the operation of the imputation system, providing corporate tax entities with a tax offset provides limited benefits to their members.
6.61 Instead of providing corporate tax entities that receive an exploration credit with an EDI tax offset or allowing them to transfer the exploration credit to their members, they instead receive the same amount as a franking credit in their franking account, arising at the time that the exploration credit is issued.
6.62 Providing the benefit of the EDI in this way allows it to be readily passed on to members of corporate investors without the significant compliance burden that would arise from the creation of a new system to allow for companies to retain and distribute exploration credits. [Schedule 6, item 2, section 418-50 of the ITAA 1997]
Example 6.3 Antony is the sole shareholder in AP Ltd, an Australian resident company. AP Ltd holds a number of the ordinary shares in Grieg Explorations Ltd, a greenfields minerals explorer.In May 2016, Greig Explorations Ltd issues $120 in exploration credits to AP Ltd.As AP Ltd is a corporate tax entity. that is not a life insurance company. it is not entitled to receive an EDI tax offset. However, as AP Ltd meets all of the other requirements to receive the EDI tax offset, it is entitled instead to receive a franking credit equal to the amount of the exploration credits it has received.In June 2016, AP Ltd declares a dividend and pays a distribution to Antony. Assuming the other franking requirements are met, it may use the franking credit that arose from its receipt of the exploration credits to frank this distribution, and provide Antony with a tax offset equal to the amount to the franking credit he received.
6.63 Corporate tax entities that are life insurance companies are only entitled to a franking credit in respect of an exploration credit to the extent that they are not entitled to the EDI tax offset in respect of the credit. [Schedule 6, item 2, section 418-55 of the ITAA 1997]
6.64 That is, consistent with their treatment for imputation, life insurance companies obtain a franking credit in respect of that proportion of a exploration credit they receive attributable to investments they hold on their own behalf, while being entitled to a refundable tax offset in respect of that proportion of an exploration credit they receive that is attributable to investments they hold for their policy-holders.
Creating and issuing exploration credits
Eligibility to issue exploration credits
6.65 Broadly, as outlined above, taxpayers may be entitled to the EDI if they receive an exploration credit or credits.
6.66 Schedule 6 to this Bill provides that exploration credits can be created and distributed in an income year by an entity that was a greenfields minerals explorer in the previous income year.
6.67 However, an entity cannot create exploration credits in an income year (the creation income year) unless they have reported their estimated exploration expenditure and estimated tax loss for the prior income year to the Commissioner in the approved form by 30 September of the financial year corresponding with the creation income year and the Commissioner declared the modulation factor for the credits to be created in that income year. [Schedule 6, item 2, section 418-70 of the ITAA 1997]
6.68 The reporting requirement ensures that the annual caps on the total financial impact of the EDI can operate. See paragraphs 6.119 to 6.127 for a detailed discussion of these caps and this requirement.
6.69 Participation in the EDI by greenfields minerals explorers is completely optional at all stages. An entity that meets the requirements to be a greenfields minerals explorer may choose not to participate at all, may choose to report its estimated expenditure and tax loss for an income year to the Commissioner but then choose not to create credits or even choose to report and create exploration credits but not issue them (though the latter choice may be disadvantageous for the entity).
Greenfields minerals explorer
6.70 A greenfields minerals explorer for an income year is an entity that has not carried on any mining operations during the income year or over the immediately preceding income year. Further, no mining operations may have been carried out during this period by another entity that is connected with or an affiliate of the first entity. Consistent with the existing use of the term in paragraph 40-730(7)(a) of the ITAA 1997, mining operations carries its ordinary meaning. [Schedule 6, item 2, section 418-75 of the ITAA 1997]
6.71 'Connected with' and 'affiliate' are both defined within the existing tax law. Broadly, they apply to entities that control the first entity, are controlled by a third entity that also controls the first entity or which the first entity itself controls (see Subdivision 328-C of the ITAA 1997). In this context control may be direct or indirect.
6.72 These limitations reflect that the concession is intended to benefit small mineral exploration companies with limited revenue. Companies that have established mining operations will not be able to access this incentive. The purpose of the EDI is to assist entities obtain capital to support greenfields exploration and prospecting, reflecting the particular challenges faced in obtaining capital at this stage of the life cycle of a project when returns are highly speculative. Once entities that have identified mineral resources and commenced mining operations, their ability to raise funds is significantly improved and they are no longer in need of the support of the EDI. Further, they are no longer engaging in greenfields exploration or prospecting which is what the EDI is intended to support. As a result where an entity has recently been engaged in mining operations it will not be entitled to be a greenfields mineral explorer and access the EDI.
6.73 Similarly, entities that may themselves be small but which form part of a larger grouping of entities, some of which engage in mining, will not and are not intended to be able to participate in the EDI. While these entities may themselves be small, they are part of a wider economic structure that includes entities that have found or are in the process of exploiting known mineral resources. Again, where an entity is part of a wider economic structure that has recently been engaged in mining operations it will not be entitled to be a greenfields minerals explorer and access the EDI.
6.74 A greenfields minerals explorer must also be a disclosing entity (within the meaning of section 111AC of the Corporations Act 2001) and a constitutional corporation. [Schedule 6, item 2, paragraphs 418-75(1)(b) and (c) of the ITAA 1997]
6.75 The requirement that a greenfields minerals explorer be a disclosing entity is intended to achieve two purposes. First, it targets the concession to entities that are seeking to raise capital from the general public, maximising the potential effect of the incentive (and reducing the scope for manipulation that might apply for closely-held entities). Secondly, it also excludes the need to establish a new reporting regime for greenfields minerals explorers - instead companies will be able to provide the same information for the purposes of the EDI and Corporations Act 2001.
6.76 The requirement that the entity be a constitutional corporation ensures that a refund of the EDI tax offset is appropriately supported by the constitutional powers of the Commonwealth.
6.77 Finally, a greenfields minerals explorer must incur greenfields minerals expenditure in the relevant income year. [Schedule 6, item 2, paragraph 418-75(1)(a) of the ITAA 1997]
Greenfields minerals expenditure
6.78 Expenditure related to exploration and development of mineral resources is already subject to a number of concessions and special rules in the income tax law.
6.79 Amongst other things, entities are generally entitled to immediately deduct all expenditure incurred on exploration and prospecting (section 40-730 of the ITAA 1997). While the purpose of this provision is to ensure that entities are able to immediately deduct capital expenditures which otherwise would not be immediately deductible, it applies to all expenditure for exploration or prospecting, whether capital or revenue, other than those relating to depreciating assets (see paragraphs 7.7 to 7.28 of the explanatory memorandum to the New Business Tax System (Capital Allowances) Bill 2001) and subject to the rules around amounts that would be able to be deducted under a number of provisions.
6.80 A list of the activities that are included in the definition of exploration and prospecting is set out in subsection 40-730(4) of the ITAA 1997. While this list is not exhaustive, it does detail the principal types of qualifying expenditure. Not included is administrative expenditure. Section 40-730(1) is quite specific that the deduction it provides extends only to expenditure on exploration and prospecting, not related expenditure such as administration costs.
6.81 Entities are also generally entitled to immediately deduct the cost of depreciating assets used in these activities (see sections 40-25 and 40-80 of the ITAA 1997, noting changes made in relation to mining information by the Tax and Superannuation Laws Amendment (2014 Measures No. 3) Act 2014).
6.82 Schedule 6 provides that an entity's greenfields minerals expenditure will be the sum of the amounts that it can deduct, that are amounts of expenditure on exploration and prospecting for minerals (but not petroleum or oil shale) of a sort described in subsection 40-730(1) which also meets the conditions set out in that subsection. [Schedule 6, item 2, paragraph418-80(1)(b) of the ITAA 1997]
6.83 In some cases an amount may be potentially deductible under both subsection 40-730(1) and another provision in the ITAA 1997, such as the general deduction provisions (section 8-1) or the specific deduction for making a loss from a profit making undertaking or plan (section 25-40). In this case the amount will be deductible under only the most appropriate provision - see section 8-10 of the ITAA 1997.
6.84 The EDI is intended to cover all exploration expenditure, whether or not it is deductible as a result of section 40-25, 40-730 or another provision of the tax law if that provision overlaps with section 40-730. To ensure this, the greenfields minerals expenditure includes all amounts of expenditure that:
- are deductible; and
- meets the description and in relation to which the entity satisfies requirements of subsection 40-730(1), regardless of whether this provision is the one that makes them deductible.
6.85 Consistent with the discussion in paragraph 6.80, this means that greenfields minerals expenditure includes amounts of expenditure of the sort set out in subsection 40-730(4), but does not include administration costs and similar expenditure that, while it may be related to the activities of the entity, is not expenditure on exploration and prospecting.
6.86 This also means that if an amount would be deductible under subsection 40-730(1), but is not deductible because of some other provision, the relevant amount is not greenfields minerals expenditure.
6.87 Greenfields minerals expenditure is also defined to include all deductions for declines in value of depreciating assets used in exploration and prospecting which are immediately deductible because of section 40-80 of the ITAA 1997. [Schedule 6, item 2, paragraph 418-80(1)(a) of the ITAA 1997]
6.88 However, there are a number of qualifications on what exploration expenditure will constitute greenfields minerals expenditure to ensure that amounts are sufficiently connected to exploration and prospecting in greenfields areas.
6.89 First, the expenditure must be incurred in an eligible greenfields area - that is, an area within the land territory of Australia where the entity holds a suitable right or interest and in which minerals of the sort being explored for have not already been identified. [Schedule 6, item 2, subsection 418-80(3) of the ITAA 1997]
6.90 These exclusions reflect various policy considerations. Encouraging exploration outside Australia is not within the scope of the EDI and so expenditure in relation to such activities is excluded. Similarly, as the EDI is not targeted to exploration for petroleum, which is the only significant form of offshore exploration, exploration expenditure incurred in relation to Australia's sea and seabed territory is excluded.
6.91 The EDI is also not intended to benefit contractors and similar entities who incur exploration expenditure as part of providing a service to another entity and so only expenditure incurred in relation to an area over which the entity holds a mining, quarrying and prospecting right will count as exploration expenditure. In this context, it is important to note that mining, quarrying and prospecting right has a very wide definition. It includes not just any sort of right or licence under an Australian law, but also a lease permitting prospecting for minerals and any sort of interest in a right, permit or lease. This means that it includes farm-in, farm-out arrangements and other forms of contingent interests in the underlying right.
Example 6.4 Big Co is a large multinational mining company. Amongst its other assets, it holds an exploration licence in relation to Area A. It has undertaken preliminary exploration activities in Area A and, based on the results from these activities, has decided that pursuing further exploration in that area is a low priority.Small Co is a small mineral exploration company. It is interested in exploring within Area A. Big Co and Small Co reach an agreement under which Big Co agrees to transfer Small Co a part of Big Co's interest in Area A after one year if Small Co undertakes agreed exploration and prospective activities in Area A over that period.The agreement with Big Co provides Small Co with a contingent interest in the exploration licence for Area A held by Big Co. This interest meets the definition of a mining, quarrying and prospecting right under the ITAA 1997. If Small Co is a greenfields mineral explorer and its expenditure in relation to Area A meets the other requirements, this expenditure may be greenfields minerals expenditure.
6.92 The EDI is intended to support greenfields exploration - it is targeted to initial speculative activities where capital constraints are likely to be particularly acute. Even once a mineral resource has been identified, there is considerable work to be done in developing the identified resource into a mining operation. However, at this stage, raising capital is quite a different proposition, and assistance in the form of the EDI is less warranted. As a result, the EDI does not apply to expenditure in relation to an area where the existence of a mineral resource has been identified. In most cases, a mineral resource will be considered to have been identified where it has been identified as at least an inferred mineral resource in a report complying with the Australasian Code for Reporting of Exploration Results, Minerals Resources and Ore Reserves (commonly referred to as the JORC Code). However, an alternative standard may be specified by regulations.
6.93 However, this restriction does not apply in respect of expenditure incurred in relation to a resource of a different sort to those identified in the report. [Schedule 6, item 2, subsection 418-80(4) of the ITAA 1997]
6.94 While most entities engaged in exploration will generally have significant market incentives to prepare reports that comply with the JORC code (and in some cases may be required to do so by their market disclosure obligations) the tax law does not generally oblige them to do so.
6.95 However, these amendments do provide the Commissioner with the power to request that an entity that is a greenfields minerals explorer prepare a report that complies with the JORC code. The Commissioner is only expected to request such a report where he or she is of the opinion that an inferred mineral resource has been identified and the EDI is not intended to support the ongoing activities of the entity. [Schedule 6, item 2, subsection 418-80(5) of the ITAA 1997]
6.96 If a greenfields minerals explorer does not prepare a such report in the manner, form and time required by the Commissioner (including for example, having the competent person for the report being an independent person) the entity will cease to be a greenfields minerals explorer for the current income year and future income years. [Schedule 6, item 2, subsection 418-75(2) of the ITAA 1997]
6.97 This power ensures the Commissioner can prevent an entity from obtaining an undue benefit by deliberately delaying quantifying the extent of its mineral discoveries.
6.98 Secondly, amounts of deductions will not be permitted to the extent that they relate to activities that are outside of the purpose of the EDI. [Schedule 6, item 2, subsection 418-75(2) of the ITAA 1997]
6.99 As a result, where an amount is, for example, an amount of expenditure in part for exploration and prospecting for minerals, but also for some other purpose, the amount of the deduction is included as greenfields minerals expenditure only to the extent that it relates to exploration and prospecting for minerals.
6.100 Likewise, reflecting the particular policy of the EDI, certain limits are placed on the types of minerals and exploration activities to which deductions must relate to to be greenfields minerals expenditure. As a result, amounts deductible in relation to expenditures solely for the purpose of identifying the viability, as opposed to the existence, quantity, quality or location of a resource, such as feasibility studies, are also excluded even where they fall within the boundaries of expenditures deductible under subsection 40-730(1). While these activities are an important part of the development of mining projects, they represent a step beyond the initial exploratory stage of expenditure that the EDI is targeted to support.
6.101 Similarly, amounts deductible in relation to exploration and prospecting for petroleum (or oil shale, which is used for the production of petroleum) are, to this extent, not greenfields minerals expenditure, despite petroleum being included in the definition of minerals under the income tax law.
Entities with substituted accounting periods
6.102 Some entities have an income year that does not correspond with the financial year.
6.103 Substituted accounting period entities are able to access the EDI in the income years in which it is available, in the same way as entities with a standard reporting period - that is, they may create exploration credits in the 2015-16, 2016-17 and 2018-19 income years based on their estimated and actual tax loss and greenfields minerals expenditure in the previous income year (the 2014-15, 2015-16 and 2016-17 income years respectively). It is not relevant that the income years for these taxpayers cover different dates than the income years of taxpayers with a standard reporting period.
6.104 The required dates for reporting, creating and issuing credits and other actions under the EDI are the same for all entities, including entities with a substituted accounting period. This means that, for example, all entities that wish to create exploration credits in the 2015-16 income year must report their estimated greenfields minerals expenditure and tax loss for the prior (2014-15) income year by 30 September 2015. This is the case even for those entities with a substituted account period whose 2014-15 income year may not have ended. For these entities, an estimate will be required in relation expenditure they still expect to incur during the remainder of their income year.
Creating exploration credits - amounts and consequences
6.105 Entities that are greenfields minerals explorers may choose to create exploration credits in an income year. The amount of an entity's tax loss for the previous income year is reduced to reflect the amount of the exploration credits it creates. [Schedule 6, item 2, section 418-95 of the ITAA 1997]
6.106 The amount of the credits an entity chooses to create must not exceed its maximum exploration credit amount, which is the smallest of its:
- estimated tax loss for the prior income year reported to the Commissioner (see paragraph 6.67);
- estimated greenfields minerals expenditure for the prior income year reported to the Commissioner (see paragraph 6.67);
- actual tax loss for the prior income year; and
- actual greenfields minerals expenditure for the prior income year,
multiplied by the corporate tax rate for the prior income year and the modulation factor declared by the Commissioner.
[Schedule 6, item 2, subsections 418-85(1) and (2) of the ITAA 1997]
6.107 There are two components to the maximum exploration credit amount. First, entities may only issue credits up to the amount of the lesser of their tax loss or greenfields minerals expenditure in the prior income year. As outlined previously, the purpose of the EDI is to allow small mineral exploration companies to transfer the benefit of that part of their tax loss that arose from exploration to their shareholders. Allowing them to exceed the amount of either their tax loss or their exploration expenditure would provide a greater and unintended benefit not related to greenfields exploration.
6.108 Secondly, the amount of exploration credits an entity may issue must not exceed the estimates of its loss and expenditure in the prior income year that it has provided to the Commissioner (see paragraph 6.67). This ensures that the modulation process operates correctly and applies fairly to all participants.
6.109 Any credits the entity creates above its maximum exploration credit entitlement are excess exploration credits.
6.110 In some circumstances an entity will incur a deductible amount of expenditure in one income year for which it is subsequently reimbursed, in what is referred to as a assessable recoupment (see Subdivision 20-A of the ITAA 1997). The amount of any recoupment which gave rise to a deduction is generally included in the taxpayer's assessable income in order to ensure the taxpayer does not benefit from an expense that they did not ultimately bear.
6.111 Similarly, there are circumstances in which an entity will become entitled to obtain a deduction in respect of the decline in value of an asset then, subsequently dispose of the asset or otherwise cease to use the asset in a way that would result in the entity no longer bearing the full cost of the asset for which they claimed a full deduction. In these cases the entity will need to include an amount in their assessable income, referred to as a balancing adjustment which has the effect of reducing the deduction.
6.112 If an entity receives a recoupment or has a balancing adjustment in respect of an entity's greenfields minerals expenditure for an income year, the entity's actual loss and actual greenfields minerals expenditure for that income year must be reduced by the amount of the recoupment or balancing adjustment. This ensures that the entity is not able to obtain a benefit from losses or outgoings that it has not ultimately borne and is not able to transfer losses which are effectively recouped in a later year. [Schedule 6, item 2, subsections 418-85(3), (4) and (5) of the ITAA 1997]
6.113 There are also circumstances in which an entity may have incurred a tax loss in respect of an income year but may no longer be able to make use of this loss. [Schedule 6, item 2, subsections 418-85(3) and (4) of the ITAA 1997]
6.114 This can occur where there is a change in ownership or control of the entity or a change in the entity's activities that results in the entity ceasing to satisfy the continuity of ownership and control tests and the same business test during the period between when the expenditure is incurred and the end of the income year in which credits are created (see Divisions 165 and 166 of the ITAA 1997).
6.115 It may also occur where an entity became part of a consolidated group after incurring the expenditure. In this situation, while the group is treated as a single entity for most income tax purposes, including the EDI, the group's access to the losses of the entity may be limited (see Division 707 of the ITAA 1997 on losses transferred into a consolidated group and the available fraction). A further case where an entity may not be able to fully access its losses is where the entity has earned exempt income in the income year in which the credit is created (see Division 36 of the ITAA 1997).
6.116 Where an entity does cease to be able to access some or all of its losses for the prior year, it must accordingly reduce its actual loss for that year for the purposes of determining its maximum exploration credit amount. [Schedule 6, item 2, section 418-95 of the ITAA 1997]
6.117 In the case of losses, unlike recoupments and balancing adjustments, there are no consequences if an entity ceases to be able to use a loss for an income year after the income year in which the entity creates exploration credits.
6.118 If as a result of a recoupment, balancing adjustment or a loss ceasing to be able to be utilised, an entity has a lower maximum exploration credit amount for that income year, any credits the entity creates or has created above this reduced amount will be excess exploration credits and the entity will be subject to excess exploration credit tax which seeks to claw back the excess tax benefits passed onto to shareholders.
Creating exploration credits - the modulation factor
6.119 The total financial impact of the EDI is capped for each of the three income years in which it operates. This global cap is implemented by imposing a limit on the value of the exploration credits entities may issue, based on the total value of exploration credits that could be issued by all entities in that year. Schedule 6 provides that this limit, referred to as the modulation factor, is to be determined by the Commissioner. [Schedule 6, item 2, step 3 in the method statement in subsection 418-85(2) and section 418-90 of the ITAA 1997]
6.120 As the modulation factor will affect the amount of exploration credits that can be created, no entity can create exploration credits in an income year before the modulation factor for that year has been declared by the Commissioner.
6.121 The Commissioner will determine the modulation factor as soon as practicable after the date entities are required to report their estimates of their tax loss and greenfields minerals expenditure (30 September of the relevant financial year). It is expected that this will be done by the Commissioner as soon as is practicable after entities report their estimates, and no later than 1 January of the relevant financial year.
6.122 As the modulation factor must be set at a level to ensure the total amount of exploration credits issued does not exceed the cap, it can only be determined once the full value of the exploration credits that can be claimed is known. Determining this based on entities' actual loss and expenditure for an income year would require deferring the issue of the modulation until all greenfields minerals explorer have received their income tax assessment for the relevant income year. This would result in a very significant lag in the issuing of credits.
6.123 To reduce this lag, the cap is instead based on entities' estimates of their tax loss and greenfields minerals expenditure for the relevant income year, which must be reported to the Commissioner by 30 September in the financial year corresponding with the following income year. However, for the cap to be effective when determined using estimated tax losses and expenditure, the amount of exploration credits that can be created must also be no greater than the amount of these estimates.
6.124 The Commissioner's declaration of the modulation factor for an income year is a legislative instrument, but is not subject to disallowance. The declaration is essentially the result of a mechanical calculation by the Commissioner. More significantly, the modulation factor has immediate consequences for commercial and corporate arrangements. Revising or withdrawing the modulation factor after entities have begun the process of creating or issuing credits would undermine these arrangements and potentially expose taxpayers to significant compliance costs and penalties in respect of something that is wholly beyond their control. Therefore, it is not appropriate for the legislative instrument to be subject to Parliamentary disallowance. [Schedule 6, item 2, subsection 418-90(6) of the ITAA 1997]
6.125 To protect taxpayers from similar issues in the event of an error by the Commissioner, the validity of the Commissioner's declaration of the modulation factor for an income year is not affected if the Commissioner errs in complying with the exact technical process set out for the calculation of the modulation factor. [Schedule 6, item 2, subsection 418-90(5) of the ITAA 1997]
6.126 The choice whether or not to create exploration credits for an income year must be made on or before 30 June of the financial year corresponding with the income year. The choice is final and irrevocable - if a taxpayer chooses to create credits of a particular amount, or does not choose to create credits by the relevant 30 June, it is not possible to subsequently change this decision. Greenfields minerals expenditure that is not used to create exploration credits cannot be carried forward for the purpose of creating credits in subsequent income years. [Schedule 6, item 2, subsection 418-70(5) of the ITAA 1997]
6.127 Ensuring the decision to create credits cannot be revised or undone, ensures that the entitlements of recipients of exploration credits will be fixed and avoids the complexities and potential abuses that might result from the creation of exploration credits at different times in an income year. It also minimises compliance costs for greenfields minerals explorers and their members as well as administration costs for the Commissioner.
Example 6.5 GME Co is a publicly listed mineral exploration company that holds a number of exploration licences covering areas of South Australia.In 2014-15, GME Co incurs significant expenditure exploring for minerals in the areas covered by its exploration licences.GME Co decides that it may wish to access the EDI in respect of its exploration expenditure in 2014-15. It identifies that it is a greenfields minerals explorer for 2014-15 as at no time in the past year has GME Co or any of its connected or affiliated entities carried on any mining operations and it meets all other requirements to be a greenfields minerals explorer.To ensure it is eligible to access the EDI and issue credits in respect of this expenditure in 2014-15, GME Co must also report its estimated tax loss and greenfields minerals expenditure for 2014-15 to the Commissioner by 30 September 2015. On 28 September 2015, GME Co declares to the Commissioner that its estimated tax loss and greenfields minerals expenditure for 2014-15 are $1.2 million and $1 million respectively.On 1 December 2015, the Commissioner determines the modulation factor for exploration credits issued in 2015-16 to be 0.5. Following this, on 1 December 2015, GME Co lodges its tax return for 2014-15 and receives its assessment. Consistent with its estimate, GME Co has a tax loss of $1.2 million and has incurred greenfields minerals expenditure of $1 million.As a result, GME Co's maximum exploration credit amount is $150,000. This amount is the product of the least of its actual and estimated tax loss and greenfields minerals expenditure in 2014-15 ($1,000,000), the corporate tax rate for 2014-15 (0.3) and the modulation factor determined by the Commissioner (0.5).GME Co chooses to create exploration credits up to its maximum exploration credit amount - $150,000. As a result of creating these credits GME Co foregoes an equivalent amount of its tax loss for 2014-15 - $500,000 (calculated as the amount of exploration credits created ($150,000) divided by the corporate tax rate for the relevant income year (0.30)).
Issuing exploration credits
6.128 An entity that has created exploration credits may choose to issue some or all of those exploration credits to its shareholders whose shares are equity interests (shareholders) (see the rules for debt and equity interests in Division 974 of the ITAA 1997). [Schedule 6, item 2, section 418-110 of the ITAA 1997]
6.129 If the entity does choose to issue exploration credits, the amount issued to each shareholder must be in proportion to the number of shares in the entity that are equity interests (shares) the shareholder holds as a proportion of the total equity shares in the entity. [Schedule 6, item 2, section 418-120 of the ITAA 1997]
6.130 Unlike access to franking credits, the issue of exploration credits to shareholders is not linked to a distribution out of profits. As a result, the rules that generally apply around the distribution of profits under the Corporations Act 2001 do not apply to the issuing of exploration credits.
6.131 In the absence of any link to the rules applying to distributions, Schedule 6 requires exploration credits be issued strictly in proportion to the number of shares that each shareholder holds. This results in a straightforward method of allocation amongst the entities that participate in the economic risk of exploration.
6.132 One exception applies to this rule. Before an entity issues any exploration credits, it may elect to restrict the availability of the EDI to shares issued on or after 1 July 2014.
6.133 The principal purpose of the EDI is to provide an incentive for investment. This purpose could be achieved by restricting the incentive to new capital issued after the incentive has been announced.
6.134 However, the compliance costs associated with this approach may be significant - at a minimum, greenfields minerals explorers would need to arrange for separate listing or trading of pre-EDI and post-EDI interests. Taking into account these compliance costs, exploration credits generally must be issued to all entities holding shares in the greenfields minerals explorer.
6.135 Some entities, though, may consider bearing these costs to be worthwhile given the additional incentive confining the EDI to new capital provides for new investment. To accommodate these cases, Schedule 6 provides greenfields minerals explorers with the option to choose for the incentive to be available only for shares issued on or after 1 July 2014. To avoid ongoing complexity, this choice is irrevocable and must be made before an entity has ever issued any exploration credits. [Schedule 6, item 2, section 418-115 and paragraph 418-120(1)(a) of the ITAA 1997]
6.136 Entities that issue exploration credits must notify the Commissioner in the approved form. If the entity is an investment body under section 202D of the ITAA 1936 this notification must be provided at the same time as the annual investment income report for the entity. Otherwise, the notification must be lodged at the same time as the entity's income tax return for the relevant income year. [Schedule 6, item 2, section 418-130 of the ITAA 1997]
6.137 Exploration credits that are created but not issued before 30 June in the financial year corresponding with the income year in which they are created cease to exist. The expiry of a credit means that it cannot be issued, but does not undo the effect the creation of the credit had on the entity's tax loss or any of the consequences that arose from the creation of the exploration credit. This ensures fairness amongst entities participating in the EDI. [Schedule 6, item 2, section 418-125 of the ITAA 1997]
6.138 Entities must also report to the Commissioner on any exploration credits they create which expire. [Schedule 6, item 2, section 418-130 of the ITAA 1997]
Example 6.6 Continuing from Example 1.4, GME Co chooses to issue the $150,000 of exploration credits it has created to its shareholders on 1 June 2016.GME Co has only one class of shares, with 6 million shares on issue. Its shares are held by a number of entities, including Investor Co, which holds 300,000 shares.GME Co must issue exploration credits to shareholders in proportion to the fraction of the total shares in GME Co that they hold.This means that Investor Co receives $7,500 of exploration credits or 5 per cent of the total of $150,000 of credits as it holds 5 per cent of the issued shares of GME Co (300,000 out of 6 million).As Investor Co is a corporate tax entity, it is not entitled to claim a tax offset in respect of the credits in its tax return for the 2015-16 income year. Instead, when Investor Co receives the exploration credit (1 June 2016), it receives a credit in its franking account equal to the amount of the exploration credit ($7,500).After distributing exploration credits, GME Co must report to the Commissioner in the approved form on or before the date when it must lodge its annual investment income report for 2015-16 - which is likely to be 31 October 2016 (subject to the Commissioner providing otherwise).
Excess exploration credit tax
6.139 Under the provisions set out in Schedule 6, entities may not issue exploration credits in excess of the maximum exploration credit amount.
6.140 However, breaches of the cap can occur for a number of reasons. In some cases the breach may not be identified for a number of years - for example, if the entity made an error in determining its tax loss for the income year that was only identified in a subsequent audit by the Commissioner.
6.141 Where such a breach of the cap is found, it would generally be inappropriate to penalise the recipients of these credits for matters that are generally entirely beyond their control (however, different circumstances may be triggered where the general anti-avoidance rules applies). Instead, where it is identified that excess exploration credits have been issued, the entity that issued credits in excess of its cap will be subject to excess exploration credit tax on the amount by which the cap for the relevant year was exceeded. [Schedule 6, item 2, subsection 418-85(6) and section 418-150 of the ITAA 1997, and the Excess Exploration Credit Tax Bill 2014]
In May 2016, SP Ltd determined that, for the 2014-15 income year, it had an actual tax loss of $100,000 and actual minerals exploration expenditure of $125,000. In its report to the Commissioner, it had estimated its tax loss to be $110,000 and its mineral exploration expenditure to be $150,000.Based on these figures, and the Commissioner's determination of a modulation factor of 0.5 for 2015-16, SP Ltd works out its maximum exploration credits amount for 2015-16 to be $15,000, calculated as the product of:
6.142 Rather than introducing a new assessment regime, Schedule 6 includes excess exploration credit tax in the general tax assessment regime set out in Division 155 in Schedule 1 to the Taxation Administration Act 1953 (TAA 1953). [Schedule 6, items 30 and 31, paragraph 155-5(2)(g) and item 4 in the table in subsection 155-15(1) in Schedule 1 to the TAA 1953]
6.143 Excess exploration credit tax will operate on a full self-assessment basis, broadly consistent with the franking deficit tax. An entity that incurs a liability for excess exploration credit tax in a year must provide the Commissioner with an excess exploration credit tax return in the approved form within 21 days of the end of the financial year corresponding with the income year. [Schedule 6, item 2, section 418-160 of the ITAA 1997]
6.144 This return will give rise to an assessment of this amount, which will be payable at the same time as lodgement. The Commissioner is generally able to amend this assessment for up to four years after the assessment has been deemed to be made (see Subdivision 155-B in Schedule 1 to the TAA 1953). [Schedule 6, items 30 and 31, paragraph 155 5(2)(g) and item 4 in the table in subsection 155-15(1) in Schedule 1 to the TAA 1953]
6.145 Underpayments of excess exploration credit tax will be subject to the shortfall interest charge until the underpaid amount is included in an amended assessment. Likewise, if any amount of the liability remains unpaid after the due date for payment of excess exploration credit tax for an income year, the general interest charge will apply in respect of the unpaid excess exploration credit tax (and any unpaid shortfall interest charge) until the tax and interest is paid. [Schedule 6, items 2 and 33, sections 418-165 and 418-170 of the ITAA 1997 and section 280-101 in Schedule 1 to the TAA 1953]
6.146 Overpaid amounts of excess exploration credit tax are treated in the same way as overpayments of income tax under section 172 of the ITAA 1936. That is, they can be applied against other tax debts, allocated to a running balance account of the taxpayer or refunded. [Schedule 6, item 2, section 418-175 of the ITAA 1997]
6.147 Taxpayers are required to keep the same records for the purposes of the excess exploration credit tax as they are under section 262A of the ITAA 1936 for income tax. [Schedule 6, item 2, section 418-180 of the ITAA 1997]
Additional consequences of issuing excess exploration credits
6.148 A variety of additional consequences may apply in circumstances where a taxpayer incurs a liability for excess exploration credit tax.
6.149 In particular, the amendments provide that the amount of excess exploration credit tax is also a shortfall amount for the purposes of the administrative penalties provisions of the Division 284 in Schedule 1 to the TAA 1953.
6.150 To the extent an entity has a shortfall amount that has arisen due to a failure to take reasonable care, recklessness or intentional disregard of the tax law, the entity is liable for administrative penalties. As a result, where an entity incur excess exploration credit tax they may also be liable for administrative penalties. [Schedule 6, item 36, item 5 in the table in subsection 284-80(1) in Schedule 1 to the TAA 1953]
6.151 Schedule 6 also provides that the Commissioner may, by written notice, determine that an entity that has incurred a liability for excess exploration credit tax will no longer be a greenfields minerals explorer and may no longer participate in the EDI. This determination has effect for exploration credits issued after the notice of the determination has been received by the entity. [Schedule 6, item 2, subsection 418-75(2) and section 418-185 of the ITAA 1997]
6.152 It is expected in exercising this discretion that the Commissioner will take into account the circumstances in which the excess exploration credits were created and the degree of the entity's culpability (or lack thereof). Factors that are likely to suggest that the discretion should not be exercised are that the amount was small, the error occurred despite the entity taking reasonable care and the entity reported the error to the Commissioner when it became aware it had occurred. Factors that are likely to suggest that the discretion should be exercised are that the amount of the excess credits was significant relative to the entity's maximum exploration credit amount, the excess arose as a result of a deliberate decision, recklessness or carelessness and the entity did not report error or did not provide appropriate assistance to the Commissioner in identifying or remedying the error.
6.153 The EDI is a concessional regime provided to a very limited class of entity. Similar to other comparable regimes such as the research and development tax incentive, the Commissioner is provided with a power to exclude subsequent access to the scheme by taxpayers who have been identified as seeking to make inappropriate use of the concession. This also protects other genuine participants in the scheme.
Example 6.8 Continuing from Example 1.6, the amounts of SP Ltd's excess exploration credit tax liability would also be a shortfall amount under section 284-80 in Schedule 1 to the TAA 1953.As SP Ltd took reasonable care to comply with its tax obligations, it will not be subject to any administrative penalty as a result of this shortfall amount.If SP Ltd had failed to take reasonable care or had not taken a reasonably arguable position where one was required, or if the shortfall amount had arisen because SP Ltd was either reckless or intentionally disregarded a taxation law, SP Ltd would be subject to an administrative penalty under Division 284 in Schedule 1 to the TAA 1953.Additionally, as SP Ltd has incurred a liability for excess exploration credit tax, the Commissioner has the power to determine that SP Ltd will not be a greenfields minerals explorer for the purposes of subsequent participation in the EDI.The exercise of this power is a matter for the Commissioner's discretion. However, given that in this case the liability arose despite SP Ltd taking all reasonable care, absent further factors it is expected that the Commissioner would not chose to exercise this discretion.
6.154 The Commissioner's determination is subject to merits review in the manner set out in Part IVC of the TAA 1953. [Schedule 6, item 2, subsection 418-185(3) of the ITAA 1997]
6.155 A number of consequential amendments are made to the tax law, especially to guide material, checklists and definitions, to reflect the introduction and operation of the EDI. [Schedule 6, items 2, 16 to20, 22, 24 to 27, 28, 33 and 35 to 36, sections 418-1 and 13-1, item 1 in the table at the end of section 36-25, section 197-42, item 7 in the table in subsection 205-105(1), item 8 in the table in subsection 219-15(2), the definitions of 'annual investment report', 'excess exploration credit tax', 'exploration credit', 'greenfields minerals expenditure', 'greenfields minerals explorer', 'maximum exploration credit amount' and 'tax loss' in subsection 995-1(1) of the ITAA 1997, item 16A in the table in subsection 8AAB(4) of the TAA 1953 and the method statements in sections 45-340 and 45-375, item 38D in the table in subsection 250-10(2), paragraph 280-105(1)(a) and subsections 280-110(1) and 284-80(1) in Schedule 1 to the TAA 1953]
Application and transitional provisions
6.156 The measure applies to greenfields minerals expenditure for the 2014-15, 2015-16 and 2016-17 income years, allowing the distribution of credits in the 2015-16, 2016-17 and 2017-18 income years. [Schedule 6, item 73]
6.157 The amendments will be automatically repealed following the general expiry of the income tax amendment period. [Schedule 6, items 38 to 72]
6.158 However, the operation of the repealed law will be preserved in relation to the period of the law when the EDI applied. [Schedule 6, items 74 to 79]
6.159 Contingent amendments are also included to take into account changes proposed by the Treasury Legislation Amendment (Repeal Day) Bill 2014. [Schedule 6, items 21 and 23, subparagraphs 418-80(2)(b)(ii) and (iii) and the definition of 'annual investment income report' in subsection 995-1(1)]
REGULATION IMPACT STATEMENT
6.160 On 3 September 2013, the Coalition made an election commitment to introduce an Exploration Development Incentive to encourage investment in small exploration companies undertaking greenfields mineral exploration in Australia. The incentive applies to eligible exploration from 1 July 2014 and will provide refundable tax offsets to Australian resident shareholders of small mineral exploration companies for Australian greenfields mineral exploration undertaken by those companies. The scheme will initially apply for three years and its cost capped at $100 million.
Overview of the resource exploration sector
6.161 Resource exploration represents a small share of the Australian economy. However, exploration is important as a precursor to resource development and extraction.
6.162 In 2012-13, exploration expenditure was around $7.8 billion, equivalent to about half of one per cent of gross domestic product (GDP). Resource extraction on the other hand, accounted for around 9 per cent of GDP. 
6.163 The resources sector also accounted for approximately 2-2½ per cent of all employment in Australia in 2011-12, or almost 10 per cent of the total if both direct and indirect employment in the resources sector is taken into account. Employment in resource exploration accounts for 0.2 per cent of national employment.
6.164 The Productivity Commission considers that exploration is broadly classified as greenfields or brownfields. Greenfields exploration is the exploration of unexplored or incompletely explored areas directed at discovering new resources. Brownfields exploration occurs in areas near established resources or in areas where resources have been mined in the recent past, and is mainly focused on proving up reserves or extending existing mining operations. 
6.165 Most greenfields mineral exploration is undertaken by 'junior explorers' with millions of dollars of capitalisation, while large companies with established resource extraction operations, billions of dollars in assets and multinational operations, perform most brownfields exploration.
6.166 The level of greenfields exploration in Australia is generally measured in two ways: expenditure; and metres drilled. While greenfields exploration expenditure has remained relatively stable in real terms over recent years, it has fallen as a proportion of total exploration from 40 to 33 per cent over the last decade. 
6.167 It is important to note that any increase in the level of greenfields exploration expenditure may not translate into a greater level of metres drilled. This is because the average cost per metre drilled has doubled in real terms since the late 1990s.  Similarly, any increase in metres drilled does not necessarily indicate an increase in geographic coverage, but rather may indicate an increase in depth or resource definition; reflecting an increasing focus on the potential for deposits under deep cover.
6.168 The lowest level of greenfields metres drilled in the last decade was in 2013-14 (Diagram 2.1). It is also worth noting that relevant data on greenfields and brownfields exploration was not published by the Australian Bureau of Statistics prior to 2003. A representation of exploration statistics over a longer time period can therefore not be provided.
- Source: Australian Bureau of Statistics (2014). Mineral and Petroleum Exploration, Australia (8412.0 ), Table 2: Mineral exploration (other than for petroleum).
6.169 The Government's election commitment to introduce an Exploration Development Incentive acknowledges that the future prosperity of the mining sector and the Australian economy is dependent on our ability to make new mineral discoveries.  A strong resource exploration sector is the key to replenishing and maintaining a stream of new resource projects.
6.170 Feedback received from consultation suggests that the junior mineral exploration sector in Australia is struggling for two key reasons: a tax disadvantage junior companies face relative to larger mining and exploration companies, and the general difficulty in attracting the capital necessary to conduct greenfields exploration. Some in the sector have argued that these issues constitute a market failure. 
6.171 One problem for junior explorers with no production and therefore no (or little) assessable income, is that they face a tax disadvantage relative to larger mining and exploration companies. These larger companies have assessable income against which exploration expenditures can be claimed as an immediate tax deduction. While a tax deduction allows a company with assessable income to reduce its tax liability, a company will not gain any immediate benefit from its deductions when they exceed its assessable income. The company can only carry forward these deductions as losses at zero interest to offset against future income.
6.172 This difference in tax treatment is a source of non neutrality in the tax system that favours companies with profits against which to offset expenses over companies that accumulate losses they are unable to utilise. Arguably, this area of non neutrality in the tax system has an acute impact on junior exploration companies that may need to wait many years before their losses can be utilised, and many will never generate sufficient income to utilise their losses.
6.173 This effectively makes exploration more expensive for junior explorers, relative to companies with ongoing sources of income (that is, companies with extraction operations), likely reducing the level of greenfields exploration undertaken in the economy.
6.174 Junior explorers' inability to immediately use their deductions also makes them less attractive on the stock market, relative to companies that have income to claim their deductions against and profits for distribution to shareholders. Unlike many other sectors, it is possible for junior exploration companies to post losses for many years. It is important to note this is largely a function of geology and other factors intrinsic to this industry, which are out of the explorer's control. Even a low-cost exploration company with highly-trained personnel face the prospect of simply never discovering a resource of sufficient value to warrant exploitation, given prevailing market prices. The accumulation of these losses, combined with the seemingly low prospect that a junior explorer will ever turn a profit in such a high risk industry, puts these companies in a difficult position in terms of raising capital.
6.175 Junior exploration companies are often funded by small capital raisings through initial public offerings (IPOs). Recent analysis suggests that junior exploration companies are finding it increasingly difficult to attract capital. HLB Mann Judd  writes: While resource stocks have dominated the statistics in recent years, this was not the case in 2013. A combination of falling commodity prices and reduced investor sentiment appear to have had a negative impact on resource IPOs during 2013. There was very little [stock exchange] activity from those companies with market caps of less than $10 million in 2013, with only four companies of this size successfully concluding listings during the year. This has historically been a market position occupied by junior exploration companies and the low volumes reflect the difficult conditions currently facing this sector.
6.176 The 2013 IPO activity continues a downward trend that has been evident for a number of years. In 2011, the amount of capital raised by small capital IPOs on the Australian Securities Exchange (ASX) was 17 per cent lower than in 2010, despite a 10 per cent increase in the number of small capital IPOs on the ASX.  In 2012, the number of small capital IPOs was over 50 per cent lower than in 2011, with capital raised falling by more than 63 per cent on 2011 levels.  As capital becomes more difficult to raise, the negative impact on the level of greenfields mineral exploration in Australia and the sustainability of the broader resources sector will become more pronounced.
6.177 The nature of greenfields exploration, along with several challenges unique to the industry, contributes to the difficulty junior exploration companies face raising capital.
6.178 Greenfields minerals explorers face a significant and unavoidable delay between the time the exploration company is created and exploration activity commences. This delay is further exacerbated by delays usually encountered before revenue can be earned from a new discovery that develops into a commercial resource extraction operation. Once a commercial resource has been discovered, it will typically take at least ten years to convert the deposit into a revenue producing mine. To the typical investor, these delays reflect poorly on junior exploration companies and their ability to turn a profit. In contrast, start-up businesses in other industries can go from concept to operation in the space of a year.
6.179 One of the main differences between junior exploration companies and start-up companies in other sectors is their respective ability to identify, develop and market a saleable product in a timely manner. While market research by both junior explorers and other types of businesses can be undertaken to improve the prospect of selling a product, a junior explorer will not know with any great accuracy the quality or quantity of the product they will be able to provide for some time. Combined with the timeframes outlined above, this can potentially be decades into the future and significantly impact on the risk profile of the company and its attractiveness to potential investors.
6.180 The risks and delays associated with the need to have community acceptance, or a social license to operate, are other factors that arguably impact more on junior exploration companies than companies in other sectors. The perception that exploration companies negatively impact the environment also makes it harder for them to raise capital.
6.181 All of these factors impact on the ability of junior exploration companies to raise the capital needed to undertake greenfields mineral exploration. The amount of investment in exploration affects the ability of Australia's resources sector to sustain strong growth and maintain its contribution to the national economy over the medium to long term.  As most of Australia's major discoveries were made more than twenty years ago, additional investment is required to discover and develop high quality resources that will sustain this contribution.
6.182 In order to attract investment, resource companies generally look for shorter-term revenue streams to satisfy shareholders and investors. For major resource companies, this can mean focusing on existing projects, at the expense of longer-term options such as greenfields investment. The high risk nature of greenfields exploration, coupled with periods when the global capital market is constrained, results in larger organisations seeking to lower the risk in their investment portfolios. This, in turn, means that most greenfields exploration is left to the junior sector. It is estimated that in South Australia, 56 per cent of greenfields exploration was undertaken by junior explorers in 2013.  More anecdotal evidence puts this estimate at up to 95 per cent in some regions. 
6.183 In recent years, brownfields exploration has been relied on to meet the significant increase in demand for Australia's resources. Such exploration is used to increase the resource base and production capacity of existing operations and known resource regions. It also helps companies retain investor attention by releasing a constant flow of drill intersections and defined results. Brownfields exploration can be more profitable than greenfields exploration because of the lower incremental cost of exploiting deposits that have ready access to existing infrastructure or processing facilities. The shorter lead times from exploration to discovery for brownfields projects can allow companies to capitalise on the 'window of opportunity' offered by high commodity prices. Development approval requirements for new mines are also significantly greater than those required for expansions of existing mine sites.
6.184 There are industry concerns about the sustainability of Australian mining in the medium term given the increasing focus on brownfields exploration. Existing known deposits may last many years at the current rate of extraction, but new deposits are more likely to be found in more remote greenfields locations, may be of lower grade, deeper in the ground, mixed with greater impurities and/or require more difficult and costly exploration and extraction techniques. As a result, more 'effort' will be needed to produce each unit of resource output, and the measured productivity of exploration (that is, eventual resource extraction) will decline.
6.185 As noted above, greenfields exploration is generally higher risk and can be a long-term investment. There is a high possibility that, even after a new ore body has been discovered, it will ultimately prove to be of insufficient quantity or quality and uneconomic to produce given prevailing market prices and conditions. Mineral exploration is also capital intensive and requires approximately $5-7 million for an average drilling program. 
6.186 Much of Australia has only been explored at a reconnaissance level, or to shallow depths, and large areas of the more remote, buried frontier provinces still remain under-explored. Junior explorers are often more entrepreneurial than larger explorers and producers, and accept the risks inherent with greenfields exploration in the hopes of selling discoveries to established producers with the experience and financial capacity to develop mines. Consequently, a strong junior sector is needed to search for the next generation of Australia's mineral deposits.
6.187 Without further investment in greenfields mineral exploration, the national resource inventory will decline. This represents a significant cost to the Australian economy when considered in the context of recent analysis that suggests that about half of Australia's non-bulk commodities mines will be exhausted in between 7 and 18 years. 
6.188 The objective of Government action is to increase greenfields mineral exploration by incentivising investment in junior mineral exploration companies.
6.189 The Exploration Development Incentive was announced on 3 September 2013 by the then Shadow Minister for Energy and Resources, and was outlined in the Coalition's Policy for Resources and Energy September 2013 (see Table 6.1).
|The Coalition will introduce an Exploration Development Incentive that will allow investors to deduct the expense of mining exploration against their taxable income.
Under our scheme, the Australian Taxation Office will determine a proportion of expenses that can be claimed as tax credits by investors. Our scheme will target small exploration companies by limiting eligibility to companies with no taxable income.
Our scheme will start for investments made from 1 July 2014. The scheme will be capped at $100 million over the forward estimates.
The Coalition will get the exploration industry back on its feet following the devastating loss of confidence for investment in mineral exploration in Australia caused by the Rudd-Gillard Government's introduction and gross mishandling of the MRRT.
The future prosperity of the mining sector and the Australian economy is dependent on our ability to make new mineral discoveries.
The Exploration Development Incentive will provide incentives for minerals exploration activity, with a focus on the small and mid-tier exploration sector.
Under the proposed program, a tax credit will be provided to Australian resident shareholders for eligible 'green fields' exploration expenditure incurred in Australia. A 'no taxable income' test will ensure that the program is only available to junior minerals explorers.
Final implementation details will be determined in consultation with peak industry representative bodies, and will be reviewed every twelve months. Subject to these review outcomes, the program may be extended for a further period.
6.190 This regulation impact statement assesses the impacts of the Government's election commitment to introduce the Exploration Development Incentive. Consistent with the requirements set out in The Australian Government Guide to Regulation, alternatives to the election commitment are not required to be considered in this regulation impact statement. Rather, it focuses on the commitment and how the commitment should be implemented.
6.191 The Exploration Development Incentive is expected to attract additional investment in small companies undertaking greenfields mineral exploration. Additional exploration activity will lead to increased employment. Stakeholder feedback suggests this increased investment will also have a significant multiplier effect.  Long term benefits include new mineral discoveries, and in turn, new mines. Such benefits would include the possibility of new infrastructure in regional areas, new and diversified employment opportunities, and increases in royalty and taxation revenue.
6.192 Since private sector investor behaviour is presumably driven by costs and benefits of investment, the Exploration Development Incentive should increase investment in junior exploration companies. However, the extent to which the scheme changes investor behaviour, or redirects private sector capital from other sectors toward junior mineral explorers, is difficult to quantify, particularly given current uncertainty on the likely level of participation in the scheme. Likewise, the lag between discovery and mineral extraction means that the net benefit of the scheme will materialise some time in the medium or long term.
6.193 An accurate assessment of the net benefit of the scheme could therefore only be determined if it were possible to compare:
the actual contribution to the economy of all successful and unsuccessful exploration made possible by investment attributable to the Exploration Development Incentive (and any mine that results from it)
the actual contribution to the economy of every other venture, potentially in another sector, that an investor may have chosen to invest in had they not been influenced by the Exploration Development Incentive.
6.194 Given the impracticality of such an exercise, precise calculations of the fiscal benefit to the greenfields exploration industry or the broader economy are not available. However, it is possible to describe in more broad terms the potential net benefit that could arise, given the observable benefits to the wider economy of mining projects more generally.
6.195 The introduction of the Exploration Development Incentive increases the incentive for investors to favour shares in junior exploration companies compared to the absence of such a scheme. This is because they would effectively be 'cheaper' given the associated tax benefits. It follows that greater investment in junior explorers increases the likelihood of the discovery of further economically recoverable resources. Accordingly, any longer term development of a mining operation as a result of this increased exploration activity may yield a significant benefit to the economy.
6.196 Stakeholders have identified the range of benefits that mining operations usually deliver, and that broadly could be attributable to the implementation of the Exploration Development Incentive, noting that the magnitude of such benefits will be dependent on the level of participation in the scheme:
- a longer term increase in net taxation revenue from the industry;
- an increase in jobs;
- an increase in the value of the industry;
- improving the low discovery rates of new mines;
- a reverse of the ongoing reduction in the global share of Australian greenfields exploration activities; and
- an increase in the low number of IPOs for mineral projects in Australia. 
6.197 Modelling undertaken by KPMG on the Mineral Exploration Tax Credit (a similar policy design to the Exploration Development Incentive, but without a financial cap) found that a multiplier factor of two in additional exploration activity would conservatively result in:
- potential to provide a positive annual tax revenue stream to Government of up to $283 million;
- up to 4,356 additional jobs across the whole mining sector; and
- contributing an additional $2.2b in GDP across the mining sector.
6.198 Further, AMEC estimates that with a $100 million cap, the Exploration Development Incentive will represent at least $350 million in eligible exploration expenditure and create approximately $1 billion in subsequent economic activity. 
Impact on Industry
6.199 Industry has advocated the introduction of an incentive to promote mineral exploration by small exploration companies for many years. The Exploration Development Incentive is seen by industry as a positive policy solution to the problems identified above.
6.200 There is a lack of Australian-centric data to accurately determine the level of investment that would occur when the Exploration Development Incentive is implemented. However, industry bodies report anecdotal evidence from members that the policy would result in a net positive impact on investment.
6.201 A similar program implemented in Canada ('Flow Through Shares') has helped junior mining companies raise CAD$5 billion over five years,  and resulted in significant new discoveries.
6.202 Participation in the Exploration Development Incentive is not compulsory; companies must make a conscious decision to participate. Those that choose to participate will have the ability to pass on a portion of their eligible tax losses (in the form of exploration credits) to their shareholders. This will give their shareholders an entitlement to a refundable tax offset.
6.203 Junior exploration companies that choose to participate in the Exploration Development Incentive will face small additional compliance costs. These costs generally result from the need to:
- report additional information on the nature of their exploration expenditure;
- divert, employ or engage additional resources to manage administrative requirements (including training those resources); and
- update systems and procedures to accommodate the requirements of participating in the scheme.
6.204 The information required by a company to participate in the Exploration Development Incentive will be broadly similar to the type of information currently needed to complete the company's tax return, report on their exploration activity to state/territory governments, and report to the ASX. In this regard, it is anticipated that the compliance costs of collecting additional information will be minor, as the information required should be readily available. However, participating companies will identify and provide some additional information to the Australian Taxation Office (ATO), such as greenfields exploration expenditure, and will inform shareholders of the company's intentions.
6.205 Consultation with stakeholders supports the compliance cost calculations outlined in this RIS.  The design of the Exploration Development Incentive is consistent with earlier models of similar schemes proposed by the industry. Like the Exploration Development Incentive, the design of these schemes was cognisant of minimising the administrative burden. The additional time and cost will come in the form of providing the appropriate reporting measures under the legislation. Stakeholders are of the view that these small costs are outweighed by the benefits of the policy.
6.206 Companies that choose to participate in the Exploration Development Incentive may require additional work from accountants to ensure compliance and manage the administrative requirements of the scheme. For instance, following the application of the cap, companies will need to work out the losses they can convert into exploration credits and the resulting exploration credits available to shareholders. Additional financial advice may also be required on the economic impact of a company relinquishing their entitlement to tax losses.
6.207 Companies may choose to make minor modifications to their financial management systems and procedures to facilitate participation in the Exploration Development Incentive.
6.208 These additional costs were considered in consultations with a range of industry stakeholders. Based on those consultations, average annual compliance costs of $1,144 were calculated for a typical junior exploration company using the Office of Best Practice Regulation's Business Cost Calculator.
6.209 To determine an average annual cost of compliance for the broader minerals exploration sector, it is necessary to estimate the level of industry participation in the scheme.
6.210 According to data sourced from the Australian Bureau of Statistics, on average 133 companies reported a non-zero amount for greenfields exploratory drilling each quarter during the period July 2010 to June 2013. To formulate an estimate of how many companies will undertake greenfields mineral exploration each year from July 2014, a simple assumption has been made that there will be 133 separate and distinct active companies each quarter; resulting in an annual estimate of 532 companies undertaking greenfields mineral exploration. In reality, the figure is likely to be lower given that some companies' drilling operations may continue into the subsequent quarter.
6.211 To account for companies that had a taxable income (and would not be eligible for the scheme), this figure has been reduced by 25 per cent - consistent with analysis undertaken by KPMG  - resulting in an estimate of 400 eligible mineral exploration companies per year. Given recent declines in exploration activity and the financial difficulties faced by the junior exploration sector, this is likely to be a considerable overestimate of eligible companies.
6.212 It is important to note that due to the voluntary nature of the scheme, it is unlikely that all eligible exploration companies will participate, although it is not possible to know the extent of non-participation. This makes it very difficult to quantify overall participation and therefore the associated cost of compliance.
6.213 While feedback from consultation with industry bodies indicates that eligible companies 'are likely to participate in the Exploration Development Incentive',  there are several factors that will ultimately determine the proportion of eligible companies that will choose to participate. For example, there will be cases where an eligible junior explorer anticipates a possible future revenue stream from a resource discovery in the short to medium term. In such cases, that company may determine that the project cash flow benefit of retaining accumulated losses to reduce any future tax liability outweighs the benefit of participating in the Exploration Development Incentive. Eligible companies may also decide not to participate in the scheme if, in their view, the expected size of the benefit available for distribution to shareholders is not sufficient enough to influence shareholder investment behaviour. Similarly, where the administrative costs of distributing the credits exceed the value of the credits that could potentially be distributed, companies may choose not to participate.
6.214 There is also a possibility that investment at the beginning of the scheme will be subdued due to explorers and investors deferring investment to learn from first movers.
6.215 On the available evidence, it is difficult to draw a conclusion on the percentage of eligible companies that will participate in the scheme. Based on the discussion above, it is clear that not all eligible companies will participate.
6.216 Perhaps the best indication of potential take-up of the scheme, at least in the immediate term, is a measure of how many companies currently hold sufficient cash to undertake eligible exploration activities. A recent survey of junior mining and exploration companies found that in 2014, 50 per cent of companies surveyed had a cash balance of under $2 million. Further, 18 per cent of companies surveyed in 2014 had a cash balance of less than $500,000.  As previously stated, exploration is capital intensive and requires approximately $5-7 million for an average drilling program. This means that without additional funding, many companies will not be in position to undertake eligible activities, at least not in the immediate future. These companies will not be eligible to participate in the scheme.
6.217 As such, a conservative estimate of 50 per cent participation in the Exploration Development Incentive has been adopted to calculate the average annual cost of compliance. However, reflecting uncertainty about the extent of participation, the annual average cost of compliance for the mineral exploration sector has been presented as a range, assuming 10 per cent, 20 per cent and 50 per cent of eligible companies will participate.
6.218 No significant risks have been raised by industry during consultation. Industry bodies have expressed a slight risk of estimations for the modulation factor to be incorrect at the time of calculation due to unforeseen circumstances (that is, geological in nature) in the financial year arising from higher than expected expenditure. However, in discussions with explorers likely to take advantage of the Exploration Development Incentive, this risk is minimal and companies are confident that an accurate assessment of expenditure can be provided.
Impact on Stakeholders
6.219 The compliance costs for shareholders arising from the Exploration Development Incentive will be small relative to the tax benefits that they will receive. While shareholders will be required to identify any exploration credits received when completing their income tax return each year, this will be a relatively small addition to existing requirements. There will be no cost for investors in a company that does not participate in the scheme.
Impact on Government
6.220 The cost of the Exploration Development Incentive is capped at $100 million. Exploration credits are capped at $25 million for exploration expenditure incurred in 2014-15, $35 million for exploration expenditure incurred in 2015-16 and $40 million for exploration expenditure incurred in 2016-17. Where the cost of the Incentive is less than the cap for any given year, the caps applying to subsequent years will not be adjusted.
6.221 In the short-term, implementation costs will be incurred to draft the legislative amendments. There will also be costs incurred to review the Exploration Development Incentive.
6.222 The ATO will incur costs in administering the scheme and ensuring compliance. New administrative arrangements and education products will be required to support the Exploration Development Incentive. Any integrity requirements will be designed with a view to minimising compliance costs on shareholders and mineral exploration companies, while still providing the necessary protection to revenue.
6.223 In designing the Exploration Development Incentive, the Government has undertaken consultation with peak industry bodies, shareholder representative groups and other interested parties. Consultation included multiple face to face meetings, as well as the public release of a discussion paper that provided stakeholders the opportunity to provide feedback on the design of the scheme.
6.224 On 2 July 2014, operational details for the Exploration Development Incentive were released to reduce uncertainty for small mineral exploration companies and their investors ahead of release of the legislation that will give effect to the measure.
6.225 On 10 October 2014, draft legislation and explanatory materials were released for public consultation. Submissions closed on 24 October 2014.
6.226 In preparing this regulation impact statement, targeted and public consultation has been undertaken with peak industry bodies and interested parties to help assess the impact of the Exploration Development Incentive on industry.
6.227 The ATO is also consulting with peak industry bodies and interested parties on the administrative arrangements for the scheme.
6.228 The majority of interested parties support the introduction of the Exploration Development Incentive, and have expressed interest in such a scheme for some time. Industry bodies consider it to be a long term investment strategy for Australia's mineral resources sector, and exhibit a sense of optimism that this scheme will deliver similarly successful results to the Canadian 'flow through shares' scheme.
6.229 There is overwhelming agreement amongst most stakeholders that compliance costs will remain minimal, particularly when set against the expected benefits. The main limitation identified was the cap of $100 million over the forward estimates. This is generally considered too small based on the expected demand for the scheme.
6.230 Some stakeholders have expressed the view that no market failure exists preventing an efficient level of investment in greenfields projects. Accordingly these stakeholders consider there will only be limited take-up of the Exploration Development Incentive. This appears to be a minority view based on the consultation that has been undertaken.
6.231 The Government is proceeding to implement its election commitment to introduce an Exploration Development Incentive. The mineral exploration industry has advocated the introduction of such a scheme for many years.
Conclusion and recommended option
6.232 The Exploration Development Incentive commenced for exploration expenditure incurred from 1 July 2014. Schedule 6 to the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 amends the income tax law to implement the scheme.
6.233 The key risk to implementation of the Exploration Development Incentive is the timely passage of legislation through Parliament. The ATO requires sufficient time to develop and implement the necessary administrative processes for the scheme. This risk is being managed by consulting early and regularly with the ATO on the administration of the incentive.
6.234 The Department of Industry will monitor greenfields exploration and the scheme throughout its operation, with a review of the scheme in 2016. Key performance indicators for the scheme, against which the review will be conducted, will be finalised by the end of 2014. Subject to the outcome of the review, the programme may be extended for a further period.
STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS
Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011
Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 - Exploration development incentive
6.235 Schedule 6 to the Bill and the Excess Exploration Credit Tax Bill 2014 are compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.
6.236 Schedule 6 to the Bill and the Excess Exploration Credit Tax Bill 2014 introduce an exploration development incentive by amending the Income Tax Assessment Act 1997 (ITAA 1997) and other tax legislation to provide a tax incentive to encourage investment in small mineral exploration companies undertaking greenfields mineral exploration in Australia. Australian resident investors of these companies will receive a tax incentive where the companies choose to give up a portion of their losses relating to their exploration expenditure in an income year.
6.237 The total value of the tax incentives available to taxpayers in respect of expenditure in an income year is restricted to $25 million for greenfields minerals expenditure incurred by eligible companies in 2014-15, $35 million for greenfields minerals expenditure incurred in 2015-16 and $40 million for greenfields minerals expenditure incurred in 2016-17.
6.238 The incentive is not available in respect of for expenditure incurred in income years after 2016-17.
Human rights implications
6.239 Schedule 6 and the Excess Exploration Credit Tax Bill 2014 do not engage any of the applicable rights or freedoms.
6.240 The measure affects only a small group of companies (mineral exploration companies) and their shareholders, and simply allows the company to convert a tax loss into a more immediate benefit for shareholders.
6.241 The exploration development incentive regime does result in differing treatment for residents and non-residents. This is consistent with the well-established body of international law and practice that differential tax (and social security) treatment of residents and non-residents does not constitute discrimination, but is an appropriate recognition of the differing circumstances of these entities.
6.242 Schedule 6 and the Excess Exploration Credit Tax Bill 2014 are compatible with human rights as they do not raise any human rights issues.