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Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017



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BILLS DIGEST NO. 59, 2017-18 20 DECEMBER 2017

Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017 Paul Davidson Economics Section

Contents

Purpose of the Bill ............................................................... 3

Structure of the Bill ............................................................. 3

Background ......................................................................... 3

The exploration development incentive ................................. 3

Explanation of the exploration development incentive ........ 4

The junior minerals exploration incentive ............................... 5

Committee consideration .................................................... 6

Selection of Bills Committee.................................................... 6

Senate Standing Committee for the Scrutiny of Bills .............. 6

Policy position of non-government parties/independents ..... 6

Position of major interest groups ......................................... 6

Financial implications .......................................................... 7

Table 1: estimated impact of the Bill over the forward estimates ............................................................................... 7

Statement of Compatibility with Human Rights .................... 7

Parliamentary Joint Committee on Human Rights .................. 7

Key issues ........................................................................... 7

Table 2: information about the EDI for the relevant income tax years ................................................................... 8

Figure 1: expenditure and metres drilled at new deposits, June 2007—June 2017 ........................................... 9

Feedback from stakeholders ............................................... 10

Key provisions ................................................................... 10

Schedule 1—Junior minerals exploration incentive .............. 10

Main amendments .............................................................. 10

Date introduced: 19 October 2017

House: House of Representatives

Portfolio: Treasury

Commencement: Parts 1 and 2 and Division 1 of Part 4 of Schedule 1 to the Bill commence on the first 1 January, 1 April, 1 July or 1 October to occur after Royal Assent. Part 3 and Division 2 of Part 4 commence on 1 July 2023. Schedule 2 commences the day after Royal Assent.

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the Federal Register of Legislation website.

All hyperlinks in this Bills Digest are correct as at

December 2017.

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Creation of exploration credits ......................................... 10

Exploration credits allocation............................................ 12

Issuing exploration credits ................................................ 13

Excess exploration credits ................................................. 14

Modified capital gains tax treatment .................................. 14

Repeal of the JMEI from 1 July 2023 ................................... 15

Part 4—Application, transitional and saving provisions ..... 15

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Purpose of the Bill The Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017 (the Bill) amends the Income Tax Assessment Act 1936 (ITAA 1936), the Income Tax Assessment Act 1997 (ITAA 1997), and the Taxation Administration Act 1953 (Tax Administration Act) to provide concessional tax treatment for investors in certain greenfields minerals exploration entities. The Bill does this by replacing the Exploration Development Incentive with the Junior Minerals Exploration Incentive (see below).

Structure of the Bill The Bill has two Schedules. Schedule 1 has four parts:

• Part 1 provides for the main amendments to the ITAA 1997 to establish the Junior Minerals Exploration Incentive

• Part 2 provides for other amendments to the ITAA 1936, ITAA 1997 and the Tax Administration Act to reflect the replacement of the Exploration Development Incentive with the Junior Minerals Exploration Incentive

• Part 3 provides for the repeal on 1 July 2023 of Division 418 of the ITAA 1997 which covers the junior minerals exploration incentive and

• Part 4 contains application, transitional and savings provisions.

Schedule 2 of the Bill makes consequential amendments to the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Act 2015.

Background The Bill replaces the effectively expired exploration development incentive (EDI) with the junior minerals exploration incentive (JMEI).

Background information about a review of the EDI, as well as data from the Australian Bureau of Statistics and the Australian Taxation Office are presented in the Key issues section below.

The exploration development incentive The EDI was first announced by the Coalition in the lead-up to the 2013 federal election.1 According to the Explanatory Memorandum to the Bills introducing the EDI, two key problems were identified:

• 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.2

The objective of the Bills was ‘to increase greenfields mineral exploration by incentivising investment in junior mineral exploration companies’.3

As stated in the Explanatory Memorandum:

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. [footnotes omitted]

4

As the EDI was an election commitment, the regulation impact statement only considered the implementation of the commitment, as opposed to alternative measures to achieve the same objective.5 However, it was

1. Liberal Party of Australia and the Nationals, The Coalition’s Policy for resources and energy, Coalition policy document, Election 2013. 2. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 and Excess Exploration Credit Tax Bill 2014, pp. 114-15. For simplicity, references are only made to the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 and associated materials from hereon. A greenfields minerals explorer and greenfields minerals expenditure are defined in sections

418-75 and 418-80 of the ITAA 1997, respectively. 3. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, p. 119. 4. Ibid., p. 120.

5. Ibid.

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important to review the effectiveness of the EDI given the modified regulation-making treatment. This was acknowledged in the Explanatory Memorandum:

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.

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The review is discussed in more detail in the Key issues section below.

Explanation of the exploration development incentive Generally, most small minerals exploration companies’ expenditure would be classified as capital in nature for the purposes of income tax law. The full value of any expenditure for a depreciating asset (generally considered to be an asset with a limited useful life) used for minerals exploration can be immediately deducted under ITAA 1997 section 40-80. Other expenditure incurred (whether capital or revenue in nature) can be immediately deducted under ITAA 1997 section 40-730. Therefore, the vast majority of expenditure incurred by such companies is likely to be deductable. As noted in the Explanatory Memorandum to the Bill:

…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.

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[…]This 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. Junior explorers, with no production and therefore no (or little) assessable income, are unable to offset their exploration expenditure. 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 that exceed its assessable income.

8

In simple terms, the relative benefit that tax deductibility provides varies depending on whether the entity in question is making a profit or loss. Where entities are making a profit, they can claim immediate relief via a tax deduction for such expenditure incurred, thus lowering their assessable income (and hence tax payable). However, where entities are not making assessable income, such accumulated losses cannot be deducted. The losses can however generally be rolled over to future income years to offset against profits in those future income years.

The EDI commenced in March 2015 and essentially permitted small mineral exploration companies which undertook greenfields minerals exploration in Australia to convert some of their tax losses into exploration credits. In turn, those exploration credits could be distributed to investors as a tax offset, or as a franking credit, depending on the investor entity.9

The concessional tax treatment under the EDI was to last for three years, with maximum concessions of $25 million, $35 million, and $40 million for each year, respectively.

The EDI was introduced as an amendment to the ITAA 1997 as Division 418. Section 418-1 provides a general overview of the Division. The Division comprises six subdivisions:

• Subdivision 418-A sets out the object of the Division to provide for concessional tax treatment for investors who invest in small mineral exploration companies which undertook greenfields minerals exploration in Australia.

6. Ibid., p. 129.

7. Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, p. 11. 8. Ibid., p. 45.

9. For more information on the background and anticipated impacts of the EDI, see: K Swoboda and L Nielson, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 [and] Excess Exploration Credit Tax Bill 2014, Bills digest, 75, 2014-15, Parliamentary Library, Canberra, 2015, pp. 22-31. A greenfields minerals explorer and greenfields minerals expenditure are defined in sections 418-75 and 418-80 of the ITAA 1997, respectively.

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• Subdivision 418-B contains the entitlement to receive the EDI tax offset, which is dependent upon the type of investor entity (for example, there are different rules depending on whether the investor is a life insurance company or a member of a trust). It also covers the amount of the tax offset.

• Subdivision 418-C covers EDI franking credits, which again differ depending on the type of investor entity.

• Subdivision 418-D covers the creation of exploration credits, in particular the entities which are eligible to create exploration credits, as well as a number of important related definitions. The Subdivision provided that an entity cannot create exploration credits in excess of their maximum exploration credit amount. The maximum exploration credit amount was calculated on either the estimated or actual tax loss or estimated or actual greenfields mineral expenditure (whichever was the smallest), multiplied by the corporate tax rate, which was then multiplied by the modulation factor. The modulation factor was in turn calculated where the exploration credits were expected to exceed the exploration cap (the values are listed above), otherwise it was set at a value of one.

• Subdivision 418-E covered the issue and expiry of exploration credits, which could be provided to member shareholders of the entity, proportionately in accordance with their shareholding.

• Subdivision 418-F covered excess exploration credits—entities which issued exploration credits in excess of their maximum exploration credit amount were liable to pay excess exploration credit tax. This subdivision also provided for a range of related administrative measures such as when payment of excess exploration credit tax fell due, whether interest was also payable, refunds for overpaid amounts, and general record keeping requirements. In the event that an entity was liable to pay excess exploration credit tax that entity may have been excluded from accessing the EDI in the future.

The EDI ceased to have effect after the 2016-17 income year, although exploration credits accrued could be distributed in the 2017-18 income year.

The junior minerals exploration incentive The 2017-18 Budget let the EDI run its course, and as such did not extend it. This decision was reported to have angered industry participants,10 and, perhaps as a result of industry feedback, the JMEI was first announced by the Prime Minister and Deputy Prime Minister on 2 September 2017.11 It was reported that the reason for changing from the EDI to the JMEI was because the EDI ‘had not been as effective as hoped’.12

As noted in the Explanatory Memorandum to the Bill, the JMEI operates in substantially the same way as the EDI, and has three main components:

First, the amendments establish a framework for eligible companies to give up a portion of their tax losses attributable to greenfields minerals exploration to create and issue exploration credits to investors where they have received an allocation of credits from the Commissioner.

Secondly, the amendments entitle an entity that invests in a greenfields minerals explorer and receives an exploration credit to either a refundable tax offset (the JMEI tax offset) or (for corporate tax entities other than in some cases life insurance companies) an additional franking credit.

Finally, the amendments extend the application of the excess exploration credit tax rules. 13

The Explanatory Memorandum to the Bill provides that the government intends to review the operation of the JMEI by 30 June 2020 ‘to assess both its uptake and efficacy in attracting investment’.14 However, it is not clear whether the review will be public.

The Key issues and provisions section below explains the operation of the Bill in more detail.

10. See, for example: S McKinnon, ‘Scheme axing angers juniors’, The West Australian, 12 May 2017, p. 62; B Harvey, ‘Feds throw explorers a bone’, The West Australian, 7 June 2017, p. 33. 11. M Turnbull (Prime Minister) and B Joyce (Deputy Prime Minister), Investing in the future strength of the Australian resources sector, joint media release, 2 September 2017. 12. S Martin, ‘$100m mining boost’, The Weekend West, 2 September 2017, p. 1. 13. Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, p. 16. 14. Ibid., p. 12.

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Committee consideration Selection of Bills Committee The Committee for the Selection of Bills recommended that the Bill not be referred to a committee for inquiry.15

Senate Standing Committee for the Scrutiny of Bills The Committee for the Scrutiny of Bills made no comment in relation to the Bill.16

Policy position of non-government parties/independents At the time of writing, the position of non-government parties is not known. However, the Labor Party supported the Bills which introduced the EDI in 2015.17 Greens Senator Whish-Wilson expressed ‘disbelief’ at the introduction of the original Bills,18 and the party unsuccessfully sought to amend Schedules 1 and 6 of the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, which would have had the effect of removing the EDI entirely.19

Position of major interest groups Concerns had been raised by the mining industry at the budget decision to let the EDI expire.20

Chief Executive of the Association of Mining and Exploration Companies, Simon Bennison, has reportedly said there is appetite among junior companies for exploration and stated ‘…we are looking forward to this new initiative turning [one of the worst periods of greenfield exploration] around’ and that ‘[i]t will give those companies with some highly prospective and clearly identified quality assets a much better chance of raising that capital’.21

Acting Chief Executive Officer of the Association of Mining and Exploration Companies, Graham Short, said:

The Federal Government’s recently announced $100m over 4 years Junior Mineral Exploration Tax Credit (JMETC) is a timely and important step to boosting that investment in exploration. This will allow eligible companies to renounce their losses in the form of tax credits back to their shareholders. 22

The South Australian Chamber of Mines & Energy was reported to have welcomed the JMEI initiative.23

15. Senate Standing Committee for Selection of Bills, Report, 13, The Senate, 16 November 2017, p. 3. 16. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 13, The Senate, 15 November 2017, p. 60. 17. G Gray, ‘Second reading speech: Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, Excess Exploration Credit Tax Bill 2014’, House of Representatives, Debates, 24 February 2015, p. 1184. See also T Hammond, Delivering a stable policy environment: Labor’s

approach to the resources sector, speech delivered to the AMEC Convention 2017, 7 June 2017. 18. P Whish-Wilson, ‘Second reading speech: Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, Excess Exploration Credit Tax Bill 2014’, Senate, Debates, 3 March 2015, p. 943. 19. Australia, Senate, Journals, 80, 2014-15, 3 March 2015, p. 1026. The effect of the amendments would have entirely removed the provisions

relating to the EDI. 20. See below for further information, but also see, for example, A Hobbs, Exploration incentive axed for 2018 media release, 11 May 2017. 21. Martin, ‘$100m mining boost’, op. cit. 22. G Short, Exploration crucial for the future of mining, media release, 16 October 2017. 23. L Griffiths, ‘Explorer spend up $1m in SA’, The Adelaide Advertiser, 5 September 2017, p. 29.

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Financial implications The Explanatory Memorandum to the Bill states that the measure is expected to reduce government revenues by $100 million over the forward estimates.

Table 1: estimated impact of the Bill over the forward estimates

2017-18 2018-19 2019-20 2020-21

-$15m -$25m -$30m -$30m

Source: Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, p. 7.

Although not directly related to the Bill, the financial impacts of the EDI have been less than anticipated when the EDI was first introduced (see below). It remains to be seen whether the Bill will result in similar financial impacts.

Statement of Compatibility with Human Rights As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible.24

Parliamentary Joint Committee on Human Rights The Joint Committee on Human Rights considered that the Bill did not raise human rights concerns.25

Key issues As noted above, the key issues are whether the EDI has worked as intended, and whether it (or an alternative, such as the JMEI) remains necessary, especially given the modified regulation-making treatment afforded to the Bills that introduced the EDI. A review of the EDI could evaluate both of these issues.

A review of the EDI had been foreshadowed on numerous occasions,26 and a review was signalled by (then) Resources Minister Josh Frydenberg in mid-2016.27 Pursuant to freedom of information documents, it appears that the Department of Industry, Innovation and Science was responsible for conducting the review, and had engaged consultants to prepare a report.28 However, the budget decision to let the EDI expire at the end of its three-year period was heavily criticised by the Association of Mining and Exploration Companies national policy manager Graham Short:

The Government has had a non-transparent and unpublished internal review but it has been based on a short time frame and limited data…

It appears as though the Government just doesn't understand, or its advisors just don't understand the importance of this program. 29

Given that the review has not been made public, it is difficult to evaluate the efficacy of the EDI. It was reported that the Government decision not to extend the scheme was because few businesses took advantage of the scheme and that the number of participants significantly fell between the first and second years of operation.30 Resources Minister Matt Canavan stated that ‘[t]he review did consider options to improve the scheme but

24. The Statement of Compatibility with Human Rights can be found at page 39 of the Explanatory Memorandum to the Bill. 25. Parliamentary Joint Committee on Human Rights, Twelfth report of the 45th Parliament, 28 November 2017, p. 96. 26. See, for example: Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, p. 82; Senate Economics Legislation Committee, Answers to Questions on Notice, Industry Portfolio, Budget Estimates 2014-15, Question BI-64; Senate

Economics Legislation Committee, Answers to Questions on Notice, Industry Portfolio, Budget Estimates 2014-15, Question BI-84. 27. J Lucas, ‘Tax scheme under review’, The West Australian: Kalgoorlie Miner, 26 May 2016, p. 7. 28. Treasury, FOI disclosures, ‘Exploration development incentive’, Review of the Exploration Development Incentive, 28 July 2017. 29. B Fitzgerald, ‘Mining exploration companies say Federal Government “betrayal” will cost jobs in regional WA and Queensland’, ABC News,

12 May 2017. See also, B Pearson, Budget investment focus welcome but reform challenge remains, media release, 9 May 2017. 30. Harvey, ‘Feds throw explorers a bone’, op. cit.

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found these would have benefited only a small number of participants rather than improving the scheme’s overall operation’.31

Available information suggests that the EDI has not been as attractive to junior minerals companies as intended. It was estimated that approximately 200 entities would participate in the EDI annually,32 yet data from the Australian Taxation Office (ATO) indicate that participation in the EDI was not that successful (table 2).

Table 2: information about the EDI for the relevant income tax years

Income year No. of

applications Total notified exploration expenditure

Modulation factor

Exploration credit cap

Estimated maximum exploration credits issued

2014-15 84 $70,323,723 1.00 $25 million $21.1 million

2015-16 54 $45,672,570 1.00 $35 million $13.7 million

2016-17 40 $44,482,118 1.00 $40 million $13.3 million

Source: Australian Taxation Office (ATO), ‘Exploration development incentive’, ATO website, last modified 28 November 2017.

As shown in table 2, less than half of the estimated number of applications were received in 2014-15, falling to almost a quarter of the estimated applications in 2015-16. Despite the relatively low take-up, over 84 per cent of the $25 million cap in 2014-15 was allocated to applicants, suggesting that had there been 200 applicants, the modulation factor would have been substantially less than one,33 resulting in a smaller return (in the form of a tax concession) to investors.

The number of applications fell by over a third between 2014-15 and 2015-16, with commensurate falls in both exploration expenditure and exploration credits issued. In 2015-16, the take-up was only 27 per cent of that originally estimated, with 54 applications.

In the 2016-17 income year, the number of applications fell further, to just 20 per cent of the estimated number of applications. The results in 2016-17 compared with 2014-15 indicate that the EDI has become relatively less important to eligible entities.

The relatively low take-up rate by junior minerals companies would indicate that the existence of the EDI is not critical to decision-making about whether to incur greenfields exploration expenses. This conclusion is also supported by data from the Australian Bureau of Statistics (ABS) on expenditure and metres drilled for new deposits in Australia (figure 1). The reason for focussing on new deposits is because the EDI is only available to greenfields minerals exploration.

Figure 1 illustrates that expenditure and metres drilled for new deposits have historically been quite volatile. Since the introduction of the EDI, some of that volatility has reduced, but it is not possible to conclude that the reduction is due to the EDI’s existence. Nor is it possible to state that the existence of the EDI has resulted in additional expenditure and/or metres drilled at new deposits. In order to test that statement, information would be required about the extent of expenditure and metres drilled which would have occurred in the absence of the EDI.

The ABS data also represents the entire greenfields minerals exploration industry, rather than only those with taxable losses, which are the relevant entities for the purposes of the EDI.

The Henry Tax Review considered the implementation of an exploration tax credit, as part of a flow-through share scheme. The Review stated:

There are no strong grounds to believe that exploration generates unusually large positive spillovers that would justify a subsidy. Exploration does produce information of public value, and explorers are required to make such

31. Ibid.

32. Calculation based on Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, pp. 125-6. 33. The modulation factor is determined by the Commissioner of Taxation so as to ensure that the total amount of exploration credits created by eligible entities is no greater than the annual cap of exploration credits that may be issued (see table 2 for the exploration credit cap amounts).

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information publicly available. However, nearly all activities generate information that is of benefit to others; for example, that a particular business model does or does not work. 34

Based on the above information, it is questionable whether the EDI has worked as intended when it was first announced in 2013. It is also unclear whether an EDI (or an alternative such as the JMEI) is necessary to induce greenfields minerals exploration that would otherwise not go ahead. As part of consultations when the EDI was introduced:

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. 35

Figure 1: expenditure and metres drilled at new deposits, June 2007—June 2017

Source: Based on Australian Bureau of Statistics, Mineral and petroleum exploration, cat. no. 8412.0, ABS, Canberra, 2013.

The minority view of stakeholders however appears to more accurately reflect the outcomes of the EDI than that of the majority which identified that the ‘main limitation’ was the exploration credits cap which was ‘generally considered too small based on the expected demand for the scheme’.36 This is because in the three years that the EDI operated, the cap was not reached.

34. K Henry, J Harmer, J Piggott, H Ridout, and G Smith, Australia's future tax system: report to the Treasurer, (Henry Tax Review), pt 2, vol. 1: detailed analysis, [The Treasury], [Canberra], December 2009, p. 177. 35. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, p. 128. 36. Ibid.

0

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Jun-2007 Dec-2007 Jun-2008 Dec-2008 Jun-2009 Dec-2009 Jun-2010 Dec-2010 Jun-2011 Dec-2011 Jun-2012 Dec-2012 Jun-2013 Dec-2013 Jun-2014 Dec-2014 Jun-2015 Dec-2015 Jun-2016 Dec-2016 Jun-2017

Expenditure on new deposits ($ millions) (LHS) Metres drilled at new deposits ('000s) (RHS)

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Feedback from stakeholders The Explanatory Memorandum to the Bill notes that stakeholders provided feedback on the EDI. Two key issues identified were that the benefits to new investors were diluted, and that the modulation factor created uncertainty.37

The Bill remedies the issue regarding diluted investor returns by ensuring that where credits are issued they are issued to the investors which contributed to the capital raisings.38 The Bill remedies the latter issue as a result of the proposed repeal of section 418-90, which covers the modulation factor. However, the removal of the modulation factor is substituted by the determination process by the Commissioner of Taxation.39 Whether this process creates uncertainty (or additional uncertainty compared to the modulation factor) is yet to be seen.

Key provisions Schedule 1—Junior minerals exploration incentive

Main amendments Part 1 of Schedule 1 amends Division 418 of the ITAA 1997, which currently provides for the EDI. The amendments reflect the changes introduced by the JMEI. The main changes are:

• in relation to the timing of both the creating and issuing of exploration credits

• the removal of the modulation factor and introduction of the Commissioner of Taxation being responsible for allocating exploration credits

• the ability to rollover an unused allocation of exploration credits (which currently does not exist)

• the introduction of rules to ensure that exploration credits are provided proportionately to all investors, based on the size of their investment and

• allocations of exploration credits are on a first come first served basis (which is currently not the case due to the operation of the modulation factor).

Item 1 repeals and substitutes section 418-1 which provides for an overview of Division 418. Proposed section 418-1 reflects the legislative changes from the EDI to the JMEI in summary form, similar to those listed above.

The JMEI maintains Subdivisions 418-A, 418-B, and 418-C, which cover the object of the Division, as well as the entitlement to receive a tax offset or franking credit, depending on the type of investor entity.

Creation of exploration credits Item 2 repeals and substitutes Subdivision 418-D which deals with the creation of exploration credits. Proposed subsection 418-70(1) reflects the changes to the timing in relation to the creation of exploration credits. Currently, eligibility is based on being a greenfields minerals explorer in the previous income year, as well as the provision of a declaration estimating both their tax loss and greenfields minerals expenditure for that previous income year. Proposed subsection 418-70(1) now permits entities to create exploration credits in the income year, and (as opposed to requiring a declaration) the entity must have an exploration credits allocation40 for the income year (or an unused allocation of exploration credits from the immediately preceding income year).41

Proposed subsection 418-70(2) reflects necessary changes as a result of the repeal of the modulation factor (see below). Proposed subsection 418-70(3) provides that exploration credits cannot be created for the 2021-22 income year (or any later income year).

The definition of greenfields minerals explorer (under section 418-75) is unchanged, meaning that the JMEI will apply to the same entities as did the EDI. The definition of greenfields minerals expenditure (under section

37. Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, p. 44. 38. Proposed section 418-110. 39. Proposed section 418-81 and proposed Subdivision 418DA. 40. An exploration credits allocation is explained below. 41. An income year is defined in section 995-1 of the ITAA 1997.

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418-80) is extended to include transferees under farm-in farm-out arrangements.42 The effect of this change is to broaden the application of the JMEI compared to the EDI. This extension is acknowledged in the Explanatory Memorandum to the Bill, but no reason for its extension is provided.43

An equivalent to proposed section 418-81 did not exist under the EDI. It provides for the definition of exploration credits allocation for an income year. An entity has an exploration credits allocation for an income year if the Commissioner of Taxation makes a determination (under proposed section 418-101) allocating that entity with exploration credits for the income year. If no determination is made, the allocation is nil. The allocation process is set out in proposed Subdivision 418DA, as discussed further below.

An equivalent to proposed section 418-82 did not exist under the EDI. It provides for the definition of unused allocation of exploration credits for an income year. An entity has an unused allocation of exploration credits from an income year if the exploration credits allocation for the income year exceeds the exploration credits created by the entity for the income year. The amount of unused allocation of exploration credits from the income year is the amount of the excess.

Section 418-85 currently provides that exploration credits must not exceed the maximum exploration credit amount. In summary, the maximum exploration credit amount is currently defined to be:

• the smallest amount of:

- the entity’s estimated tax loss - the entity’s actual tax loss - the entity’s estimated greenfields minerals expenditure or - the entity’s actual greenfields minerals expenditure. • multiplied by the corporate tax rate that applied in the previous income year and

• multiplied by the modulation factor.44

Proposed subsection 418-85(2) replaces this calculation method by providing that an entity’s maximum exploration credit amount for an income year (the credit year) is the smallest of the following amounts:

• the entity’s greenfields minerals expenditure for the credit year, multiplied by the entity’s corporate tax rate for the credit year

• the entity’s tax loss for the credit year, multiplied by the entity’s corporate tax rate for the credit year or

• the sum of the entity’s exploration credits allocation for the credit year and the entity’s unused allocation of exploration credits from the income year immediately preceding the credit year.

The changes reflect the policy decision to alter the timing of the JMEI compared to the EDI.45 The removal of the requirement for an entity to provide estimates of their tax loss and greenfields minerals expenditures, respectively, reflects this change.46 That change is also reflected in bringing forward the relevant year to which the corporate tax rate relates. Proposed paragraph 418-85(2)(c) reflects the policy decision to allow entities to distribute their unused allocation of exploration credits from the income year immediately preceding the credit year.

Current subsection 418-85(3) provides the method for calculating an entity’s tax loss for the purposes of subsection 418-85(2). Proposed subsection 418-85(4) maintains the definition and contains necessary consequential amendments which reflect the changes to the timing of the creation of exploration credits. Proposed subsection 418-85(5) (which is equivalent to the current subsection 418-85(4)) contains analogous necessary amendments in terms of the changes relating to timing. Analogous changes are also contained in proposed subsection 418-85(3) in relation to calculating an entity’s greenfields minerals expenditure for the purposes of subsection 418-85(2).

42. Proposed paragraph 418-80(3)(b). A Farm-in farm-out arrangement is defined in section 40-1100 of the ITAA 1997. 43. Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, p. 28. 44. See above for the explanation of the modulation factor. 45. The decision for amending the timing is explained in: Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration

Incentive) Bill 2017, pp. 31-3. 46. Although it should be noted that entities do need to provide these estimates when applying for an exploration credits allocation under proposed section 418-100.

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As explained earlier in this Digest, the EDI currently relies on modulation factors. Section 418-90 covers the modulation factors and is proposed to be repealed by item 2. The reason for repealing the modulation factor was due to industry feedback that it created additional uncertainty as to the amount of exploration credits which could be issued.47

Exploration credits allocation Item 2 also inserts proposed Subdivision 418DA which deals with the exploration credits allocation. As outlined earlier, under proposed section 418-70, an entity must have been a greenfields minerals explorer in the income year, and the entity must have an exploration credits allocation for the income year or an unused allocation of exploration credits from the immediately preceding income year—in order to be able to create exploration credits. An entity can therefore only create exploration credits if exploration credits have been allocated to it.48 The process of gaining an exploration credits allocation involves:

• An application to the Commissioner of Taxation (proposed section 418-100)—an entity may apply to the Commissioner for Taxation for a determination to allocate exploration credits to the entity for an income year. The application must be made within one month from the start of the financial year corresponding to the income year for which the application is sought,49 and must include estimates of the entity’s greenfields minerals expenditure, tax loss, and corporate tax rate.

• A determination by the Commissioner of Taxation (proposed section 418-101)—the Commissioner may make a determination allocating exploration credits of a specified amount for an income year. The Commissioner must not make a determination if the Commissioner50 is not satisfied that there is a reasonable possibility that the entity will have greenfields minerals expenditure, applicable tax loss, and applicable corporate tax rate of the amount estimated or greater,51 and that the entity meets any other prescribed requirements.52 The amount of exploration credits specified in the determination must be the smallest of:

- the entity’s estimated greenfields minerals expenditure for the income year, multiplied by the entity’s estimated corporate tax rate for the income year or - the entity’s estimated tax loss for the income year, multiplied by the entity’s estimated corporate tax rate for the income year or - either:

• five per cent of an amount equal to the annual exploration cap for the income year or • if another amount, or a method for working out another amount is prescribed—the other amount.53

The method for calculating the first two amounts relating to an entity’s greenfields minerals expenditure and tax loss is analogous to the current process under section 418-85 (as far as the entity’s estimated values are concerned). However the introduction of five per cent of the annual exploration cap is a new provision unique to the JMEI. The Explanatory Memorandum provides that this provision ‘ensures that there is a broad spread of the benefit of the JMEI amongst exploration companies each income year’.54 Given the annual exploration cap (see proposed section 418-103 below), five per cent of each annual cap (assuming that there are no unused allocations or different amounts prescribed) would mean a maximum allocation of exploration credits to just 20 entities of:

• $750,000 for the 2017-18 income year

• $1.25 million for the 2018-19 income year and

• $1.5 million for each of the 2019-20 and 2020-21 income years.

47. Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, p. 44. 48. See proposed subsections 418-70(1) and 418-81(1). 49. Proposed subsection 418-100(2). 50. A discussion about where such a situation may arise is noted in: Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals

Exploration Incentive) Bill 2017, pp. 21-2. 51. Proposed paragraph 418-101(2)(a). 52. Proposed paragraph 418-101(2)(b). 53. Proposed subsection 418-101(3). 54. Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, p. 19.

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It should be noted that this would only apply in the event that the greenfields minerals expenditure and the tax loss were such that more than five per cent of the annual exploration cap would be allocated to a particular entity. If there were 20 such entities then the cap would breached, and accordingly each entity would receive five per cent of the annual exploration cap, and the associated investors would receive a resultant smaller tax offset. The likelihood of such an event is unknown at present, but the limited information about various greenfields minerals explorers that does exist in relation to the EDI indicates that the majority of entities would be below the five per cent threshold.55

Additional aspects of proposed Subdivision 418DA are:

• Compliance with the general allocation rules (proposed section 418-102)—the total amount of exploration credits must not exceed the annual exploration cap. The Commissioner of Taxation must consider applications on a first-come, first-served basis; with the possibility that entities which apply later than others may not receive their full entitlement of exploration credits as a result of the process outlined above.56

• The definition of annual exploration cap (proposed section 418-103) with the amounts allocated to each income year as follows:

- $15 million for the 2017-18 income year - $25 million for the 2018-19 income year and - $30 million for each of the 2019-20 and 2020-21 income years. • A safeguard provision in the event of a failure by the Commissioner of Taxation to comply with the requirements in proposed Subdivision 418DA.57 This is to ensure that any inadvertent error by the Commissioner of Taxation in relation to any one application does not affect all subsequent determinations.

Issuing exploration credits Item 2 also repeals and substitutes Subdivision 418E which deals with issuing exploration credits. In summary, the issuing of exploration credits relates to the tax treatment of certain investments by investors in minerals explorers.

Proposed section 418-110 is the operative provision that provides that an entity that has created exploration credits (called the minerals explorer) may issue an exploration credit for that income year to another entity (called the investor). The exploration credit issued to the investor may relate to one of two things: an exploration investment made by the investor in the minerals explorer in the:

• income year or

• immediately preceding income year.

This is subject to a number of limitations (see below).

An exploration investment has been made if:

• shares in the mineral explorer are issued to the investor by the minerals explorer on or after the day the Commissioner of Taxation makes a determination (under proposed section 418-101) allocating exploration credits to the minerals explorer for the income year and

• the shares are issued before the end of the income year and

• those shares are equity interests.58

In practice this means that the shares must be newly issued shares by the minerals explorer, they cannot be via the (secondary) traded market. This helps to ensure that the policy of attracting new capital funds is met. Additionally, the exploration credit is based on the value of the exploration investment so as to ensure that the credits are solely as a result of the entity undertaking eligible expenditure. This is an integrity measure to ensure that the capital raising is only directed to eligible activities which can then receive concessional tax treatment in the hands of the investor.

55. Lucas, ‘Tax scheme under review’, op. cit., p. 7. 56. Proposed subsection 418-102(4). 57. Proposed section 418-104. 58. Proposed subsection 418-111(1).

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Proposed section 418-115 provides for a priority order for the receipt of exploration credits and introduces an issue pool concept to facilitate the order. It provides for three possible scenarios. Under one scenario, for example, if there is an unused allocation of exploration credits from a preceding year and further exploration credits are then created in the following year, the investors who made an investment in the preceding income year are entitled to receive exploration credits ahead of investors who made an investment in the current year (in the event that such credits are created). This reflects the fact that entities are effectively provided with two years to incur relevant expenditure, and without having first incurred the expenditure, exploration credits cannot be created.

Proposed section 418-116 provides that each investor is entitled to a distribution that is proportionate to the value of their investment, as a percentage of the total value to be distributed in the relevant issue pool. This helps to ensure that each investor is treated equally, whilst also ensuring that those investors who have funded the capital raising are the ones receiving the tax benefit (since entitlement to a distribution is based on initial capital contribution and not current shareholding). As noted in the Explanatory Memorandum, this is a superior approach to that which applied under the EDI ‘where all shareholders were entitled to receive a proportion of the exploration credits that were received’.59

Excess exploration credits Item 4 inserts proposed section 418-151 which relates to the complying exploration credit amount. Entities are liable to pay excess exploration credit tax where they have issued exploration credits in excess of the complying exploration credit amount.60 In the event that an entity issues exploration credits that it is not entitled to (for example, an entity issued credits where it did not undertake qualifying expenditure) then that entity is liable to pay excess exploration credit tax. Items 3 and 5-6 make minor consequential amendments to reflect the changes in terminology and timing in relation to the JMEI.

Modified capital gains tax treatment Items 13-15 amend the ITAA 1997 to provide for modified capital gains tax (CGT) (see box 1) treatment in the event of a disposal of shares issued to an investor by a minerals explorer. The modified CGT treatment reflects the fact that investors are entitled to a share of exploration credits that are distributed in the income year, provided that the other requirements are met (see above). As a result of having access to the exploration credits—which cannot be transferred—investors may have paid a premium for the shares, and that premium is not reflected in the sale price in the event that the shareholder decides to sell their shares. In effect, that means that the sale price would be ‘too high’. Since the sale price cannot be reduced (that is simply the market price paid for the shares), items 13-15 have the effect of reducing the reduced cost base of the shares, which thereby affects the amount of capital loss incurred. The reduced cost base is reduced by the corporate tax rate that applied to the minerals explorer when the share was issued, multiplied by the amount paid up by the investor on the share during the investment period.61 This has the effect of lowering the reduced cost base of the shares, which in turn lowers the amount of capital loss that can be claimed by the investor.

Other amendments

Items 7-10 in Part 2 of Schedule 1 make consequential amendments to the ITAA 1936 as a result of the change in the name from EDI to JMEI. Items 11-12 and 16-26 make similar changes to the ITAA 1997. Items 27 and 28 make similar changes to the Tax Administration Act.

59. Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, p. 27. 60. Item 3 amends section 418-150 to reflect the introduction of the complying exploration credit amount by proposed section 418-151. 61. Proposed section 130-110 as inserted by item 15.

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Box 1: summary of capital gains tax (CGT)

In simple terms, if a capital asset is disposed of, the disposal usually results in either a capital gain or a capital loss. Shares would be considered a capital asset, and the sale of shares would qualify as a disposal.

The initial purchase price of shares would generally be considered to be the cost base of the shares, and the sale price of the shares would be considered to be the capital proceeds. A capital gain is the difference between the capital proceeds and the cost base. Capital gains tax (CGT) is the tax that is payable on such gains.

Where the capital proceeds are less than the cost base (which is called a reduced cost base), a capital loss is generated. Generally, capital losses can be rolled over and can be offset against future capital gains.

The Bill proposes to modify the CGT treatment of exploration investments in junior mineral explorers by amending the usual rules which would apply in calculating the reduced cost base, which in turn, affects the amount of capital loss.

Sources: ITAA 1997, Parts 3-1 and 3-3, section 995-1; Explanatory Memorandum, Treasury Laws Amendment (Junior Minerals Exploration Incentive) Bill 2017, pp. 33-5.

Repeal of the JMEI from 1 July 2023 Items 29-41 repeal cross-references to Division 418 of the ITAA 1997 (which is the Division where the JMEI is inserted by Parts 1 and 2) in the ITAA 1936. Items 42-44 and 46-52 repeal Division 418 and references to that Division in the ITAA 1997. Item 45 ensures that the future disposal of shares by investors after 1 July 2023 remain subject to a reduction in the reduced cost base, as was introduced by items 13-15 of Schedule 1. Items 53-64 repeal cross-references to Division 418 of the ITAA 1997 in the Tax Administration Act. These amendments will commence on 1 July 2023 and reflect that the JMEI is time-limited and only applies to the 2017-18 to 2020-21 income years.

Items 1 and 2 of Schedule 2 repeal and substitute two table items of the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Act 2015. That Act provided for the introduction of the EDI. Item 1 repeals and substitutes Table item 12 of subsection 2(1) of that Act, which currently provides for the repeal of Division 418 on 1 July 2020 as it relates to the EDI. Instead, item 1 proposes that the repeal of Division 418 does not commence if Parts 1 and 2 of Schedule 1 to the Treasury Laws Amendment (Junior Minerals Exploration Incentive) Act 2017 commence before 1 July 2020. This ensures that Division 418—as it would then relate to the JMEI—is repealed on 1 July 2023 as outlined above in relation to Schedule 1.

Item 2 of Schedule 2 similarly repeals and substitutes table item 14 in subsection 2(1) of the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Act 2015.62

Part 4—Application, transitional and saving provisions Item 66 of Schedule 1 provides that an application to the Commissioner of Taxation for an allocation of exploration credits for the 2017-18 income year must be made on or after 1 February 2018 but before 1 March 2018, as opposed to the usual time of one month prior to the start of the financial year. This reflects the fact that the 2017-18 financial year has already commenced and the JMEI was not announced until September 2017.

Item 67 provides that greenfields minerals explorers in the 2016-17 income year can still create and issue exploration credits under the EDI, despite the fact that the EDI is repealed and replaced with the JMEI in Parts 1 and 2 of Schedule 1.

62. There appears to be a small error in the drafting of item 2 of Schedule 2 to the Bill. The replacement provision is incorrectly identified as table item 12, rather than table item 14.

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