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Client Update: Resource exploration rebate

6 May 2010

In brief: As part of its response to the Henry tax review, the Federal Government has announced that it intends to introduce a refundable tax offset for eligible exploration expenditure. Senior Associate Katrina Parkyn looks at how the offset will work and who will benefit.

Key features of proposal

  • The Federal Government has accepted the Henry tax review's recommendation for a resource exploration rebate.1
  • The proposal is for a refundable tax offset, to be calculated at the prevailing company tax rate, for eligible exploration expenditure incurred on or after 1 July 2011.
  • While the rebate will be available to all companies, it will be particularly important to small exploration companies that have not yet become profitable.2
  • The rebate will apply to the same range of exploration expenses as are immediately deductible under the existing tax laws, provided that the exploration is carried out in Australia.
  • The rebate will also apply to expenditure incurred in exploring for geothermal energy.
  • The rebate is in substitution for a flow-through share scheme, and is intended to make exploration more attractive to investors.3
  • The Government has said that it will consult on exposure draft legislation to give effect to the rebate.

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How will the rebate work?

Companies will be entitled to a refundable tax offset at the prevailing company tax rate for their eligible exploration expenditure. Exploration expenditure will also be immediately deductible for the purposes of the proposed new resource super profits tax.

For a company in a tax loss position that incurs $1 million on eligible exploration expenditure, the rebate will provide an immediate cash benefit, by way of refund, of $300,000 (based on the current 30 per cent company tax rate). Note, however, that the Government has also announced a reduction in the company tax rate to 28 per cent from the 2014-15 income year.

For a company that is in a tax paying position, the rebate will operate as a tax offset against tax payable. For a company that incurs $1 million on eligible exploration expenditure, the rebate will provide a tax offset against tax payable of $300,000. As the tax offset is calculated at the prevailing tax rate, the after-tax position of the company, after taking into account the resource exploration rebate, should be the same as under the current tax laws.

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Who will benefit?

The aim of the rebate is to encourage exploration expenditure.

Under the current tax laws, expenditure incurred in exploring or prospecting for minerals, petroleum or quarry minerals can be immediately deductible (ie. 100 per cent deductible in the year it is incurred).4 An immediate deduction may also available for expenditure incurred on depreciating assets that are first used for exploration or prospecting.5

An issue, however, for smaller exploration companies is that they do not generally earn sufficient assessable income to be able to utilise the tax deductions arising from exploration expenditure until they become profitable.

This means that the deductions generated from exploration activities are of no real benefit unless the company becomes profitable (ie. when it has taxable profits against which to utilise its carry forward losses). This timing difference undermines the value of the tax deduction. In some cases, the losses that are generated may be not be able to be used in the future (through, for example, a failure to satisfy the stringent carry forward loss rules).

While the rebate will be available to all companies, it is expected to be particularly attractive for pre-profit mining companies. This will be achieved by enabling those companies to obtain an immediate cash benefit in respect of their eligible exploration expenses.

The structure of the rebate may tend to encourage reinvestment of any cash rebate into further exploration activities rather than paying it back to shareholders (as a taxable unfranked dividend).

All other things being equal, the rebate might also make joint venture exploration companies more attractive than under current law. A difficulty faced by joint venture exploration companies under current law is the fact that exploration deductions become 'trapped' in the joint venture company and are not available to the joint venturers as a deduction against other mining income. A refundable tax offset would alleviate this issue by providing the joint venture company with an immediate benefit for the exploration expenditure in the year it is incurred.

Footnotes
  1. Recommendation 32 (Australia's future tax system – Report to the Treasurer – Part 2, Volume 1 of 2, page 177).
  2. The Review recommended that the rebate be limited to exploration expenditure incurred by 'Australian small listed exploration companies'. As announced, however, the rebate will be available to all companies.
  3. The Review considered, but did not favour, adopting a flow-through share scheme for exploration companies. In essence, the Review considered that 'although the current treatment of losses may disadvantage exploration relative to other investments, targeted provisions for expenditure on resource exploration could reverse that bias and favour investment in exploration at the expense of other, potently (sic) more profitable, investment opportunities' (Australia's future tax system – Report to the Treasurer – Part 2, Volume 1 of 2, page 179).
  4. Section 40-730, Income Tax Assessment Act 1997 (Cth).
  5. Section 40-80, Income Tax Assessment Act 1997 (Cth).

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