Docstoc

EXPLORATION POLICY

Document Sample
EXPLORATION POLICY Powered By Docstoc
					 


€




                                        EXPLORATION POLICY
    A RESPONSE TO THE POLICY TRANSITION GROUP ISSUES PAPER



       REPRESENTING THE AUSTRALIAN MINERALS INDUSTRY FOR AND ON BEHALF OF:
                                              MINERALS COUNCIL OF AUSTRALIA
                    CHAMBER OF MINERALS AND ENERGY OF WESTERN AUSTRALIA
                                            QUEENSLAND RESOURCES COUNCIL
                                         NEW SOUTH WALES MINERALS COUNCIL
                            SOUTH AUSTRALIAN CHAMBER OF MINES AND ENERGY
                    VICTORIAN DIVISION OF THE MINERALS COUNCIL OF AUSTRALIA
                                                TASMANIAN MINERALS COUNCIL
          NORTHERN TERRITORY DIVISION OF THE MINERALS COUNCIL OF AUSTRALIA
                          AUSTRALASIAN INSTITUTE OF MINING AND METALLURGY



                                                             NOVEMBER 2010




                                   1 
 
 


CONTENTS

EXECUTIVE SUMMARY ........................................................................................................................................................... 3 
INDUSTRY OVERVIEW ............................................................................................................................................................ 6 
        The role of junior explorers  ................................................................................................................. 7 
                                    .
EXPLORATION TRENDS.......................................................................................................................................................... 8 
        International trends ............................................................................................................................ 9 
        Shifts in Australian exploration activity  ............................................................................................... 11 
                                                 .
        Trends in discovery rates and resource quality  ................................................................................... 12 
                                                      .
THE CASE FOR NEW POLICY MEASURES  ............................................................................................. 15 
                                .
        Addressing a tax asymmetry ............................................................................................................. 15 
        No linkage with MRRT ...................................................................................................................... 17 
A PROPOSED ETC SCHEME: FEATURES AND TAX EXPENDITURE ESTIMATES ........................................................... 18 
APPENDIX A – SYNERGIES REPORT (EXCERPT) .............................................................................................................. 21 
Modelling approach .................................................................................................................................. 21 
        Expenditure base (eligible exploration expenditure) ............................................................................. 21 
        Induced (additional expenditure) ........................................................................................................ 22 
        Expenditure base estimates .............................................................................................................. 23 
Rate........................................................................................................................................................ 23 
Tax Expenditure Estimates ....................................................................................................................... 24 




                                                                                       2 
 
 


EXECUTIVE SUMMARY 
 
1.      Minerals exploration in Australia: recent trends

The pipeline of minerals resource projects for future generations in Australia appears uncertain at best based on current
exploration trends. Enabling regulatory and taxation frameworks are required to drive exploration in Australia, especially for
smaller, entrepreneurial operators disadvantaged by existing arrangements.

Despite a pick-up in expenditure in recent years, real mineral exploration activity (measured by metres drilled) is well down
on levels recorded in the 1990s. Most of Australia’s minerals production is from deposits found 20 or more years ago. The
profile of exploration expenditure shows a steady shift away from “greenfields” projects and toward “brownfields” deposits.
There has also been a shift in exploration focus from the early 2000s with increased activity being directed to the bulk
commodities, especially iron ore and coal, and away from gold and base metals. And across most commodities there has
been a decline in discovery rates and in the average grade of exploration discoveries.

In addition, Australia’s share of global exploration expenditure has declined as other nations have adopted pro-exploration
policies. Though notable vis-a-vis developing economies, Australia’s position has also slipped relative to more established
competitors such as Canada where the latter’s Flow-Through Shares (FTS) scheme has provided a solid platform for long-
term exploration growth.

These trends were all identified in the PTG Issues Paper released on 1 October 2010. The minerals industry considers that
they point unequivocally to a suboptimal level of minerals exploration in Australia at a time of historically high mineral
commodity prices.

Australia remains a prospective continent for both bulk commodities and higher value precious and base metals. It is also
prospective for light and rare earth metals – metals of the “electronic economy”. Taxation measures should encourage
investment in exploration for all these existing or emerging materials.

There are two key aspects that influence a mineral explorer’s decisions where to explore. The first is their perception of
prospectivity and the second, especially for the junior sector, is their access to risk capital to fund their exploration activities.
At a time of historically high global demand for mineral commodities, Australia may run the risk of slipping behind competitor
nations that have adopted more equitable, pro-exploration policies. To maintain exploration impetus, Australia also needs to
get smarter in its development and application of advanced exploration technologies to find new blind deposits and deeply
buried deposits and to provide greater certainty when seeking to extend already known deposits.

The importance of an expanded mineral exploration effort in Australia was highlighted by Geoscience Australia (GA) in its
most recent report on Australia’s Identified Minerals Resources 2009, released in January 2010. It noted that that there
have been “very few world class discoveries in Australia over the last two decades and the inventory has been sustained
largely through delineation of additional resources in known fields”. This comment underlines the importance of the need for
a smarter and an expanded mineral exploration effort in Australia.

The Chief of GA’s Onshore Energy and Minerals Division, Dr James Johnson, has cautioned that:

        While Australia’s resource stocks are healthy overall, the country’s position as a premier minerals producer is
        dependent on continuing investment in exploration to locate high quality resources and to upgrade known deposits to
        make them competitive on the world market.1

Exploration is critical to the growth, vitality and diversity of the Australian minerals industry. Both regional communities
highly dependent on the industry and the wider Australian economy stand to benefit from increased exploration activity.

2.      The case for new policy measures

Both government and industry have recognised the case for new measures to improve Australia’s minerals exploration
performance. In 2007, Labor’s Plan for a Stronger Resources Sector committed a future Labor Government to “promote
investment in exploration by allowing the selective use of flow-through shares schemes for smaller operators in the gas, oil
and mineral exploration industries”.2 The Australian minerals industry welcomed this commitment and its fulfilment remains


                                                            
1 Geoscience      Australia, ”Australia’s mineral resources maintain world status”, Media release, 7 January 2010.
2
     Australian Labor, “Labor’s plan for a stronger resources sector”, Election 2007, p. 7.

                                                                         3 
 
 


an industry expectation. Consistent with this commitment, in November 2008 a joint industry submission was presented to
the Australian Government on a proposal to introduce a Flow-Through Shares/Exploration Tax Credit (ETC) scheme.3

Australia’s suboptimal level of exploration expenditure relates directly to the tax asymmetry problem faced by junior
explorers unable to utilise immediate deductions for exploration expenditure due to their lack of taxable income. This
effectively increases the costs for junior explorers of carrying out exploration. As a result, small exploration companies
exploring in Australia are less attractive as investment options compared with other industries and exploration companies in
competing jurisdictions with pro-exploration policies.

The Australian Bureau of Agricultural and Resource Economics (ABARE) has estimated that this asymmetry increases
exploration costs of small exploration companies by around 7-8 per cent.4 This is a significant structural barrier to an activity
already characterised by high risk, escalating costs, extensive regulatory requirements and pressures for new restrictions
(for example, new land access provisions in States such as Queensland and additional monitoring and compliance
requirements in NSW).

By distorting the allocation of finance to the junior sector, and hence penalising risky projects, this feature of the tax system
can result in a degree of financial market “incompleteness”. Revising those features of the tax system, or attempting to offset
them through other measures, is likely to yield important net welfare gains.

To address this problem, the minerals industry considers the Australian Government should adopt an Exploration Tax Credit
scheme, a variation on the Canadian Flow-Through Shares scheme tailored for Australia’s unique policy context. An ETC
would enable the transfer of eligible deductions of eligible individual exploration companies operating in Australia to
individual Australian resident investors at the company income tax rate. Rather than being accumulated as tax losses which
are only realisable if and when the company earns a taxable income, the tax credit for exploration expenditure is leveraged
in the capital markets so as to attract external investors. By targeting only those exploration companies with unutilised tax
deductions, the ETC will necessarily target juniors and, by default, greenfields exploration.

The situation faced by junior explorers has clear parallels with other areas, such as the biotechnology industry, where the
case for policy action has been acknowledged by the Australian Government (in the form of the revamped Research and
Development Tax Credit presently before the Commonwealth Parliament).

The PTG Issues Paper states that: “Funding for new incentive mechanisms would need to be fully offset from within the
PTG’s recommendations”.5 The industry views this as prima facie a departure from the Heads of Agreement released on
2 July 2010 in which the design parameters of the MRRT were in no way contingent on the Government’s fiscal strategy or
no new measures for exploration.

The industry is strongly of the view that the ETC policy is justified in its own right. The industry does not accept
that it should be considered within the revenue “envelope” of the Minerals Resource Rent Tax (MRRT). This was
not the basis of the 2 July Heads of Agreement on the MRRT. The MRRT must not be refashioned to fund policies
to promote exploration expenditure.

3.     A proposed ETC scheme: features and tax expenditure estimates

An ETC seeks to address the core problem of junior exploration companies having significant difficulties raising the equity
capital to fund increasingly expensive and challenging exploration activity. The industry regards the ETC as a superior
option to the Resource Exploration Rebate (RER) proposed this year by the Australian Government; a similar proposal is
outlined in the PTG Issues Paper as an Exploration Refundable Tax Offset (ERTO).

An ETC mechanism allows the tax benefit associated with deducting exploration expenses to flow through to shareholders.
By providing a tax incentive to investors who acquire the shares, this leverages capital markets and makes investment in
this sector more attractive. Key features include:

       •      ETCs would be accessible to Australian resident shareholders of Australian companies;

                                                            
3
   Joint Industry Submission to the Minister for Resources and Energy, the Hon. Martin Ferguson AM MP, A proposal to introduce ‘flow-
through shares’ (FTS) in Australia, 5 November 2008.
4
   Australian Bureau of Agriculture and Resource Economics, Tax incentive options for junior explorers, May 2003, p 31. 
5
   Australian Government Policy Transition Group, Issues Paper, 1 October 2010, p. 105.

                                                                   4 
 
 


        •     ETCs would be available to shareholders of all eligible companies undertaking eligible exploration expenditure in
              Australia;
        •     the credit would be available at the company tax rate (presently 30%). Eligible taxpayers would be entitled to the
              credit based on this rate;
        •     the ETC system would be voluntary – eligible exploration companies could retain their exploration deductions for
              their own future use, or pass them through to shareholders;
        •     there would be no time limit on the use of tax credits; and
        •     a range of transparent, integrity measures would be implemented to target the mechanism at junior explorers and
              ensure the scheme operates as intended.6

The minerals industry has commissioned economic consultants Synergies to update earlier cost/benefit analysis of an ETC
scheme, including vis-a-vis the ERTO/RER option. Assuming a high response scenario, the previous research provided a
net cost of approximately $145 million per annum to Government from implementation of an ETC scheme.7 This took
appropriate account of spillovers from exploration activity (i.e. ETC costs would be offset in part by increases in other taxes
from the resultant increase in economic activity). This work found that for each dollar of revenue foregone roughly $1.7 in
additional exploration is induced.

Given the limited time available, Synergies has made only a gross estimate of costs - i.e. no allowance is made for the net
tax effects associated with the expansionary impact on the economy. This analysis suggests the gross costs of the ETC
would range from $218 million to $247 million per annum over the forward estimates (see Table below). It would be
incumbent on Government forecasters to use these costings as a starting base to calculate the net costs. Overall, however,
the industry considers the ETC scheme to have clear advantages over the ERTO/RER option in that: 1) it would be targeted
to bona fide greenfields operations; 2) it would be less expensive to fund; and 3) it would likely encourage greater short and
long term spillovers.

The industry holds that an ETC is a superior policy response for dealing with the tax asymmetry and for encouraging private
sector investment in exploration. The signal to investors is more direct by passing the tax credit through the company to the
shareholders rather than via a rebate to the company.

Exploration has strong backward and forward linkages with the rest of the economy and is a labour intensive activity.8 In the
longer term, more drilling of targets upgraded by smart exploration technologies increases the chances of making a
discovery that can ultimately be converted to a new mining project. New mining projects deliver major benefits to all
Australians via significant expenditures of goods and services, shareholder returns to investors, and high wages and
salaries to direct and indirect workers. Additional discoveries also increase government revenues through royalties and
taxes as resource deposits are developed.



                          Tax expenditure estimates, $ million
                                                                  RER - Juniors                      ETC - Juniors

                           2010/11                                       251                               218
                           2011/12                                       257                               231

                           2012/13                                       258                               237
                           2013/14                                       270                               247

                           2014/15                                       238                               229




                                                            
6   A simple way of achieving this objective could be to limit credits to firms in tax loss or firms under some threshold of taxable income.
7 http://www.qrc.org.au/_dbase_upl/Flow%20through%20shares%20-%20Synergies%20Report%20May%20%202009.pdf
8   http://www.qrc.org.au/_dbase_upl/Flow%20through%20shares%20-%20Synergies%20Report%20May%20%202009.pdf, Page 27.

                                                                        5 
 
 




INDUSTRY OVERVIEW
Australia is a world leading mining nation and its minerals sector is Australia’s premier global industry. The minerals
industry’s successful negotiation of the global financial crisis and its harnessing of the opportunities presented by renewed
growth in global commodities demand have directly increased Australia’s national income and wealth.

The industry also measures its success in terms of responsible social development and effective environmental
management. Over the last decade, the Australian minerals industry has delivered significant dividends to the nation across
this ‘triple bottom line’.

The Australian mining industry:
       •      comprises about 8 per cent of Australia’s Gross Domestic Product and a similar share of Total Gross Value Added
              in the economy;
       •      invests about 15 per cent of Australia’s Gross Fixed Capital Formation;
       •      earns more than half of Australia’s total export income - up from about a third early in the decade;
       •      directly employs 184,5009 people or 1.6 per cent of the Australian workforce
       •      is a major source of economic activity and jobs in regional and remote Australia (Figure 1);
       •      pays more than $18 billion in wages and salaries;
       •      invests $3.3 billion annually in research and development10; and,
       •      contributes $7.6 billion in royalty revenues and $14.3 billion in company tax.11
Excluding oil and gas projects, committed projects in the sector amount to more than $40 billion of investment, with an
additional $122 billion of less advanced projects.



Figure 1 Employment in regional communities




                                                            
9
  ABS May 2010: 179,400 in mining including oil & gas extraction plus 5,100 in petroleum & coal product manufacturing
10 ABS Cat. No. 8104.0 Research and Experimental Development, Businesses 2007-08
11 Access Economics estimates for the MCA, 2008-09 


                                                                   6 
 
 


The role of junior explorers

As at October 2010, there were 780 mineral resource-related companies listed on the Australian Stock Exchange. One-third
(260) have operating mines with the rest (530) classified as junior explorers.

Junior explorers play an important role in the Australian exploration industry, especially (but not only) in relation to gold and
base metal exploration. Analysis by ABARE suggests that the industry structure in Australia is likely to reflect the benefits of
specialisation in certain kinds of exploration activities. Comprehensive exploration programs that are capital intensive and
targeted at major deposits are likely to be best conducted by large well-capitalised companies. By contrast, “small
companies are likely to be better suited to exploration activities that require rapid decision making, flexibility and
innovation”.12

Research for the minerals industry by MinEx Consulting shows that over 70 per cent of all exploration projects in Australia
are owned by companies with market caps less than $100 million. Most of these companies are junior explorers and the
long-term pipeline of projects for the minerals industry is highly dependent on their exploration success. A breakdown of
ownership by project stage also shows that junior companies dominate the early stages of exploration (Figure 2).

Figure 2 Breakdown of ownership of exploration projects




Note: Unlisted companies are mainly (large) overseas companies not listed on the ASX.

Typically, only one in five of these companies is successful. MinEx concludes that the median explorer runs on 1 to 1.5
years of cash reserves. Year on year, the investment community’s preparedness to invest is usually very volatile and
correlates strongly with global commodity prices and general sentiment at that time. On average, for every dollar raised by
the industry via initial public offerings and company floats, a further five dollars needs to be raised in later years through
successive capital raisings. This proportion has remained constant over the decade suggesting that companies are required
to regularly return to the market for additional funds through a variety of mechanisms such as share issuances and private
placements.

Capital scarcity is an important factor explaining why many companies concentrate on brownfields exploration to maintain
short-term interest rather than direct capital to the riskier, but critically important, greenfields exploration. As this submission
will highlight, anomalies in the taxation system add to the burden of junior explorers financing their operations.




                                                            
12
   ABARE, Tax incentive options for junior exploration companies, Report for the Department of Industry, Tourism and Resources, May
2003, p. 7. 

                                                                          7 
 
 


EXPLORATION TRENDS
 
Australia’s minerals exploration effort appears suboptimal and the pipeline of minerals resource projects for future
generations in Australia is uncertain at best. Notwithstanding higher exploration expenditure, rising costs of exploration (for
labour, fuel and equipment) mean that today’s exploration dollar does not go as far as it once did. Actual activity (measured
by metres drilled) is well down on average levels of the 1990s, a period of much lower commodity prices (Figure 3).

Most of Australia’s minerals production is from deposits found 20 or more years ago. A further notable trend is the steady
shift of exploration activity away from new greenfields projects and toward lower risk brownfields sites. (Figure 4). The result
is a lack of new, large-scale projects. At the same time, as noted by the Australian Institute of Geoscientists, there has been
a decline in success rates and in the average size and quality of ore bodies discovered in Australia, especially for base and
precious metals.

The PTG Issues Paper identifies all these trends. To the minerals industry, they point to Australia living off past discoveries
with a suboptimal level of exploration at a time of historically high mineral commodity prices that should be stimulating new,
higher risk/reward exploration activity.

Figure 3




Figure 4




                                                               8 
 
 


International trends

Australia’s exploration performance also looks mediocre from an international perspective. Data compiled by the Metals
Economic Group (MEG) indicates that Australia’s share of global exploration expenditure has fallen from more than 20 per
cent in the mid 1990s to an estimated 12 per cent in 2010.13 Changing risk/reward perceptions, often associated with policy
variables, help explain prevailing trends.

As developing countries in particular have opened up to foreign investment, they have become more attractive relative to
established minerals provinces such as Australia, because of perceptions of greater prospectivity and hence reward. Many
countries with outcropping or shallow deposits are providing a “red carpet” treatment for explorers, with global exploration
dollars going increasingly to countries such as Peru, Mexico, Chile, Brazil, Argentina, China, Russia and Mongolia.


Figure 5 World share of mineral exploration expenditures: 1996-2010 - Excluding bulk commodities




Equally, however, Australia’s international position has slipped relative to more established competitor economies. The
comparison is most stark relative to Canada, where policy variables (in this case, its Flow-Through Shares, or FTS scheme)
appear a key part of the explanation.
Since Canada introduced an FTS scheme there has been an exponential growth in Canada’s equity financings. The
Toronto Stock Exchange is home to 60 per cent of the world’s public mining companies and Canada has the world’s largest
mining analyst community. Canadian exchanges have become the world’s leading markets for raising equity capital for
mining.
At the same time, Australian companies are increasingly “voting with their feet” and going to more “exploration-friendly”
regions overseas. In 2010, Australian-headquartered companies are estimated to spend 52 per cent of their exploration
budget within Australia – with the balance going overseas. This is 10 percentage points lower than the level a decade ago.
In contrast, the share of domestic exploration expenditure by Canadian-headquartered companies has risen – from 23 per
cent in 1997 to around 37 per cent (Figure 6). It is acknowledged that Canada does not have as rich bulk commodity
prospects as Australia. Nonetheless, in the non-bulk area Canada has enjoyed rapid growth in exploration share as Figure 5
shows.




                                                            
13
      This data does not include bulk commodities. 

                                                               9 
 
 


Figure 6 Share of exploration budgets allocated to domestic exploration by location of corporate headquarters:
Canada versus Australia 1995-2010 (Excludes bulk commodities)




                        


Based on the latest Corporate Exploration Strategies Survey by the Metal Economics Group (MEG), US$1276 million was
spent on minerals (excluding bulk commodities) exploration14 in Australia in 2010. Of this US$946 million (74 per cent) came
from companies headquartered in Australia. The remaining 26 per cent came from foreign companies. The survey also
shows that Australian-based companies spent US$891 million in other countries, with around 40 per cent of the new listings
in 2010 raising funds for overseas operations (Figure 7).


Figure 7 Source and destination of Australian exploration budgets: 2010 (Excludes bulk commodities)




 

 




                                                            
14
       This figure excludes uranium and bulk minerals.

                                                               10 
 
 


 

Shifts in Australian exploration activity


Exploration around existing or known deposits has made up an increased proportion of total exploration expenditure in
Australia. Australian Bureau of Statistics data shows that 39 per cent of spending on exploration was on new deposits in
June 2010, down from 43 per cent in June 2004.

The Metals Exploration Group defines the various exploration stages as follows:

     •    Grassroots – exploration from the earliest stage through perimeter drilling to the quantification of initial resources;
          also includes reconnaissance and evaluative forays.
     •    Late Stage and Feasibility – exploration to further define, quantify, and upgrade a previously identified ore body
          after initial resources have been identified; also includes all feasibility work up to the point of a positive production
          decision.
     •    Mine Site – all exploration (regardless of stage) at or immediately around an existing mine site held by the
          company; includes the search for satellite ore bodies within an economic transportation distance of an operating
          mine and exploration at or immediately around a project that is committed to development (preproduction stage).

Latest estimates show the level of grassroots exploration in Australia – excluding bulk commodities – has dropped over the
last seven years from 50 per cent of total expenditure in 2003 to an estimated 38 per cent currently (Figure 8). Within this
grassroots category, MinEx Consulting advises that about half of what the Metals Exploration Group describes as
greenfields exploration carried out by junior companies is more commonly viewed in the industry as brownfields exploration.
Thus the total amount of funding for greenfields exploration in Australia is likely to have fallen even more. This in turn has
significant implications for discovery rates for new mineral deposits in Australia.

Figure 8 Breakdown of expenditures by stage: 1996 to 2010 - percentage (excluding bulk commodities)




                                                               11 
 
 




Trends in discovery rates and resource quality

As noted above, current mine production in Australia is largely from maturing mines or resource accumulations that have
mostly been discovered more than 20 years ago. In some instances the mines are nearly exhausted and production rates
are falling (the one important exception to this being the Olympic Dam deposit, which although discovered in 1975 has not
yet been developed to its full potential). In other cases, especially in iron ore and coal, mining of known resources is
expanding as commodity prices increase and project economics improve, even though grade or product quality has declined
from previous levels. Dormant resources, many of which were discovered years ago, are being re-evaluated in preparation
for feasibility studies that may include further “brownfield” and/or resource drilling.

In non-bulk commodities, some 285 significant15 mineral deposits have been found in Australia since 1975. On average over
the past decade, there was only one “giant” deposit found per year and 43 significant deposits. The lack of giant discoveries
stems from the general decline in exploration success as many of the near surface deposits have been discovered (see
Figure 10). By comparison, in the 1980s and 1990s more than 10 significant deposits were found each year on average.
Hence, in spite of increased exploration expenditures, Australia’s discovery rate has roughly halved since the start of the
decade (Figure 11).

Figure 9 Location and depth of cover for Major mineral discoveries in Australia (Excluding bulk commodities)




Changes in exploration practices and technology do affect activity. The growth in activity in the late 1970s was a direct
result of an increasing focus on gold driven by success of Carbon In Pulp processing technology and its impact making
lower grade gold reserves economic. Technology triggers will impact exploration activity, none more than industry’s ability to
gain access to pre-competitive geological data, of the type made available by Geoscience Australia and the various State
and Territory Geological Surveys and Mines Departments. Australia is a world leader in the development and application of
smart exploration and mining technologies and as mineral deposits get deeper and harder to find, smart exploration
technologies will be needed to build the pipeline of new resource projects.

Australian and global exploration companies continue to support Australian research initiatives designed to improve
discovery rates and reduce discovery costs. The Predictive Mineral Discovery Cooperative Research Centre (pmd*CRC)
which operated from 2002-09 pursued this theme and delivered a legacy of improved national access to geoscientific data.
A new CRC, Deep Exploration Technologies (DET) will pursue improvements in drilling and subsurface sensing
technologies to increase discovery rates.



                                                            
15Significant is defined as a (Moderate-sized) deposit containing >100kt Cu (or its equivalent), >10 kt Ni, >100 koz Au or >5kt U3O8. A
Major-sized discovery is defined as containing >1mt Cu, >100kt Ni, >1 moz Au or >25 kt U3O8. A Giant-sized discovery is defined as
containing >5mt Cu, >1mt Ni, >6 moz Au or >125 kt U3O8.

                                                                   12 
 
 


Figure 10 Exploration expenditures and number of discoveries in Australia 1975-2009




Again, international competitiveness is critical. Australian has fared well in the past but discovery rates are slipping
compared with other nations.




Figure 11: Australia’s discovery performance versus Western World




 The importance of an expanded mineral exploration effort in Australia was highlighted by GA in its most recent report on
Australia’s Identified Minerals Resources 2009, released by in January 2010. It noted that there have been “very few world
class discoveries in Australia over the last two decades and the inventory has been sustained largely through delineation of
additional resources in known fields”. The Chief of GA’s Onshore Energy and Minerals Division, Dr James Johnson, has
cautioned that:

       While Australia’s resource stocks are healthy overall, the country’s position as a premier minerals producer is
       dependent on continuing investment in exploration to locate high quality resources and to upgrade known deposits
       to make them competitive on the world market16 (emphasis added).


A pipeline of future resource projects is critical if Australia’s minerals industry is to take advantage of Asia’s continued
industrialisation and a period of elevated demand for mineral commodities. Analysis by Access Economics as part of the
Minerals Council of Australia’s Vision 2020 Project, suggests that for Australia to simply maintain market share, large
increases in production will be required across a range of commodities (Figure 13).


                                                            
16   Geoscience Australia, ‘Australia’s mineral resources maintain world status’, Media release, 7 January 2010.

                                                                     13 
 
 


For major bulk commodities, iron ore and coal, that would mean a tripling of the growth seen during the period of 2002 to
2007. For the non-bulk commodities the scale is also large and would require a significant exploration effort to achieve.

Figure 12




Market share is an indicator of competitiveness. The perceived competitiveness of the nation in turn affects the ability to
raise capital. Market share also is indicator of opportunity. During the period from 2002 to 2007, despite increases in
production market share fell across 8 leading commodities. Access Economics notes that the lost opportunity cost the
economy dearly. Had Australia maintained global market share the Australian industry would have earned a further $17
billion (in 2007 dollars) or 1.6 per cent of nominal national income.

Looking forward, Access Economics calculates that if Australia lost market share through 2013 to 2020 at the same pace,
Australia would miss out on $91 billion of income, or 8.5 per cent of national income. Conversely, improving market share
would deliver significant benefits. If Australia was able to recover lost market share by 2013 and then increase its presence
in global markets by 2020, national income would increase by an additional $129 billion.

Exploration is critical to this growth as well as the vitality and diversity of the Australian minerals industry. Both regional
communities highly dependent on the industry and the wider Australian economy stand to benefit from increased exploration
activity.




                                                              14 
 
 


THE CASE FOR NEW POLICY MEASURES
Based on exploration trends outlined earlier in this submission, government and industry have recognised the case for new
measures to improve Australia’s minerals exploration performance. The 2007 election document, Labor’s Plan for a
Stronger Resources Sector, committed a future Labor Government to new policy measures aimed at addressing the
“slowdown in exploration” which saw the value of exploration in real terms fall between 1996-97 and 2005-06. It also drew
attention to the fall in Australia’s share of global exploration expenditure such that “we are now being outpaced by our
competitors in Latin America, Canada and Africa”. Against this backdrop, a future Labor Government committed itself to
“promote investment in exploration by allowing the selective use of flow-through shares schemes for smaller operators in the
gas, oil and mineral exploration industries”.17

The Australian minerals industry welcomed this commitment and its fulfilment remains an industry expectation. In
November 2008, a joint industry submission was presented to the Australian Government on a proposal to introduce a
scheme tailored to Australian circumstances. The industry work originally focused on adapting the Canadian FTS model
based on discrete capital raisings for exploration expenditure and evolved subsequently into a model for Exploration Tax
Credits (ETCs) based closely on Australia’s existing franking system.

Addressing a tax asymmetry

The Australian Government, in proposing a resource exploration rebate linked to the Resource Super Profits Tax (RSPT),
drew attention to the “competitive disadvantage” faced by small, pre-profit exploration companies “because losses they
generate from exploration often cannot be used to offset other taxable income”.18 This followed on findings of the Henry Tax
Review that asymmetrical treatment of gains and losses (with limits on the refundability of losses while businesses with
taxable income can immediately deduct exploration expenditure) is likely to reduce incentives for risky exploration activity.19

Australia’s suboptimal level of exploration expenditure relates directly to the tax asymmetry problem faced by junior
explorers unable to utilise immediate deductions for exploration expenditure due to their lack of taxable income. This
effectively increases the costs for junior explorers of carrying out exploration. As a result, small exploration companies are
less attractive as an investment option compared with other industries and exploration companies in competing jurisdictions
with pro-exploration policies.

ABARE has estimated that this asymmetry represents a competitive penalty to junior explorers of 7-8 per cent. This is a
significant penalty for a section of the Australian industry that has played an increasingly important role in greenfields
exploration and that has tended to provide the pipeline for “majors” (which often acquire prospective tenements from juniors
once they have been discovered and the relevant resource estimated at a high level of confidence).

By penalising risky projects, this feature of the tax system can have the effect of causing a degree of market
“incompleteness”. A system of markets is said to be complete if there is a market for every good. One of the most important
functions of financial markets is to reallocate risk throughout the economy and to accurately price these risks so that the
resulting market prices reflect the social marginal benefits and costs of risk.

The ability of financial markets to allocate risk efficiently is closely related to the completeness of those markets. If financial
markets are incomplete, then it is possible that they will not allocate risk efficiently. There are several possible reasons why
financial markets may be incomplete, including:
        1.    large transaction costs;
        2.    other market frictions such as trading restrictions and government regulations; and
        3.    disagreement or ignorance about the true set of possible events in the economy which make it impossible to
              transfer and price risk for all possible contingencies.




                                                            
17
      Australian Labor, “Labor’s plan for a stronger resources sector”, Election 2007, p. 7.
18   Australian Government, The Resource Super Profits Tax, 2010, p. 32.
19
      Commonwealth of Australia, Australia’s Future Tax System, Report to the Treasurer, Part Two, 2010.

                                                                        15 
 
 


Mineral exploration usually involves investing in one or more assets which typically exhibit the following three important
features:

       1.     exploration activity incurs relatively substantial, sunk (non-recoverable) upfront costs including regulatory and
              taxation costs;
       2.     the payoffs from mineral exploration activities are uncertain and exhibit significant ex-ante volatility; and
       3.     there may be a significant amount of idiosyncratic risk involved in mining exploration (that is, payoff risk for which a
              significant component is non-systematic or unique to the particular exploration project).
None of these three features necessarily means that exploration activity will be inefficiently underfinanced or that assets
issued in order to finance exploration activity will be mispriced by financial markets. But it can be the case that regulatory
and taxation arrangements (such as the taxation asymmetry) can contribute to incompleteness of markets. In that event,
revising those features of the tax system, or attempting to offset them through other measures, is likely to yield important net
welfare gains.

With the rationalisation of the mining industry globally, the Australian market has become more stratified with the larger
global or national companies at one end and the smaller miners/explorers at the other end. With the increased reliance on
the smaller end of the market, the dependency on an efficient and effective market for financing is critical. The asymmetric
treatment of gains and losses distorts financing away from the junior sector.

The Australian Institute of Geoscientists suggests in this context that mineral exploration investment is being allocated into
less productive opportunities than might otherwise be the case:

              [The] short term capital market focus impacts on both major and junior companies....

              In the case of the juniors, the impact is felt through very strong pressure to deliver short‐term “news‐flow” with
              “concrete” results such as drill hole intersections and/or resource statements. Given the limited funding resources
              of most junior companies, this can usually only be achieved in mature areas with known mineralisation. In most
              cases, such areas of known mineralisation are only likely to be available to the junior company if they are also
              considered by the industry to be relatively poor quality and/or already largely depleted. Therefore, the ultimate net
              result in terms of mineral discovery tends to be relatively small, incremental new deposits at best and
              sub‐economic resources at worst.20

To address the tax asymmetry, the minerals industry considers the Australian Government should adopt an Exploration Tax
Credit (ETC), a variation on the Canadian Flow-Through Shares scheme tailored for Australia’s unique policy context. An
ETC would enable the transfer of eligible deductions of individual exploration companies operating in Australia to individual
Australian resident investors at the company income tax rate. Rather than being accumulated as tax losses which are only
realisable if and when the company earns a taxable income, the tax deduction for exploration expenditure is leveraged in the
capital markets in the subject year, thus attracting external investors. By targeting only those exploration companies with
unutilised tax deductions, the ETC will necessarily target juniors and, by default, greenfields exploration.

The situation faced by junior explorers has clear parallels with other areas, such as the biotechnology industry, where the
case for policy action has been acknowledged by the Federal Government in the form of the revamped Research and
Development Tax Credit. Legislation shifting the Research and Development Tax schemes from a tax concession to a tax
credit is now before the Commonwealth Parliament following a recommendation from the panel conducting the Review of
the National Innovation System in 2008:

              In arriving at these recommendations the Panel emphasises the significant and direct benefit these measures will
              provide to smaller technology firms still in tax loss, including key industries like biotechnology.21

Exploration activity is not eligible for the R&D tax concession nor the proposed R&D tax credit.




                                                            
20
    Australian Institute of Geoscientists, Market failure in the Australian mineral exploration industry: The case for fiscal incentives, April
2010, p. 29
21 Review of the National Innovation System Panel, VenturousAustralia: Building strength in innovation, August 2008, p 106.



                                                                       16 
 
 


No linkage with MRRT

The industry is firmly of the view that the ETC policy advanced in this submission is justified in its own right; industry does
not accept that it should be considered within the revenue “envelope” of the Minerals Resource Rent Tax (MRRT). This was
not the basis of the 2 July Heads of Agreement on the MRRT. The MRRT must not be refashioned to fund other measures
which have a public policy justification in their own right.

As part of the 2 July 2010 “breakthrough agreement” on the MRRT, the Government announced that the resource
exploration rebate would not be pursued, but that exploration would be considered by the Ferguson-Argus Policy Transition
Group charged with ensuring the smooth implementation of new resource taxation arrangements. No reference to
exploration was made in the Attachment to the Government Press Release which set out “Agreed principles for Australia’s
resource rent tax arrangements”.22

The PTG Issues Paper states that: “Funding for new incentive mechanisms would need to be fully offset from within the
PTG’s recommendations”. The industry views this as prima facie a departure from the Heads of Agreement released on 2
July 2010 in which the design parameters of the MRRT were in no way contingent on the Government’s fiscal strategy or no
new measures for exploration.




 


 
 


 
 

 




                                                            
22
   The Prime Minister, the Deputy Prime Minister and Treasurer and the Minister for Resources and Energy, “Breakthrough agreement
with industry on improvements to resources taxation” 2 July 2010. 

                                                                17 
 
 


 
A PROPOSED ETC SCHEME: FEATURES AND TAX EXPENDITURE ESTIMATES
The PTG Issues Paper outlined four policy options to promote future exploration:

     1.   an Exploration Refundable Tax Offset (ERTO) similar to the Resource Exploration Rebate (RER) proposed by the
          Australian Future Tax System Review which would directly target cash flows by providing a tax offset refundable at
          the company tax rate for all eligible exploration expenses;
     2.   the industry-endorsed ETC model where the tax benefit is made available to resident shareholders at the
          prevailing company tax rate;
     3.   a Canadian style Flow-Through Shares scheme where a company issues a special class of shares and deductions
          are passed through to shareholders at their marginal rate; and
     4.   tax concessions similar to those for research and development.

The industry would regard options 2 and 3 as consistent with the ALP’s 2007 election commitment to introduce a flow-
through shares scheme and superior to either the ERTO/RER proposal or some variation of the R&D concession. The
primary advantage of these models is that in providing a benefit to shareholders rather than directly to companies they
address the specific problem faced by junior exploration companies, namely the difficulty of raising equity capital.

More broadly, the industry considers the ETC scheme to have clear advantages over the ERTO/RER option in that: 1) it
would be targeted to bona fide “greenfields” operations; 2) it would be less expensive to fund; and 3) it would likely
encourage greater short and long term spillovers. More detailed costing analysis of both the ETC proposal and the
ERTO/RER proposal is in the Appendix to this submission.

The industry’s aim is to promote a simple and workable mechanism which:

     •    encourages eligible junior exploration companies to undertake exploration for mineral deposits in Australia;
     •    minimises administrative costs for companies, regulators and investors;
     •    minimises distortions between shareholders;
     •    minimises tax compliance costs;
     •    minimises risk for investors and regulators; and
     •    minimises distortions for investment decisions by companies.

Key features of the ETC model proposed by the industry are as follows:

          Exploration tax credits would be allowable to Australian resident shareholders of eligible Australian companies in
          respect of Australian exploration expenditure incurred by those companies.

          All relevant terms are defined under current tax law and would be adopted unchanged for this model.

          The model has been adapted from Australia’s franking credit system, a central plank of Australia’s company tax
          law which is widely understood in the community. The industry considers that the ETC system can be developed
          simply using the constructs of the franking system.

          The ETC would be available to shareholders on the register on the day the ETC was “declared” – which cannot
          happen until after exploration expenditure is actually incurred. Once the ETC is declared eligible shareholders can
          include the ETC in their tax returns.

          The credit would be available to shareholders of Australian companies undertaking eligible exploration in Australia.
          This is consistent with access to the R&D concession and with the franking system generally. The industry would
          not object if the Government sought to make a statutory audit compulsory for ETC companies to help ensure the
          veracity of their financial information.

          The credit would be available at the company tax rate, currently 30%. Eligible taxpayers would be entitled to the
          credit based on this rate (regardless of their own tax rate) – including superannuation funds with a 15% tax rate
          and individuals on low or nil tax rates. Eligible taxpayers unable to use the credit against their tax liability would be
          entitled to a refund, on the same basis as franking credits are refundable.



                                                               18 
 
 


    The ETC system would be voluntary – exploration companies could retain their exploration deductions for their
    own future use if they wished, or could pass them on to shareholders via the ETC system.

    There would be no time limit on the use of ETCs – just as the franking system has no time limits. However,
    companies which do not distribute their ETCs are likely to eventually use the exploration deductions themselves,
    as they begin to derive taxable income from mining and petroleum activities, and the ETCs will naturally dissipate
    at that point.

    A company (or corporate group) would not be permitted to choose to pay tax itself and instead use its exploration
    expenditure to distribute ETCs to shareholders. That is, if the company has net taxable income after all expenses
    and prior year tax losses have been deducted, it would be required to use its own exploration expenditure to
    reduce its taxable income to $nil.

         o    For example, if an exploration company still has taxable income of $2m after using all its other
              deductions, it must use at least $2m of its own exploration deductions to reduce its taxable income to
              $nil. That $2m of exploration expenditure would thus not be available as an ETC. It could however pass
              on any remaining exploration deductions to shareholders via the ETC mechanism, if it wished to. This
              provision is made as a further, and transparent, integrity measure in ensuring that the ETC mechanism
              is contained to junior explorers. Once a corporate group becomes taxpaying, it will no longer have
              access to the ETC system and must use its exploration deductions itself. No special legislation is
              required to bring this about – a company must use all of its available deductions in calculating its taxable
              income, and thus any un-distributed exploration expenditure would automatically be deducted in the tax
              return process where positive taxable income is present.

    The taxable income test would be considered from a corporate consolidated group perspective. Where companies
    have elected to be a consolidated group for tax purposes, the group as a whole must be in tax losses for any
    ETCs to be passed on to shareholders. This effectively limits the ETC system to junior explorers, where no
    company in the group is generating significant taxable income.

    This test alone should be sufficient to ensure that the concession is contained to junior explorers. It may, however,
    be considered necessary to have a mechanism for limiting the amount of ETCs a company may pass on. One
    simple way of doing this would be to apply an annual cap on the amount of ETCs claimed per company (or
    corporate group), but it is important that the cap does not distort exploration decision-making by companies and is
    high enough to reflect the high cost of undertaking exploration in certain areas (particularly offshore). For example,
    all companies could be eligible to pass on credits but only for a defined amount of exploration expenditure incurred
    on a per annum basis. When combined with the rule that ETCs can only be passed on by companies and
    corporate groups with tax losses, this effectively self-limits the ETC to small exploration companies: large
    companies would have taxable income, and thus be required to claim the exploration deductions themselves.

    Companies would have flexibility in the timing of passing on the credit, using a franking-account-like mechanism.
    Any eligible shareholder on the register at the company’s declared record date for distribution of the ETC would
    receive it. Shareholders who sell out early (for example, short term IPO speculators) would not receive it because
    they would have sold their shares before the company incurs actual exploration expenditure, and it is more likely
    that long term shareholding would be encouraged.

    In the case of new capital raisings, it may be possible for a company to direct the ETCs to the new shareholders
    rather than all the existing shareholders, via the use of different share classes - as is the case for franking.

    A number of well-tested Australian tax mechanisms would operate to ensure that there was no double deduction
    of the exploration expenditure either by the company, or for shareholder Capital Gain Tax (CGT) purposes. These
    mechanisms are already part of the tax law for other purposes, so no new concepts are being proposed. For
    shareholders, the ETC would reduce their CGT cost base.

    The ETC would be based on eligible exploration expenditure.

    If a company distributes ETCs and it is later found that its expenditure does not meet the eligible exploration
    definitions, this should be dealt with at the corporate level rather than at the shareholder level. A legislative
    mechanism identical to the Franking Deficits Tax model could be adopted, including the penalty provisions.

    All anti-avoidance provisions existing in the franking law would also apply to the ETC system – eg the anti-
    streaming rules, and the 45-day rule. A simple amendment would ensure that these provisions were mirrored in
    the ETC provisions.

                                                         19 
 
 


              The previous submission (2009) included a recommendation that a 25% - 75% uplift in the credit, consistent with
              the R&D uplift obtained by Australian innovation companies, should be applicable to the ETC system. This was
              designed, in part, to reflect the fact that exploration is excluded from the R&D Tax Concession Scheme, despite
              the highly innovative and technically risky elements of the activities. The industry acknowledges that Scheme may
              be subject to adjustment and does not press this element at this stage.

Some concerns have been expressed about the ETC and FTS mechanisms based on the history of past tax incentive
schemes and their capacity to distort investment activity. These are addressed in the box below.




Lessons from other tax incentive schemes – Managed Investment Schemes23

Some similarities between the RER/ETC and the agribusiness Managed Investment Schemes (MIS) might be seen as an
argument for leaving the tax treatment of exploration stand.

MIS are collective investments, with MIS investors contributing money that is pooled and used in a common enterprise.
However, the investors do not have day-to-day control over operations, with a scheme manager paid a management fee.
MIS have been employed in financing large scale agribusiness enterprises. These schemes are typically structured such
that the investor is arguably carrying out a business, by taking interest in land, and entering into a management agreement
with the scheme manager. The investor’s contribution secures an interest in the scheme, with the investor receiving a share
of harvest proceeds in return for the contribution.

In terms of tax treatment, MIS provide an incentive to invest as the investor is able to claim the contribution as tax deduction,
effectively reducing the investor’s cost of investing in the scheme. Therefore, the investor only requires a return on this after
tax investment.24 Concerns were raised regarding MIS, in particular, that they act to distort investment decisions by providing
a tax advantage for a particular type of investment, potentially resulting in an inefficient allocation of resources.

There are some similarities between the nature of the investment issues that both ETC/FTS and MIS mechanisms seek to
address. That is, mining exploration has some similarities to agribusiness investments in terms of being relatively risky
investments and, in the case of forestry, with a long period between investment and return. Non-forestry MIS, which typically
relate to horticultural activities, have differing timeframes for a return, but some are relatively labour and capital intensive.
Under both ETC/FTS and MIS, shareholders are the beneficiary, providing an incentive to invest in the activity. Clearly,
accountability arrangements are critical to the integrity of these schemes.

The accountability measures proposed by the industry on the ETC should mean that despite some similarities, concerns
around agribusiness MIS arrangements should not undermine the case to address tax distortions adversely impacting on
mining exploration. As the proposal for an ETC/FTS is designed to address policy-induced distortions in the taxation
arrangements affecting mining exploration, there is a substantive case to address these distortions in some way.




                                                            
23   This section is included in response to questions raised by the Policy Transition Group during industry consultations.
24   Australian Government, Treasury, Review of Non-Forestry Managed Investment Schemes, Report – December 2008

                                                                      20 
 
 


 


APPENDIX A – SYNERGIES REPORT (EXCERPT)
Modelling approach
 
The modelling approach has been to identify the key drivers of the tax expenditure estimates. Figure 1 portrays the three
key drivers of the estimates for both the RER and the ETC:
    • expenditure base including induced expenditure; and
    • the rebate and tax credit rate.


Figure 1 Drivers of tax expenditure estimates



                  Eligible                                                                     Tax 
                                                        Rate of
                exploration                                                                expenditure 
                                                     rebate/credit
                expenditure                                                                 estimate 

    • ABS exploration                    • Company tax rate
      expenditure data                   • Adjustment to
    • Adjustment for                       exclude non‐
      eligible expenditure                 resident
    • Additional                           shareholders (ETC
      expenditure flowing                  only)
      from rebate/credit
    • Additional 
      expenditure lagged
      over a 3 year period 


 

Expenditure base (eligible exploration expenditure)
 
The base for the expenditure estimates is exploration expenditure in Australia. Australian Bureau of Statistics (ABS) data on
mining exploration data (ABS 8412.0) is the primary data source. Exploration may be undertaken by firms of any size, but
smaller firms play a significant role with ‘junior’ exploration companies contributing significantly to Australia’s aggregate
exploration effort.

Exploration expenditure for metals and other minerals is categorised as “new” deposits and “existing” deposits. Exploration
expenditure for metals and other minerals by juniors was based on the level of “New Deposit” expenditure. This, in the first
instance, overstates junior companies’ level of exploration as senior explorers also undertake a lesser amount of new
deposit expenditure. Offsetting this, junior companies also explore in and around existing deposits. Overall, using total new
deposit exploration should provide a reasonable estimate of the level of exploration activity in Australia undertaken by junior
exploration companies.
For oil and gas exploration expenditure, APPEA has previously advised in our 2009 Report on the FTS that juniors
accounted for about 9 per cent of total petroleum exploration expenditure (on and off-shore, existing production leases and
“All Other Areas”). The 9 per cent of petroleum exploration was added to metals and other minerals new deposit exploration
to derive the estimate of total exploration expenditure by junior exploration companies.

                                                              21 
 
 


Forecasts of exploration expenditure were developed for the period 2010-11 to 2014-15. The forecasts were prepared using
the relationship between forecast resource prices and exploration expenditure. The long-run responsiveness of expenditure
to a percentage change in prices is at least unitary25. This means that a 1 per cent change in price leads to at least a 1 per
cent change in exploration expenditure26. Exploration expenditure forecasts were derived using the above relationship and
mineral price index forecasts prepared by the Queensland Resources Council (QRC) (based on ABARE forecasts in
Australian Commodities March 2010).
An adjustment to the base was made to reflect that not all junior expenditure will be eligible exploration expenditure for the
purposes of the ETC. Based on advice from QRC it was assumed that 80% of exploration expenditure would be eligible for
a tax rebate or tax credit. The reason for the reduction of exploration expenditure is that the RER policy refers to eligible
exploration expenditure. Some exploration costs reported by the ABS relate to administration and other costs which may not
be deemed eligible expenditures.27 For example, certain expenditures incurred in relation to petroleum exploration are not
eligible for deduction. The 20% reduction was assumed in the absence of a clear indication of what might be considered an
eligible deduction. It is considered a reasonable assumption if corporate overheads and administration costs are not eligible
for deduction.

Induced (additional expenditure)


There are no empirical studies which have assessed the response of exploration investment to tax policy changes in
Australia, although some assessments have been undertaken in Canada. It is necessary to make assumptions about how
exploration expenditure will respond to either policy. This affect will be referred to as the “induced expenditure” impact.
The estimates of tax expenditure differ between the RER and ETC largely because no induced expenditure has been
assessed for the RER. The effect of the RER is to increase the probability of a discovery of an economic resource deposit.
This will increase the expected capital return from mining shares increasing their attractiveness to investors. However, there
is not sufficient information on which to estimate this impact. For now, we note the potential for further induced exploration
expenditure. Because mining exploration will remain a very risky enterprise the magnitude of any induced affect is unlikely to
be large.
The main impact of the RER on exploration expenditure is through the direct impact of the cash payments from the RER to
exploration companies. These payments are assumed to fund additional exploration investment. We have assumed that this
additional exploration will not occur immediately because of the lags involved in exploration activities. The additional
exploration expenditure is assumed to occur over 3 years according to the following pattern; 25 per cent will occur in year 1,
50 per cent will occur in year 2 and the final 25 per cent will occur in year 3.
For the ETC the impact on exploration is from the increase in investment which results from the increased returns to
shareholders who are able to utilise the tax credit (that is Australian resident tax payers). The tax credit provided to
shareholders increases the rate of return from exploration company stocks compared to other investments. All else equal,
this induces increased investment in junior exploration companies – either through initial public offerings or subsequent
capital raising.
The induced affect is estimated by using research conducted on the cost of non-deductibility of exploration by ABARE and
an assumption of the responsiveness of exploration to cost changes. It is acknowledged that this is an indirect approach and
it is preferable to be able to assess the responsiveness of investment in juniors to the tax credit. However, in the time and
with the data available this was not possible.
The additional investment will occur because the cost of non-deductibility is removed by the ETC. Based on the ABARE
research mentioned above, this cost has been estimated at 7.5 cents in the dollar. Assuming a change in costs has a
similar impact to a change in price on exploration expenditure, the additional exploration expenditure will equal the product
                                                            
25          The long-run elasticity estimate is taken from the ECM models. The long-run coefficient for Australia is roughly 2.0, whereas it
ranges between 0.5 and 2.2 for the Canadian models. A value of between 1.0 and 1.5 is a plausible range for estimates.
26          The elasticities are intended to be equally applicable whether prices are rising or falling. In other words, the magnitude of the
expenditure response to a percentage change in prices is the same independent of the point in the price cycle (currently in a down cycle).
In a cycle of falling minerals prices, a reduction in costs can be viewed as reducing the magnitude of the impacts of the price declines on
expected profitability. Cost reductions from an ETC are immediate and therefore more certain relative to mineral price forecasts (although
there will be uncertainty about bidding outcomes and the premiums paid for the ETC shares, and the level of ongoing commitment to the
policies). For given equivalent percentage changes in revenues/prices and total costs, the change in costs will have a larger impact on the
expected net present value of the exploration investments because differences in probabilities are taken into account when discounting
the revenue and cost streams. This would tend to support responsiveness to a cost reduction at least as great as the estimated
responsiveness of expenditures to price changes.
27          The ABS define exploration costs to include cost of exploration, determination of recoverable reserves, engineering and
economic feasibility studies, procurement of finance, gaining access to reserves, construction of pilot plants and all technical and
administrative overheads directly associated with these functions.

                                                                     22 
 
 


of the cost reduction and the elasticity of exploration to cost. This method is very conservative and plausible when put in
context against the limited relevant empirical research. For example the Canadian Department of Finance found that its ETC
resulted in a ration of additional exploration to tax expenditure of 2.6, which implies a much larger response than the
assumption applied in this analysis.

Expenditure base estimates


Table 1 provides the data used for the expenditure bases used in forming the tax expenditure estimates. Two expenditure
bases are included:
       •   a base which will apply to all eligible expenditure by juniors under the RER
       •   a base which apply to all eligible expenditure under an ETC.
The expenditure base for juniors receiving an RER also includes additional exploration expenditure funded from the RER in
subsequent years, as described in the previous section For example, the base for 2011-12 is the forecast exploration
expenditure without an RER plus 25 per cent of the RER payments from 2010-11.
The expenditure base for the ETC will include exploration expenditure induced by the ETC. Similarly to the example for the
RER, the tax base in 2011-12 will include the forecast exploration expenditure and 25 per cent of the additional investment
in exploration induced by the ETC in 2010-11.

Table 1     Tax expenditure base
Year                              Expenditure base – Juniors      Expenditure base – Juniors
                                              RER- $ million                  ETC - $ million
2010-11                          1200                            1137
2011-12                          1395                            1205
2012-13                          1488                            1232
2013-14                          1547                            1286
2014-15                          1404                            1191
Source: ABS 8412.0, QRC, Synergies


 

Rate

The rate for the RER and the ETC is the company tax rate of 30 per cent. The exploration expenditures in Table 1 are
multiplied by this rate to estimate the tax expenditures.
An additional step is required for the calculation of the ETC tax expenditures. The ETC can only be used by resident
Australian taxpayers. It has been assumed that 80 per cent of the shareholders of junior explorers resident taxpayers and
paying income tax and therefore able to use the ETC. The basis for this assumption is that only Australian citizens can
participate in a market capital raisings (eg IPOs) in Australia. Separate documentation has to be prepared for each stock
exchange where the capital raising will be offered. This is a prohibitive cost for most junior miners and capital raising tends
to be in Australia.




                                                               23 
 
 




Tax Expenditure Estimates
 
The estimates for each policy are present in Table 2.

Table 2       Tax expenditure estimates, $ million
                                      RER - Juniors                  ETC - Juniors
    2010/11                                 251                           218
    2011/12                                 257                           231
    2012/13                                 258                           237
    2013/14                                 270                           247
    2014/15                                 238                           229



The results show that limiting a RER to junior explorers will significantly reduce the cost to Government. The difference
between the RER as announced and a policy focussed on juniors is the reported difference in exploration expenditure -
particularly for petroleum where junior expenditure comprises only 9 per cent of total exploration expenditure.
The RER estimates are higher than for the ETC. This is driven largely by the assumption the 20 per cent of the ETC will not
be used by non-resident (or non-tax paying) shareholders in junior exploration companies.
These estimates are considerably higher than the estimates Synergies reported in its 2009 report on the FTS/ETC. The
reason for this is that these estimates are gross estimates of the revenue impact. In our previous work we reported net
impacts as we estimated the stimulatory impact of an FTS/ETC. For that Report we used a Computable General Equilibrium
model to estimate the expansionary affect on the economy including the share of revenue that would flow to Government.
A further difference that should be considered is that under an RER there is no loss of deductibility of exploration
expenditure and no impact on the CGT cost base for a shareholder. However, under the ETC deductibility and the cost base
of a share for CGT purposes are both affected. Therefore the effective cost of the RER will greater than the ETC to the
extent that exploration companies are eventually earning taxable income and capital gains accrue to shareholders.




                                                             24 
 

				
DOCUMENT INFO