There is a bizarre anomaly in the Australian Taxation system that no one likes to talk about. Although exploration activity is recognised as creating a tax deduction, the majority of companies engaged in exploration are unable to realise the benefit of that deduction.
In the midst of the recent boom, this was an unwelcome hurdle for junior explorers. In the midst of the current global economic downturn in a competitive environment for investment dollars (either debt or equity derived), this anomaly places the entire exploration sector into a deep freeze.
Junior exploration accounts for about 80 per cent of all resource companies listed on the ASX, and these are responsible for most new discoveries. These resource companies are the incubation room of the Australian minerals sector. They are predominantly involved in mineral exploration as opposed to production. To be classified as a junior company, a company must have a market capitalisation of less than $200 million; a majority actually have a capitalisation of less than $30 million.
As junior exploration companies generally have no assessable income for tax purposes, they are unable to claim a tax deduction for their high risk exploration activities. The after-tax net present value of exploration projects are reduced, and indeed, may become negative. Accordingly, an inability to deduct exploration costs makes it difficult for junior companies to obtain external exploration finance.
Canada, another significant mining nation, long ago identified the anomaly in its own tax system and instigated a scheme whereby the tax deduction that could not be claimed by juniors could be passed through to shareholders. This made it significantly easier for junior explorers to raise finance in Canada, and ensured that this market failure in the lopsided operation of the existing deduction was corrected. A version of such a “Flow-Through Share Scheme” has been in operation since the 1970s, and since 2000 there has been a nationwide “Super-Flow-Through Share Scheme” offering investors a further 15 per cent increase in their deduction.
Meanwhile, successive Australian Governments have vacillated about the scheme for over two decades, on one hand recognising the obvious logic and benefits of the scheme, and on the other reluctant to commit budget spend to a sector seen as subject to successive boom and bust cycles.
Ironically the cyclical nature of the mining industry, coupled with the lag time between exploration discovery and new mines, creates an additional imperative to ensure barriers to sustained investment in exploration are removed. That is, junior explorers particularly suffer with the downturn, and by the time commodity prices pick up, a dearth of mineable deposits can hinder development of the industry.
In the current climate of a restricted financial market, the higher risk junior exploration sector has been gutted. New IPO listings from junior explorers have declined more than 75 per cent since September last year and exploration activity for many companies has been frozen, with massive job losses across the industry. Those who have lost their livelihood include geologists, the drillers, camp caterers, transport drivers, service providers of all sorts, and non-industry townspeople in many mining communities.
These losses are only the start. They do not include the thousands who will not be employed during the next 30 to 40 years, as mining companies move offshore to countries such as Canada which have recognised and addressed this market failure. And then there are the hundreds of thousands indirectly employed in a range of supporting services including construction, catering, equipment manufacture, engineering consultancy, maintenance contracts and transport that stood to benefit from an export industry worth more than $100 billion a year.
The Federal Government committed to implement a Flow-Through Share Scheme as part of its 2007 election platform, but appears to have reneged on that commitment in response to the current economic climate. Yet it is this very context that has made the Flow-Through Share Scheme so critical to junior explorers, in order that that they are able to compete equally with alternative investments and jurisdictions, raise capital and remain active.
We urge the Government to do the smart thing and honour its commitment to address the tax system anomaly and thereby rectify this pressing long term market failure. This will provide direct stimulus to the economy, with a potentially greater impact on direct employment and private and public sector revenues than any other stimulus measure announced to date. And it will ensure that all Australians will continue to reap the future windfall benefits provided by our most lucrative, yet most volatile, export industry.
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