There is no question that despite the past year’s wild COVID-19 ride, Australia’s junior mining explorers have flourished in a market hungry for new mineral discoveries.
Increased attention in the junior space has been driven by rising gold prices due to COVID-19 uncertainty, as well as an increase in the iron price as China’s manufacturing sector restarted.
While market conditions are solid, junior explorers should clearly ‘make hay while the sun shines’. At the same time, explorers should plan for future funding requirements to ensure exploration activities can continue once market conditions inevitably ease.
With this in mind, our tax team are working with junior explorers to reduce quarterly cash outlays by leveraging tax incentives. This includes taking advantage of the Employee Share Scheme (ESS) tax rules and increasing cash reserves through the Research & Development (R&D) tax incentive.
How the ESS tax rules apply to junior explorers
For tax purposes, an ESS is a scheme where a company issues shares, options or rights to an employee (or their associate) at a discount to market value. These must relate to the employee’s employment – such as being part of their remuneration package or incentive plan.
Here are three common ESS plans:
- A grant of options with an exercise price at a premium to current market value.
- A grant of performance rights, where employees are granted shares in the company at no cost once they achieve project-based or performance goals.
- A grant of shares or options that are eligible for start-up company concessions (not available for listed companies).
Depending on how the employer sets up the ESS, the employee may need to pay income tax in the year they receive the ESS interests (upfront), or in a later year (deferred tax).
The ability to defer the tax is extremely advantageous for employees. If an employer sets up an ESS but doesn’t get the scheme rules right, the employee could have to pay tax in the year they receive the ESS interest – while being prevented by the company’s share trading policy from selling them to pay the tax bill. Another risk is that the shares lose value after the tax is paid, and the employee not only cannot carry back the loss, but has to pay tax based on the higher value of shares received in a prior year.
The benefits of getting an ESS plan right
There can be significant advantages when an employee agrees to be remunerated under an ESS.
For employees, their remuneration could be significantly higher than under a cash package. Because the employee can directly influence their remuneration, they are motivated to meet performance goals and develop their career further.
For the company, the benefits include reduced cash outlay with more funds to pay suppliers and keep drilling. Where the plan is tied to performance, there is greater alignment between employer and employee goals.
Why do these matter? In the hunt for a resource discovery, the main limiting factor for a junior to achieve their objectives is the ability to access cash. This is especially important if initial drill targets are unsuccessful, with the company requiring enough funds for follow-up targets.
As an example; in creating an effective ESS plan, a company could offer its exploration manager a salary package with an 80% cash component and a 20% performance rights component. Once the employee achieves certain performance goals (which could be tied to exploration results and/or share price appreciation), the rights then vest to the employee and the discount is included in the employee’s assessable income. However, the employee can also sell the shares to pay the associated tax if needed.
It’s important to note that employees who are risk-averse or require cash each month to support their lifestyle may only accept a cash package. In this case, the company could offer them a package comprised of cash, plus a number of options with a premium exercise price. The options would be subject to upfront tax, but can be priced to have no value for tax purposes (using the generous ATO options valuation tables). This results in the employee not having to pay any tax when they receive them.
While there are no project-based goals to incentivise the employee with this option, any increase in the company’s share price increases the value in the employee’s options they hold – thereby providing an incentive to grow the company’s value.
The Tax Services team at RSM Australia have significant experience in helping companies establish ESS schemes that have win-win outcomes for all parties. If you would like to know more, simply contact your local RSM office.
How the R&D tax incentive can help junior miners boost cash reserves
Junior mining exploration companies are subject to the “exploration exclusion” for the R&D tax incentive. This prevents companies from claiming exploration-related activities as core R&D activities, including:
- prospecting, exploring or drilling for minerals or petroleum to discover deposits.
- determining more precisely the locations of deposits, or the size or quality of deposits.
Other exclusions for core R&D activities also exist, such as activities associated with complying with statutory requirements or standards.
However, these exclusions do not prevent companies in an exploration phase from undertaking activities that are eligible for the R&D tax incentive. To determine if activities are eligible, the company needs to assess its activities, including their purpose, against R&D tax eligibility criteria.
This is supported in a recent Federal Court Case, where mining company Moreton Resources Ltd was found to be undertaking eligible core R&D activities related to underground coal gasification technology and its trial in particular site conditions – resulting in the generation of new knowledge.
For companies that are currently developing and trialling a new mining technology or process, recent tax changes such as the temporary full expensing rules for depreciating assets may provide additional benefits, provided there is an R&D purpose for the new assets.
Junior explorers must consider the records they have to substantiate any R&D claims made, as well as the distinction between eligible core and supporting R&D activities (and where core R&D activity exclusions apply in the tax legislation). The R&D tax team at RSM is highly experienced with assisting junior explorers consider eligibility and substantiation requirements in making R&D claims, and can assist in discussing the implications of tax changes and recent cases.
Get help from RSM tax experts
The ability for a junior explorer to utilise the tax system for funding purposes is an invaluable tool at their disposal.
At RSM, we have helped companies utilise both the ESS and the R&D tax incentive while transforming from a junior explorer to a fully-funded mineral producer.
To explore how the ESS and/or the R&D tax incentive can help boost your company’s cash reserves, contact our resource tax team today.