Benjamin Franklin once said "but in this world nothing can be said to be certain, except death and taxes."
With regard to the taxation of mining and prospecting companies that are tax resident in South Africa and its Non-Tax resident shareholders this is arguably a half truth. What is certain is that they are subject to taxes. What is, however, uncertain and even unpredictable is (1) the type of taxes and (2) the amount of tax that these companies would be subject to and liable for.
The first uncertainty mainly originates from the "State Intervention in the Mining Sector" or so-called SIMS report that the ANC issued and the recommendations contained therein regarding the proposed fiscal changes to the taxation regime for prospecting and mining companies, the most notable being the recommendation to introduce a mineral resource rent tax, similar to what Australia introduced a few years ago which received significant opposition and criticism. However, this article touches on the second uncertainty.
The second uncertainty stems from the difference in interpretation by taxpayers and the South African Revenue Service ('SARS') of the existing and complex tax laws applicable to mining companies and prospecting companies. This is fuelled by SARS being under pressure to collect revenues in an industry where companies' profits have shrunk significantly (due to rising costs and the decline in commodity prices) and in most instances are making losses. This has had a direct impact on, inter alia, the amount of income tax and mineral royalty collections from these companies.
As a result, in the integrated tax audits that SARS conducts on mining and prospecting companies some of the areas of tax that SARS focusses on are the following:
- Mining operations versus manufacturing
Where mining companies in the past treated their mineral processing or beneficiation operations as "mining operations" for income tax purposes in order to benefit from the very beneficial 100% accelerated capital expenditure allowance (the capex allowance), they now face challenges to treat these operations rather as manufacturing as opposed to mining operations, resulting in only a claim for the manufacturing allowances or wear-and-tear allowances which firstly is limited in its application to the type of qualifying expenditure (compared to the capex allowance) and is spread over a number of years (compared to a 100% deduction for the capex allowance). This could result in a cash tax outflow much sooner than planned. This difference in interpretation arises essentially from the unclear definition of "mining" or "mining operations" contained in the Income Tax Act, No 58 of 1962 ('the Act') and the lack of a definition of the word "mineral" contained in such definition. This is further fuelled by provisions of the Mineral and Petroleum Resources Royalty Act, No 28 of 2008, and its interpretation and application in particular to the so-called "unrefined mineral resources" contained in Schedule 2 to such Act. These actions, arguably, are contrary and counter-active to the Government's call on mining companies to beneficiate the minerals locally.
- The tax treatment of prospecting expenditure
There appears to be a difference in interpretation under which section of the Act prospecting expenditure should be claimed, which impacts directly on the overall income tax position and financial viability of the project and therefore of the company.
- The application of the "ring-fencing"
As mentioned above, a mining company is entitled to claim 100% of its qualifying capital expenditure (capex) as a deduction against its taxable income, subject to two limitations or the so-called "outer" and "inner" ring-fencing provisions, i.e. such capex can only be claimed against "income derived from mining operations" or so-called mining income and secondly where a company operates two or more mines, the capex deduction per mine is limited to the mining income derived from that mine. Therefore, where a mining company operates two or more mining operations the question is whether the different mining operations are "separate and distinct" and as such are not "one mine" but separate mines. In addition, there is uncertainty (although case law provides some but not clear enough guidance) on when income constitutes mining income or non-mining income. The conclusion of the analysis on these issues has a direct bearing on the application of the ring-fencing provisions and the overall income tax position and financial soundness of the mining company.
- Mineral royalties
Although the Mineral and Petroleum Resources Royalty Act is a mere 12 or so pages, the interpretation and application of these provisions, especially to the so-called unrefined mineral resources, is very complex and creates uncertainty in the interpretation thereof to the various mineral resources. Evidence of this is in the recent change to the tax legislation which would result in coal export mining companies having to pay the mineral royalty on its export sales price for beneficiated/washed export quality coal as opposed to market related price for unwashed (typically Eskom quality) coal. Again this action, arguably, is contrary and counter-active to the Government's call on mining companies to beneficiate minerals locally.
- Diesel rebates
Mining companies face challenges by SARS on the entitlement and application of diesel rebates (which is administered through the Value-Added Tax (VAT) system) applicable to their mining operations, which could have a significant impact on the amount of VAT refund or liability of the company.
- Mining Housing
There is significant pressure on mining companies to provide ownership of housing to mine workers and their families. However, there appears to be a mismatch on the income tax (for the mining company and/or the company providing the housing), the employees' tax (PAYE) and the VAT treatment in this regard. The tax costs arising in such instance has a direct bearing on the overall cost and viability of providing mining housing to employees.
- Social and Labour Plan costs
In order to obtain and keep a mining right, mining companies must have an approved social and labour plan that involves the spending of money by the company on the activities specified in such plans. There is uncertainty on the tax treatment (from an income tax, donations tax and VAT perspective) of this expenditure in the hands of the mining companies. Again the tax cost arising in this regard adds to the overall cost of mining.
- Merger and acquisition transactions
It is notable that companies or rather their shareholders are revisiting their mining and prospecting portfolios and are either selling a mining operation or prospecting operation, that is, non-core or otherwise not viable in the portfolio (i.e. an asset sale) to a third party; or selling shares and loan claims in a company holding the mining or prospecting asset. Where an asset sale is envisaged, apart from the very complex tax consequences arising on such sale, the parties may be required to obtain a so-called "effective valuation" from the Department of Mineral Resources the purpose of which is to determine the value and the apportionment of the purchase price between the mining property (typically mining rights, prospecting rights, land etc.), for which no capex allowance is available, and the mining assets on which the purchaser can claim the 100% capex allowance. The interpretation and application of this section is complex and since the introduction of Capital Gains Tax (CGT) it is debatable whether this section has served its purposes and is still required. Where the shares in the company are being acquired (as opposed to an asset deal) the cost of the funding of the acquisition is important, especially where interest-bearing debt funding is used. The interest deductibility rules in this regard are very complex and at this stage require approval from SARS before any interest is deductible. Where the transaction involves a share exchange, there are numerous and complex tax rules to be considered, which could trip up both the seller and purchaser, which if unaware of these rules could get a nasty and hefty tax bill. Non-tax resident shareholders selling their shares (whether directly or indirectly through intermediary companies) in South African mining companies or prospecting companies may be subject to South African CGT, and if so the purchaser is obliged to withhold 7.5% of the purchase price as an advance payment of such CGT and pay it over to SARS. In this regard, it is uncertain whether mining rights or prospecting rights constitute immovable property, which would have a direct impact on the conclusion of the analysis of the CGT liability or not of such non-resident shareholder.
- Understatement penalties
Since 1 October 2012, when the new Tax Administration Act came into effect, SARS is imposing hefty understatement penalties (up to 200%) on any adjustments made to a taxpayer's tax position (whether it results in actual tax being payable or not) following audits conducted by SARS on mining and prospecting companies. In certain instances these penalties are imposed on tax years prior to 1 October 2012, which arguably is not fair and just administrative action and/or unconstitutional.
From a foreign direct investment perspective certainty and predictability are two key factors for investors when deciding on whether and the quantum of the investment they would introduce into a country. It was therefore very refreshing when the Minister of Finance announced the establishment of the Davis Commission to investigate our tax system including the taxation of mining companies. Hopefully Judge Davis will take the above-mentioned and other taxation issues into consideration when the time comes to address the taxation of mining and prospecting companies to make this industry attractive again for foreign investors.
Until such time, mining and prospecting companies and their shareholders should take advice from their mining tax advisors when faced by challenges by SARS or making investment decisions, where the types of taxes and the quantum thereof, due to inter alia the complexity thereof, no doubt plays a significant role.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.