In April 2022, the Fraser Institute published the "Survey of Mining Companies 2021", where investors weighed in on what mineral endowments and public policy factors, such as regulatory uncertainty and taxation, impacted their decision to invest in exploration in a region. Respondents indicated that 40% of their investment decision is determined by policy factors, and 60% by the jurisdiction's mineral potential.

Disappointingly, South Africa ranked in the bottom 10 jurisdictions on the investment attractiveness index, despite having abundant mineral resources and extensive mining experience.

Coincidentally the same month, the Department of Mineral Resources and Energy ("DMRE") published the "Exploration Strategy for the Mining Industry of South Africa", outlining the strengths, weaknesses, opportunities and threats relating to mining exploration, and the strategic initiatives to encourage mining exploration.

Unsurprisingly, one of the strengths of South Africa's mining industry identified by the DMRE is the country's mineral endowments as well as the range of such minerals. Equally unsurprising, the weaknesses identified include energy instability, road and rail infrastructure challenges, as well as unsatisfactory policy implementation. These identified weaknesses appear not to have gone unnoticed by investors, as South Africa's exploration budget has seen a decrease from USD400-million in 2007 to under USD100-million in 2018, with its share of global exploration budgets decreasing to approximately 1%.

In order to capitalise on the country's mineral wealth, the DMRE has outlined strategic initiatives and actions to be undertaken to encourage mining exploration. These strategic initiatives and actions include improvements in the country's geoscience data and information, government support to junior exploration companies and the formation of private-public partnerships with junior exploration companies, and a national investment drive.

The vision espoused by the strategy document is to secure a minimum of a 5% share in global exploration investment within a five-year period. This would be an impressive feat indeed, as South Africa would arguably be required to drastically improve its attractiveness, or perceptions of its attractiveness, as a mining destination to achieve the desired 4% increase in its share of global exploration investment.

Conspicuously absent from the list of strategic initiatives and actions, is the suggestion of the introduction of tax incentives for mining exploration (although this would be more appropriately handled by National Treasury).

In its report on mining, the Davis Tax Committee noted that few investments are taking place in greenfield exploration, but was unconvinced that the lack of tax incentives was to blame. The Davis Tax Committee suggested that regulatory impediments are more likely the cause for deterring investment, and recommended that the DMRE conduct an in-depth examination of the current regulatory framework governing greenfield investors, following which further tax incentives should be considered. The Committee, however, recognised that tax incentives may serve as a sweetener in the encouragement of greenfield investments.

Due to the substantial upfront investment costs at the development phase of mining, and the prolonged periods until the commencement of production, the South African Income Tax Act provides tax incentives to taxpayers who carry on mining activities.

The Income Tax Act currently provides for upfront capital allowances in respect of prospecting and development expenditure incurred by taxpayers who carry on mining activities. In particular reference to the exploratory prospecting phase of mining, the act provides for a tax incentive in the form of a deduction from a taxpayer's mining income of expenditure incurred on prospecting activities, including surveys, boreholes, trenches pits and other prospecting work preliminary to the establishment of a mine. Therefore, taxpayers are incentivised in the sense that expenditure incurred on prospecting is deductible, however such expenditure may only be deducted from income derived from mining.

Where a taxpayer who conducts prospecting is unsuccessful in its exploratory endeavours and does not derive any income from the trade of mining, the expenditure incurred would not be deductible. Prospecting expenditure is however, not ringfenced between different mining operations (as is the case with capital expenditure incurred on the development of a mine), and where a taxpayer carries on mining at numerous sites, the prospecting expenditure may be deducted from the mining income derived from existing income-earning mining operations. This may have the unintended consequence of making mining exploration the exclusive arena of established mining companies, who have the benefit of existing mining income against which prospecting expenditure may be deducted.

In considering the encouragement of greenfield exploration by way of tax incentives, the Davis Tax Committee considered the system of "flow-through shares" (applied in Canada, which incidentally, has four jurisdictions ranked in the top 10 in the Fraser Institute survey).

Essentially, the flow-through share model provides for the provision of equity funding by investors into companies that carry on prospecting and exploration activities and incur expenditure which qualifies for a tax deduction. As the exploration company would not derive any income while it carries on its exploration activities, and would accumulate deductible expenditure, which is renounced in favour of the shareholder, who may then claim the deduction against its own income. The shareholder would therefore enjoy the benefit of decreasing its tax liability as a direct result of investing in the exploration company.

The Minerals Council South Africa submitted a proposal to National Treasury in 2020 for the introduction of a flow-through share incentive in the form of a stand-alone section of the Income Tax Act. In the proposal, the Minerals Council outlined the potential benefits to be derived from the proposed tax incentive.

The Minerals Council made reference to a survey conducted by the Prospectors & Developers Association of Canada to assess the socio-economic impacts of flow-through shares in Canada, the results of which showed that flow-through shares created employment for rural communities, generated business opportunities for residents of rural communities, led to discoveries that were developed into mines, and led to advanced knowledge of deposits that were ultimately developed into mines.

In assessing the potential impact of the introduction of flow-through shares in South African tax legislation, the Minerals Council outlined the potential economic benefits to include the establishment of new financial and exploration firms, increased employment opportunities, industry specialisation and increased foreign direct investments.

In addition, the proposal by the Minerals Council submits that the introduction of the incentive would effectively leave the fiscus in a tax neutral position, as while the shareholder would be entitled to claim the deduction of the qualifying expenditure, the exploration company would be in a tax paying position faster than would be the case where the qualifying expenditure was not transferred and claimed as a deduction upon the generation of mining income.

Although the Davis Tax Committee was unconvinced regarding the success of the flow-through shares model, it may serve as a powerful incentive for junior miners to embark on exploration activities and for both local and foreign investors with other income generating activities, or who derive passive income such as interest and dividends from South Africa and incur withholding taxes, to redirect their investments to exploration companies.

Furthermore, this may result in more established mining companies who typically embark on brownfield investment due to proximity to existing mining operations to invest in greenfield exploration undertaken by junior miners, who can then specialise in exploration activities.

Given the low exploration investment in South Africa, and the decrease in mining exploration investment since the Davis Tax Committee report was issued, it may be the right time for National Treasury, together with the DMRE, to give serious consideration to the introduction of the flow-through share model.  

While it may be true that tax incentives, or the absence of tax incentives, may not be a determining factor in investment decisions, the introduction of such tax incentives, together with the required regulatory and infrastructure reforms, may aid in investors' decision to choose South Africa as a preferred investment destination. South Africa should utilise all of the tools available in its arsenal to encourage investment, and tax incentives may be an effective tool in doing so.

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