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The Davis Tax Committee
Mining Tax Recommendations
The Davis Tax Committee (the DTC / the Tax Committee) released its first interim report on mining for the Minister of Finance and has called on the public to provide comments on their recommendations.
The Davis Tax Committee (DTC) recently released its first interim report on mining for the Minister of Finance and has called on the public to provide comments on their recommendations. This article provide a summary of the tax-related proposals, as contained in the first interim report.
The DTC was established as a result of the policy document produced by the African National Congress (ANC) on State Intervention in the Minerals Sector (SIMS), which was adopted in December 2012. The adoption of the SIMS document was followed by the introduction, by the Minister of Finance Minister, of the Davis DTC in July 2013.
Acknowledging that the mining tax system in South Africa has evolved over many years by case law and in response to various geological, economic, social and environmental challenges , the DTC was mandated to consider, amongst other things, the appropriateness of the current mining tax regime. The recommendations by the DTC takes into account these challenges.
The SIMS document recommended the introduction of new taxes in the mining sector. The new taxes were proposed to be in the form of windfall taxes, rent resource tax, sovereign wealth fund and export taxes. The DTC has not recommend the introduction of any new taxes for the mining sector.
1. Capital expenditure (Capex) for non-gold mining companies
The establishment of a mine requires high upfront capital infrastructure expenditure. In addition, the nature of mining operations is such that there is a considerable time lag between the upfront Capex investment and the subsequent generation of income.
Mining companies are entitled to upfront deductions on qualifying Capex and partial deductions on employee related and transport specific infrastructure. These deductions are ring-fenced to taxable mining income in relation to a specific mine.
The DTC recommends that the upfront Capex deductions be abolished and for it to be replaced with an accelerated deduction method similar to that currently in force for the manufacturing industry. Such accelerated deduction will be available from the date that the Capex has been incurred as opposed to the date it has been brought into use as is currently applicable for manufacturing allowances.
To compensate taxpayers for the removal of the upfront Capex allowances, the DTC further recommends the removal of the ring fencing rules applicable to the mining operations. The DTC however recognises that the removal of the ring fencing rules could have compromising effects on revenue collection in one single year as a result of the influx release of the clogged losses and unredeemed Capex set-off against non-mining income. It has therefore recommended that further work be done to ensure the most effective implementation thereof. We might therefore see the phasing in of these changes over a number of years in order to minimise the tax collection impact.
Should the DTC’s recommendations be accepted, mining taxpayers might be able to set-off their Capex amount against non-mining income within a single entity and against other mines within the same entity. The administrative burden of keeping track of the unredeemed Capex will also be lifted. Furthermore, the alignment of mining allowances with manufacturing allowances will eliminate the need to differentiate between mining operations and manufacturing operations which has long been a controversial issue.
2. Gold mining formula, Capex and ring fences
Gold mining companies are taxed in terms of a formula which by and large, takes into account the profitability of the company and provides relief in cases where margins are below 5% (often referred to as the tax tunnel). The gold mining formula was introduced to encourage gold mining investment and the mining of marginal ores.
Despite the fact that the gold mining industry is reaching its sunset years, it remains a major contributor to employment in South Africa. In light of the recent labour unrest and the current high unemployment rate, the DTC recommends the retention of the gold mining formula for existing gold mines to avoid causing sudden further declines in labour, especially in the marginal mines.
Gold mining taxpayers are entitled to additional Capex allowances on top of the Capex allowances applicable to non-gold mining companies. The same ring fences applicable to non-gold mining companies are also applicable to gold mining companies.
Since the gold formula takes into account the profitability of an entity, it is also influenced by the Capex amount. Therefore, the retention of the gold formula necessitates the retention of the Capex ring fences for existing gold mines. This recommendation does not extend to new gold mines on the basis that new gold mines are likely to be established in circumstances where profits are marginal. The DTC further recommends the phasing out of the additional Capex for gold mining taxpayers to bring the gold mining industry in line with other taxpayers.
The impact of these recommendations is that existing gold mines will continue with business as usual, save for the additional Capex allowances. The removal of the additional Capex allowances will result in an increase in the tax rate as the profit ratio in the formula will increase. New gold mines will be treated as other non-gold mining companies, in other words, they will be subject to tax at the rate of 28% and will be entitled to accelerated allowances similar to manufacturing allowances as previously discussed.
Alternatively, the DTC recommends the phasing out of the gold formula for all mines over a reasonable period of time, to take into account the neutrality issues when comparing new and existing gold mines.
3. Contract mining
The mining industry has seen the entry of many contract miners over the years. However, from an income tax perspective, contract miners are not afforded the same tax incentives as mining companies in possession of mineral rights albeit conducting the exact same activities. In addition, contract miners are often excluded from participating in the diesel rebate incentives as the current system does not adequately cater for them. National Treasury will be undertaking a comprehensive review of the diesel rebates system pertaining to, amongst other things, the mining industry.
As part of its comments submitted to the DTC in 2013, Deloitte recommended the harmonisation of the different pieces of legislation dealing with mining activities, specifically in respect of contract miners. We are pleased to note that the DTC has taken our comments into account and in turn recommends the principles of an agent and principal for contract miners and mining companies holding mineral rights. To facilitate this concept, the DTC recommends the setting up of a comprehensive guide containing the terms under which the agent and principal operates.
With the recommendations of bringing the mining Capex allowances in line with manufacturing allowances, contract miners will be on par with mining companies and the debate over who is mining and who is not will be eliminated. The harmonisation of the different pieces of legislation will also, amongst other things, ensure that contract miners are able to participate in diesel rebate incentives.
4. Social labour plans
In terms of the MPRDA , taxpayers seeking to acquire mineral rights are required to sign a Social and Labour Plan (SLP) in terms of which the mineral right holder is required to assist local mining communities with infrastructure and other social amenities. The challenge with the SLP is that where infrastructure is built for the benefit of non-employees, such expenditure is treated as non-deductible capital expenditure for income tax purposes.
Deloitte’s previous submission to the DTC, included this challenge and recommended recognition of the contributions made by mining companies toward the communities around their operations from a tax perspective, in other words, for such contributions to be claimed as a tax deduction.
Deloitte is pleased to note that the DTC has taken the recommendation into account and recommends, amongst other things, that infrastructural spend for the benefit of the community at large undertaken in terms of the SLP qualify as a tax deductible expenditure.
Until such time that these recommendations are accepted and legislated, taxpayers should be cautious on the tax treatment of such expenditure and should rather seek professional tax advice in this regard.
5. Harmonisation of legislation
The mining industry is government by different pieces of legislation, such as the MPRDA, MPRRA , Income Tax Act , VAT Act , Customs and Excise Act and NEMA . Although all these pieces of legislation deal with the same industry, albeit with different objectives, there is discord between all of them.
The Committee recommends the harmonisation of the different pieces of legislation relating to the mining industry, especially with regards to definitional issues. In addition interpretational clarity on mining tax provisions as contained in the Income Tax Act is recommended.
Taxpayers are encouraged to submit their comments to the DTC with the challenges that they are facing in application of the various pieces of legislation relating to the industry.
6. Mineral royalty
The mineral royalty was introduced in 2010 as compensation for the government for the depletion of the country’s mineral resources. On that basis, a minimum charge is payable irrespective of the taxpayer’s profitability. However, a maximum charge is imposed when commodity prices are high, and therefore, profitability is not totally disregarded.
On the basis that the mineral royalty system is responsive to varying economic conditions, the DTC recommends its retention. However, technical clarification on gross sales, EBIT and the determination of the conditions specified is still required.
Since no changes to the mineral royalty is recommended, there is no impact to taxpayers. However, taxpayers are encouraged to submit their comments to the Committee with regards to the challenges that they are faced with on the application of the MPRRA.
7. Greenfield exploration
Greenfield exploration refers to chartered territory where mineral deposits are not already known to exist as opposed to brownfield exploration which refers to areas where mineral deposits were previously discovered . Greenfield exploration is therefore the foundation for continued development of the mining industry into the future. However, very little attention is directed to greenfield exploration as South Africa predominantly follows brownfield exploration.
The Committee is not convinced that fiscal incentives or lack thereof is the answer to greenfield exploration but rather suggest non-tax measures to encourage such exploration. Such measures will include certainty in sector legislation, Black Economic Empowerment and other transformative initiatives.
It will be business as usual for taxpayers involved in greenfield exploration from a tax perspective. It is recommended that such taxpayers to provide comments to the DTC with regards to the challenges they are facing and the interventions required to alleviate such challenges.
8. Recoupments relating to mining assets
The value of mining assets in a sale of a mining concern transaction is governed by section 37 of the Income Tax Act, whereby an effective value (similar to an insurance replacement value) is attributed to the mining assets (land, mining rights and Capex) by the DMR .
The Committee recommends the removal of section 37 to bring the recoupment of mining assets in line with recoupments of non-mining assets as there is no difference between the two.
The removal of section 37 will mean that taxpayers will be able to base the recoupment of mining assets on the actual proceeds received as opposed the effective value determined by the DMR. There will also no longer be delays in obtaining such value from the DMR.
The recommendations are still in draft format and require input from various stakeholders before they are made final and conclusive. Taxpayers are encouraged to make their submissions to influence the final outcome of this tax review. They should also be considering the financial implications of these proposals in order to make informed investment decisions.