With the onset of Covid-19, global markets are in a tailspin and South Africa’s mining industry has not been spared. It is therefore unfortunate that during this time of global crises, spotlight has once again been placed on the taxation of mining companies in South Africa through proposed amendments to mining tax legislation.
Proposed amendments have been introduced in the recently published 2020 Draft Taxation Laws Amendment Bill focussing on two areas; the first seeking to exclude contract mining from qualifying for mining tax allowances, and the second removing a discretion granted to the Minister of Finance to uplift the so-called tax mine ring-fencing provisions.
At first blush, one would be forgiven for cynically viewing the amendments to the mine ring-fencing provisions (which are posited as being favourable) as a trade-off to the more restrictive amendment dealing with contract mining.
However, on closer examination, it is apparent that both proposed amendments could have far-reaching negative consequences for the mining industry. So what is all the fuss about and why are mining companies up in arms?
Let’s start by looking at the proposed amendment directed at contract mining. The heart of the debate lies in whether a contract miner that carries on mining operations on behalf of a mining right holder, can be said to derive income from mining operations in order to claim mining allowances? As mining allowances are accelerated and can theoretically be fully utilised in one tax year, these would be favoured over normal capital allowances which are typically spread over several years. It is for this reason why contract miners prefer claiming mining allowances over normal capital allowances – an upfront deduction can help cash-flow thereby allowing capital to be redeployed.
For many years contract miners have argued that a contract mining arrangement which includes activities to win minerals, will allow access to mining allowances even though they may not be in possession of the mining right, may not own the ore mined, and may only perform certain parts of the entire mining process.
The test to qualify for mining allowances, as advanced by contract miners, lies in whether such contract miner performs “mining operations” even if only limited to ore extraction. The South African Revenue Service (Sars) on the other hand, held a diametrically opposed view, maintaining that contract miners do not qualify for mining allowances since they do not hold the mining right, may only perform some elements in the mining process (such as ore extraction but not processing), and do not trade in the ore (since these belong to the mining right holder).
Contract mining is an integral part of the evolution of the mining value chain, focusing on scale, cost optimisation, and expertise – all of which contract miners provide to junior and small-scale miners.
The matter was finally settled by the Supreme Court of Appeal (SCA) in the case of Benhaus Mining (Pty) Ltd v The Commissioner for SARS (2019) ZASC 17 (Benhaus Case) where the SCA held that even though the contract miner only extracted chrome ore (without processing it), and the contract miner earned a service fee and not income from the sale of ore, it still qualified for mining allowances.
Interestingly, the question of whether only a mining right holder is entitled to mining allowances was not considered by the SCA, although the minority judgment called for legislative amendments since “… the class not intended to benefit from the dispensation will continue to benefit and be entitled to the accelerated tax deductions which clearly is to the detriment of the fiscus coffers”.
It did not take long for the legislature to heed this call and in direct response to the Benhaus Case, the Draft Bill proposes amendments which seek to limit mining allowances to a holder of a mining right, thereby seeking to exclude contract miners.
The impact of this amendment must be considered beyond the limited context of the Benhaus Case, and more broadly in the context of modern-day mining.
Contract mining is an integral part of the evolution of the mining value chain, focusing on scale, cost optimisation, and expertise – all of which contract miners provide to junior and small-scale miners. It is also in this capacity that contract mining supports the objectives of the Mining Charter, allowing BEE entrants and junior miners access to mining infrastructure and expertise without the need to outlay capital, thereby mitigating financial risks.
Without the ability to access mining allowances, contract miners will have to remodel pricing of existing contracts, and any loss of tax base will inevitably be passed to clients and/or absorbed. Open-cast operators and specific sectors (such as diamond mining) which are heavily dependent on contract mining will be hardest hit.
Moreover, since the limitation will not only apply to contract miners, but any operator who does not hold a mining right, the limitation could impact various other valid mining arrangements.
In short, the proposed amendment will have a knock-on effect that will be felt beyond contract miners and only time will tell what the full impact will be to an already ailing industry.
Upliftment of Mine Ring-Fencing
The mining tax regime operates on a capex per mine ring-fencing basis, meaning that mining allowances in relation to one mine, are limited to taxable income from such mine.
This rule prevents capex from one mine reducing taxable income of another (profitable) mine (unless the ring-fence can be uplifted). Consequently, where there is more than one mining operation, as long as these can be viewed as ‘one mine’, the ring-fencing will not apply to the separate operations.
The current pandemic presents a unique opportunity for decisive government action to build a new economy, with mining as its bedrock. Mining tax proposals must be aligned with this, prioritising foreign investment and incentivising junior mining and mine exploration.
Various objective criteria would be used to assess whether different operations constitute ‘one mine’. In circumstances where mining operations do not qualify as ‘one mine’, taxpayers may approach the MOF to uplift the ring-fencing provisions, having regard to “any relevant fiscal, financial and technical implications” related to the operations. The MOF’s discretion is wide and in the past has been successfully applied to support the sustainability of marginal mines.
The Draft Bill seeks to remove the Minister of Finance’s discretion in favour of the Commissioner of SARS, and codifies criteria for upliftment (which includes contiguity of mining operations, operational synergies, overlapping employees, etc). What is striking is that these factors are typically ones used by taxpayers in objectively determining whether separate mining operations may otherwise constitute ‘one mine’, without the need to obtain the finance minister’s approval.
Whilst the proposed amendment may appear innocuous, the effect could be to limit upliftment applications only to instances where the listed criteria exist, and to remove a taxpayer’s ability to apply for the upliftment on mines that are not contiguous, even if there are compelling fiscal, financial and technical reasons (as is often the cases with marginal mines).
Time for bold initiatives
The current pandemic presents a unique opportunity for decisive government action to build a new economy, with mining as its bedrock.
Mining tax proposals must be aligned with this, prioritising foreign investment and incentivising junior mining and mine exploration.
This must include a fresh look at flow-through structures and funding instruments such as royalty streams, forward sales and off-take arrangements which could provide the industry with much needed impetus and capital.
Muhammad Saloojee is a director of Tax Lexicon