NOTE ON MINING TAXATION IN SOUTH AFRICA: A PRESENTATION BY MZOLISI (ZOLI) DILIZA
AT THE WORLD MINING CONGRESS HELD IN LONDON ON 2 JUNE 2008

1. Introduction

It is outside the scope of this note to deal comprehensively with the South African tax system. What follows is a summary of mining taxation with reference to general principles where this is necessary. In the event of more detailed information being required, readers are referred to the authorities mentioned below.(1)

The income tax system imposes tax at specified rates on what is defined as taxable income. Taxable income is arrived at by taking gross receipts and accruals of an income nature, from a source within the Republic, adding thereto any special inclusions to gross income, deducting exempt income, adding further taxable income special inclusions, and by deducting therefrom what are called general and special deductions. By this process one arrives at a taxable income or assessed loss.

Mining in South Africa occupies a pivotal position in the economy. Taking into account the fact that mining is a high risk investment, and the fundamental concept that fiscal impositions which increase mining costs have the effect of increasing the cut-off grade of ore, reducing the life of a mine, and sterilising mineral assets, mining taxation receives particular treatment.

One of the key features in the mining tax system favourable to mining is the application of the principle - endorsed as long ago as 1946 by the Holloway Committee on gold mining taxation - that wherever possible, taxes which increase costs should be repealed and where it is necessary to recover the same amount of revenue, this should be raised from taxes falling on profits. The principle that mines should be taxed on profits and not in a manner which increases costs, applies equally to all mines, the reason being that the higher the mine's costs, the higher the grades of ore which it will be able economically to mine. Depending on market forces, by driving up the costs, the lower grade ores will be left in the ground, probably forever.

It is therefore necessary first to have regard to the definitions of what is a mineral, and what are mining operations, to establish whether or not an operation is to be taxed as a mining operation.

The Income Tax Act, 1962, ("the Act") does not define a "mineral". For guidance one may, however, refer to the Mineral and Petroleum Resources Development Act, No. 28 of 2002, which defines a mineral as being:

"…. any substance, whether in solid, liquid or gaseous form, occurring naturally in or on the earth or in or under water and which was formed by or subjected to a geological process, and includes sand, stone, rock, gravel, clay, soil and any mineral occurring in residue stockpiles or in residue deposits, but excludes –

• water, other than water taken from land or sea for the extraction of any mineral from such water;
• petroleum; or
• peat"(2)

The Act defines "mining operations" and "mining" to include every method or process by which any mineral (including natural oil) is won from the soil or from any substance or constituent thereof.

2. Mining Income

A mining company may derive income from mining for gold, from mining operations other than mining for gold, and from non-mining operations. Different rules and tax rates are applied in respect of these different sources of income. This means that it is necessary to have regard to the definitions of mining for gold, which in the Act is defined to include mining for uranium,(3) and of mining operations and mining referred to in 1 above.

Income received or accrued in respect of the utilisation of the capital or working assets of a mine would be regarded as mining income, and when derived from other assets, would tend to be non-mining income.(4) Examples of non-mining income include investment income derived from liquid funds held pending minor expenditure programmes or dividend payouts, returns on investments in other companies, banker's acceptances and other discount instruments.(5) In the case of rentals, it is considered that if an asset is not used for mining purposes for a particular period, the income derived therefrom is not mining income, although it may have to be taken into account in determination of the mining tax liability as it will almost certainly constitute a capital or revenue recoupment.(6)

3. Mining Expenditure

A mining company incurs a vast range of expenditures which may be categorised as mining and non-mining expenditure. It is necessary to categorise this expenditure because of the different tax rates imposed on the two categories of taxable income, as well as the fact that various restrictions apply to deductions against mining income.(7) Under general principles, a distinction must also be drawn between revenue and capital expenditure, although in the mining industry, capital expenditure is specially treated, as more fully described in 4 below.

Working costs are not restricted to being of a revenue nature, and for tax purposes it is therefore necessary to separate working costs into capital costs and revenue costs.(8) Revenue costs are deductible in terms of the general deduction formula contained in the Act. Capital costs are deductible in terms of the capital expenditure provisions mentioned in 4 below. This measure constitutes an exception to the general deduction formula in section 11(a) of the Act which provides that for expenditure to be deductible it must not be of a capital nature. Working costs typically include salaries and wages, ropes, pipes and steel, electrical power and electrical and mechanical equipment, explosives and other construction and mining costs.

4. Capital Expenditure

Section 15 of the Act provides for the immediate deduction of the following amounts from the income derived by a taxpayer from mining operations:

(a) capital expenditure ascertained under the provisions of section 36 of the Act, in lieu of allowances for wear and tear,(9) lease premiums,(10) patents and trademarks(11) and the scrapping allowance,(12) and,
(b) expenditure on prospecting and incidental operations.

Section 36 of the Act defines capital expenditure as including the following:

(i) expenditure (other than interest or finance charges) on shaft sinking and mine equipment (other than certain expenditure qualifying only for a partial annual redemption referred to below); and,
(ii) expenditure on development, general administration and management (including any interest and other charges payable after 31 December 1950, on loans utilized for mining purposes) prior to the commencement of production or during any period of non-production; and,
(iii) a capital allowance in the case of qualifying gold mines and natural oil mines; and,
(iv) expenditure (excluding the cost of land, surface rights and servitudes), the payment of which has become due on or after 1 July 1989 in respect of the acquisition, erection, construction, improvement or laying out of various assets qualifying for partial annual redemption.

The term "capital expenditure incurred" is defined in section 36 and, in short, consists of the amount which remains after deducting mining recoupments from current capital expenditure incurred.

The capital expenditure defined above is deductible immediately from income derived by a taxpayer from mining operations, but may only be claimed once production has commenced. Prior to commencement of production, capital expenditure is carried forward to future years and then redeemed against mining income as and when the income is earned.

The Act restricts the deduction of capital expenditure in relation to any one mine to the taxable income (before the deduction of any amount allowed under section 15(a) but after the set-off of any balance of assessed loss incurred by the taxpayer in relation to that mine in any previous year) from mining on that mine.(13) However the Minister of Finance may rule that these costs may be set off against the income of another mine. Any excess not allowed will be carried forward and deemed to be an amount of capital expenditure incurred during the next year of assessment.(14) The Act provides that the restriction may be overridden in part in that where mining operations commenced after 14 March 1990, any amount of capital expenditure which is disallowed under the provisions of section 36(7F) will be allowed as a deduction from the total taxable income derived by the taxpayer from mining (after the deduction of any capital expenditure which does not fall to be disallowed and after the set-off of any assessed loss incurred by him from mining operations in a previous year) as does not exceed 25% of such taxable income.(15)

There are, however, assets which qualify only for a partial annual redemption. These assets consist of housing for residential occupation by the taxpayer's employees and furniture therefor, infrastructure in respect of residential areas developed for sale to the taxpayer's employees, a hospital, school, shop or similar amenity owned and operated by the taxpayer mainly for the use of his employees or any garage or carport for any motor vehicle, recreational buildings and facilities owned and operated by a taxpayer mainly for the use of his employees, any railway line or system having a similar function for the transport of minerals from a mine to the nearest public transport system or outlet and motor vehicles intended for the private or partly-private use of the taxpayer's employees. Expenditure on these assets is deemed to be payable in ten successive equal instalments, or in the case of motor vehicles, in five successive equal annual instalments.(16)

5. Capital Allowance

The Act provides for a capital allowance, which serves as an incentive for new mining development. The terms of the capital allowance have been amended a number of times since it was first introduced in 1956. In effect, an allowance, calculated as a percentage per annum of capital expenditure, is transformed into a deduction against current capital expenditure, and if there is insufficient current mining income for capital expenditure, it is added to the unredeemed balance carried forward to the next year.(17) The capital allowance is calculated at the rate of 10% per annum for a “post-1973 gold mine “or any other deep level gold mine “ or 12% per annum for any ”post-1990 gold mine” or any natural oil mine.

6. Environmental Management Trust Funds

The Income Tax Act provides (18) for a deduction of amounts paid by a taxpayer engaged in mining, prospecting, quarrying or similar operations to an organisation referred to in section 10(1)(cH) of the Act to be used for the purposes contemplated in that section. Section 10(1)(cH) exempts from income tax the receipts and accruals of certain organisations whose sole or principal object is to hold and apply moneys for various mining-related environmental rehabilitation or protection obligations referred to in the section. In order to qualify, the expenditure must be for the discharge of obligations imposed in terms of a law relating to mining operations.

7. Mining Recoupments

Where a mine has not been allowed a deduction in respect of expenditure, for example on land, the recovery or recoupment of this expenditure has no tax consequences. However, where the expenditure has been allowed in terms of the general deduction formula, or as a specific deduction in terms of the capital redemption provisions, any receipt or accrual of an amount comprising a refund or recoupment in respect of such expenditure, must be added to current income by virtue of a special formula.(19)

8. Direct Tax Rates

The Formula for the calculation of the rate at which a gold mine must be taxed

Mining companies earning taxable income derived from mining for gold are taxed on a formula basis. The gold formula determines the tax rate and takes the form y = a - (ab/x), where y equals the tax rate to be determined, a equals the marginal tax rate, b equals the portion of the tax-free revenue, and x equals the ratio of taxable income to the total income. The current formula, subject to what is said below in regard to the secondary tax on companies, is y = 45 - (225/x) (i.e. if the company has elected to be exempt from the secondary tax on companies)(20) .

The tax rate “y” is applied to the taxable income earned by the company from mining for gold, as determined before any excess mining capital recoupments, but after the set off of any assessed losses. The factor “a” (currently 45) represents the flat marginal rate which applies to each rand of taxable income in excess of the factor “b”. The factor “b” is commonly known as the “tax tunnel”. It is a form of depletion allowance in terms of which taxable income amounting to “b%” (currently 5%) of mining revenue is free of tax. The factor “x” is the ratio, expressed as a percentage, of mining taxable income (before excess mining capital recoupments, and before assessed losses) to the mining income.

In effect “the State receives no tax revenue at all while a gold mine operates unprofitably, or at profit levels within the tax tunnel. All revenue is applied to costs in the former case, and the vast bulk thereof is applied to costs in the latter, with a small portion comprising distributable profits. Thus, shareholders may receive a small return in the form of a dividend in a period in which the mine is not paying tax.

 Once the mine’s profitability increases sufficiently to push it out of the tax tunnel, the State receives some income tax but the amount of tax is very low at low levels of profitability. As profitability increases, tax increases disproportionately …. As profitability increases, the tax share increases rapidly until the theoretical (but impossible) maximum 100% profitability level is reached….”(21) .

 The formula is dynamic. “If the gold sector (or an individual mine) is operating at relatively high levels of profitability (resulting in a high “x” factor) the average rate of tax will be very high; when profitability drops, the average rate drops as well”(22) .

In 1993 section 64B of the Act was inserted in terms of which a secondary tax on companies was imposed. This secondary tax on companies is now calculated at the rate of 12.5% of the net amount, as defined, of any dividend declared by any company on or after 14 March 1996. Under section 64B(12) companies mining for gold were entitled to exercise an irrevocable election to be exempt from payment of secondary tax on companies. In the case of such exemption, the formula rate for gold mining companies is that set forth above. (The formula for a gold mining company that has not chosen to be exempt from the secondary tax on companies is y = 35 – (175/x).

The effect of the formula tax rate is that marginal mines with a profit to revenue ratio of 5% or less have a zero tax rate, whereas more profitable mines will pay a higher rate of tax. The underlying principle of the formula tax is that mining companies should be encouraged to mine marginal ore, which if not mined, could be lost forever.

Other Mines

Mining companies earning taxable income derived from mining for diamonds and other minerals and base metals are taxed on a flat rate basis, of 29%, but such companies are also liable to the secondary tax on companies at the above rate of 12.5%.

9. Indirect Taxes

Mining companies are liable to pay value-added tax on goods and services supplied to them, but in terms of the Value-Added Tax, No. 125 of 1991, exports are zero-rated.(23) This means that a mining company which exports all its products, for example, would not pay value-added tax on its export sales, but would be entitled to a refund in respect of all input taxes paid by it.

Other indirect taxes paid by mining companies include customs and excise duties, (24) and skills development levies(25) .

10. Fringe Benefits Tax

Although not a tax on mining itself, employees of mining companies are as any other employees, subject where applicable, to the provisions of Schedule 7 of the Income Tax Act, which provides for the inclusion in an employee's taxable income, of taxable benefits granted by his employer to him as a benefit or advantage or by virtue of employment or as a reward for services rendered or to be rendered. Taxable benefits include the acquisition by the employee of assets at less than market value, the right granted to an employee to use an asset, certain meals or refreshments, residential accommodation, certain services and loans, as well as the use of motor vehicles.

11. General

Mining companies are subject to the normal rules relating to finance, accounting, administration and procedure, and for more detail the reader is referred to the references referred to above.(26)

12. Footnotes

1 M C van Blerck. 1992. Mining Tax in South Africa. Taxfax cc. Rivonia South Africa; A De Koker. Silke on South African Income Tax. Memorial Edition. LexisNexis Butterworths; D Meyerowitz and E Spiro. The Taxpayer's Permanent Volume on Income Tax in South Africa. The Taxpayer.

2 section 1; See also Commissioner of Taxes v Nyasaland Quarries and Mining Co. 24 SATC 579 and Falcon Investments v C D Birnam 1973 (4) SA 384 (AD)

3 section 1

4 Van Blerck, page 10-3

5 Van Blerck, page 10-3

6 Van Blerck, page 10-4 & 5 see also under 6.

7 Van Blerck, page 11-2

8 Van Blerck, page 11-8

9 section 11(e)

10 section 11(f)

11 section 11(gA)

12 section 11(o)

13 section 36(7F)

14 section 36(7F)

15 section 36(7G)(a)

16 section 36(11)(d)

17 section 36(11)(c)

18 section 11(hA)

19 Van Blerck, chapter 14. section 1 "gross income" (j) of the Act.

20 This rate, applies in respect of years of assessment ending during the period of twelve months ending on 31 March 2006.

21 Van Blerck, page D-12.

22 Van Blerck, page D-11.

23 section 11 of the Value-Added Tax Act, No. 89 of 1991

24 Customs and Excise Duties Act, No.91 of 1964

25 Skills Development Levies Act, No.9 of 1999.

26 See Note 1 above.