Mining companies face a significant increase in the royalties they pay if the taxman’s current interpretation of the Mineral and Petroleum Resources Royalty Act carries.
Originally, gross sales — which are the basis for calculating mining royalties — were meant to exclude the costs for the transport, insurance and handling of minerals that miners pass on to their customers.
But the South African Revenue Service’s (SARS’s) interpretation of the law, in a draft binding general ruling, is that companies must prove exactly what costs relate to each transaction.
Tax practitioners say this an onerous and impracticable requirement that does not take into account the way mineral sales contracts are drawn up.
The effect would be that gross sales would be artificially inflated and miners would pay higher royalties.
The mining tax committee of the South African Institute of Tax Professionals (SAIT) says there is a "significant" concern that if a reasonable and practical interpretation is not found, companies will have to approach the courts.
One company, United Manganese of Kalahari, has already approached the courts for a declaratory order on the interpretation set out in the draft binding general ruling published by SARS. The case is set to be heard in May.
SAIT has requested that the finalisation of the ruling be postponed until the case has been heard in the High Court.
The principle of not penalising beneficiation was one of the issues addressed during the initial negotiations on the "resource rent" (the royalty fee on minerals) as far back as 2004.
It was also agreed that transport, insurance and handling costs would be excluded to determine what the price of the mineral will be at the "first saleable point".
The principle that must be applied, and which had been agreed upon in the early discussions around the resource rent, is that the royalty cannot be imposed on the transport, insurance or handling costs. It must be charged on the value of mineral.
According to SAIT, the original interpretation — contained in a draft explanatory memorandum that was never published in a final version — was that the calculation of gross sales disregards the transport, insurance and handling expenditure incurred to effect the disposal of a mineral resource.
In terms of the binding general ruling, it now seems that SARS will not allow the exclusion of the costs if the taxpayer cannot offer documentary proof of the expenditure passed on to the customer.
SAIT CEO Keith Engel says the seller must show that the transport costs are specifically reflected in the gross sales price agreed to by the purchaser.
"Showing costs incurred is easy. Showing that costs are specifically included in the price is often next to impossible, given the way that companies price and negotiate agreements with buyers of their minerals," says Engel.
These sales agreements are negotiated based on delivery terms used in international trade such as free on board, cost insurance freight, and ex-works.
"Based on mining royalty queries and audits, we are concerned that some SARS officials do not seem to understand how these terms work."
SAIT says in its submission to SARS that it is "wholly uncommercial" for mining companies to split their prices in agreements and on their invoices to show the details of the delivery terms. It can affect their international competitiveness.
In other words, SARS now expect of taxpayers to work out the cost of transport, insurance and handling for each and every transfer or sale. This is not in line with the way these costs are negotiated with either Transnet (which brings their product to port) or large buyers such as Eskom.
The treatment by mining companies of "expenditure beyond the specified point" has always been in line with the legislation and the draft explanatory memorandum.
"We submit that the approach followed by SARS in recent times is misguided and misplaced…. We are concerned that SARS is trying to amend the legislation by way of interpretation," says SAIT.
Ruaan van Eeden, head of tax at Geneva Management Group, says one of the aspects so often overlooked in issuing binding general rulings, is the consideration of commercial realities in a specific sector of the economy.
Mining, and the taxes imposed on that sector, are inherently complex. SARS appears to be taking a very narrow view of the undefined phrase, "without having regard to", in relation to the transport, insurance and handling costs.
This seems to be in contradiction with the original policy intent, which was not to unintentionally penalise extractors. It also seems to be in contradiction to the typical contractual arrangements that are put in place between the extractor of a mineral resource and the ultimate buyer.
"A more pragmatic approach should be considered by SARS in issuing the final version of the ruling, given that supply contracts, in most cases, go beyond the mere recovery of the mineral resource and would inextricably link the transport, insurance and handling components both before and after extraction," says Van Eeden.
A possible reason for the narrow interpretation of the wording in the act is the pressure on SARS to collect revenue.
The true effect of the latest interpretation by SARS on transport, insurance and handling costs is that beneficiation is discouraged, and a royalty is being levied on these costs and not on the value of the mineral.
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