12 April 2019 by and Tax & Exchange Control Alert

A groundbreaking victory for contract miners, won from the soil

The Income Tax Act No 52 of 1968 (ITA) provides a special regime for taxpayers engaged in mining operations. The reasoning behind this special treatment is that the establishment of a mine is an expensive and lengthy process, with long lead times until any profit is seen by the mining company.

The provisions of s15(a) of the ITA, read with s36(7C), in light of the definition of ‘mining operations or mining’ in s1, provide the mechanism and requirements for the deduction of capital expenditure incurred for a mining operation (Redemption Allowance). Mining operations are defined in s1 of the ITA to “include every method or process by which any mineral is won from the soil or from any substance or constituent thereof”. Section 15 of the ITA provides that a deduction shall be allowed as per s36, in lieu of an ordinary deduction under s11. Section 36 in turn provides for a deduction of any capital expenditure to be allowed from income derived from working any producing mine.

The effect of these provisions is that a taxpayer engaged in mining operations on a producing mine will be entitled to fully deduct related capital expenditure in the year of assessment it was incurred. This is a departure from the standard deductions relating to capital expenditure, which required amortisation of the expenditure over the useful life of the asset.

Given the vital role played by miners in the South African economy, it is important to have clarity on the nature of operations that would qualify for deductions under the Redemption Allowance. Following two earlier judgments of the Tax Court regarding the applicability of the Redemption Allowance to contract miners, the recent decision of the Supreme Court of Appeal in Benhaus Mining (Pty) Ltd v Commissioner for the South African Revenue Service (165/2018) [2019] ZASCA 17 has provided greater clarity regarding the position of contract miners involved in a particular part of the mining value chain.

Facts

Benhaus Mining (Pty) Ltd (Benhaus Co) was a company engaged in open-cast, contract mining for chrome. This entailed Benhaus Co entering into contracts with parties which held mining rights to provide certain services in relation to the extraction of the mineral ore.

Specifically, these services included establishing sites for open cast mining; constructing workshops; constructing and maintaining access roads, and primary and secondary haul roads; removing topsoil and stockpiling it in designated areas; excavating and stockpiling material extracted from the ground; blasting mineral-bearing ore; delivering the ore to the client’s premises for processing; and rehabilitating the mining area after extraction.

The Commissioner for the South African Revenue Service (SARS) initially allowed Benhaus Co’s deductions under the Redemption Allowance. However, in the 2013 tax year SARS re-assessed Benhaus Co’s 2005 - 2009 returns, disallowing the deductions that were claimed under the Redemption Allowance. SARS argued that the disallowance of the deduction was correct, because Benhaus Co was in fact providing services to a miner, rather than conducting mining operations in its own right.

Key Issues

Although it was common cause that Benhaus Co in fact dug the minerals out of the ground with a commercial motive, SARS disputed its status as a miner. Therefore, the decision in the Benhaus case turned on a determination of whether the activities undertaken by Benhaus Co under contractual relationships, as described above, constitute mining operations for the purposes of the Redemption Allowance.

ITC 1907

Prior to the decision in the Benhaus case the Tax Court dealt with a similar problem regarding contract mining and the Redemption Allowance. In ITC 1907 80 SATC 271 SARS countered the taxpayer’s, who was a contract miner, assertion that it was plainly engaged in mining operations by pointing to jurisprudence on the Redemption Allowance, specifically Western Platinum Ltd v Commissioner for SARS [2004] 4 All SA 611 (SCA). Western Platinum, and cases cited therein, recognised the potential for segmentation of mining operations, but to qualify for the Redemption Allowance the taxpayer had to be in the “business of mining”.

The nub of SARS’s reason that the taxpayer was not engaged in mining operations was that the taxpayer had insulated itself from, among other things, commodity price fluctuations and the risk attendant on mines, by negotiating a set contract fee. Thus, the source of its income was not the mining and sale of minerals, but services rendered to the holder of mining rights.

The decision of the Tax Court, per Sutherland J, through an analysis of jurisprudence on the Redemption Allowance, including Western Platinum, held that being in the business of mining means that the taxpayer’s trade must be mining. To be in the trade of mining the taxpayer must not only extract the minerals from the earth, but the trade in minerals or mining operations must be the source of the taxpayer’s income.

Sutherland J therefore held that to be a ‘digger’ of minerals is not sufficient to qualify as a ‘miner’ and that the source of the taxpayer’s income was in fact the services rendered, rather than a trade in minerals won from the soil. Had the contract miner been exposed to the risk of fluctuations in the price of the commodity, by earning a share of the profit rather than a set fee, it would have fit the policy rationale for the Redemption Allowance.

ITC 1913

A taxpayer, also a contract miner, on appeal argued that Sutherland J had erred in his analysis of the jurisprudence on the Redemption Allowance in ITC 1907. It argued that contract mining was captured by the phrase income from mining operations. Further, that this was the correct reading of Western Platinum, because although that decision had required a commercial element to be present to qualify for the deduction, this did not equate to a requirement that the taxpayer must sell the minerals on the open market. Rather, the focus of the analysis should be the work done to earn the income, rather than the mechanism for determining the extent of the income.

SARS on the other hand adopted the reasoning of Sutherland J in ITC 1907 and argued that the raison d’être for the taxpayer’s income was in fact services rendered to a mining right holder and not the operation of a mining enterprise, as defined.

The Tax Court in this appeal held that the operations of the taxpayer were not in fact mining operations. It came to this conclusion with reference to the underpinnings of the Redemption Allowance as outlined in the Davis Tax Committee and Margo Tax Committee reports. Essentially, these reports delineate the history of the Redemption Allowance and argue that it exists because of the high risk involved in mining operations and the long lead times before significant revenue generation.

A second point which the Tax Court emphasised was that the Redemption Allowance deduction is ring fenced to the income from the mine where the capital expenditure was actually expended. This disaggregation was not done by the taxpayer and therefore even if it had succeeded in proving it was engaged in mining operations it would not have been able to deduct the Redemption Allowance.

The Benhaus case

In the Supreme Court of Appeal (SCA) Benhaus Co put forward an interpretation of the Redemption Allowance, based on judgments including Western Platinum, which indicates that income derived from the business of mineral extraction is income derived from mining operations. Further, it disputed two key criteria used by Sutherland J to distinguish contract mining from mining operations as defined and also relied upon by the court in ITC 1913: the risk requirement and the insufficiency of being a ‘digger’.

Regarding the risk requirement which was decisive in ITC 1907, the SCA per Lewis ADP noted that Benhaus and contract miners indeed take commercial risks, albeit not of the market price related nature required in the judgment of Sutherland J. Secondly, regarding the insufficiency of being a ‘digger’ Lewis ADP noted that in cases including Richards Bay Iron and Titanium (Pty) Ltd v CIR 1996 (1) SA 311 (A) and CSARS v Foskor [2010] 3 All SA 594 (SCA), the SCA had held that “the entity that extracted the ore was the miner and that the entity that processed it into an entirely different state was not”.

Lewis ADP, ultimately agreed with Benhaus Co that its income earning activities indeed afforded it the benefit of the Redemption Allowance. The reason being that despite contract miners not precisely fitting into the policy rationale for the Redemption Allowance, it in fact bore the capital expenses related to the extraction of the minerals, the mining operations were the core of the income earning activity carried on by Benhaus Co and earning a set fee did not undermine the fact that it was engaged in mining operations.

Conclusion

The decision in the Benhaus case has resolved the degree of uncertainty which had lingered in the application of the Redemption Allowance to contract miners. The somewhat inapposite application of the Redemption Allowance to this class of taxpayers has been noted by the Davis Tax Committee’s reports. It is now for the Legislature to determine whether it does not wish to continue extending the incentivisation provided by the Redemption Allowance to contract miners.

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