A load off: UMK received clarity on the treatment and deductibility of transport, insurance and handling costs in transporting minerals. Picture: KATHERINE MUICK-MERE
A load off: UMK received clarity on the treatment and deductibility of transport, insurance and handling costs in transporting minerals. Picture: KATHERINE MUICK-MERE

The high court has delivered a landmark tax judgment that will be good news for mining companies.

United Manganese of Kalahari (UMK), the fourth-largest manganese producer in the world, took the South African Revenue Service (SARS) to court to obtain clarity on the treatment and deductibility of transport, insurance and handling (TIH) costs that mining companies incur when transporting minerals to customers.

According to SARS, these costs form part of the gross sales amount unless the mining company can show that these costs were specifically recovered, for example, as a separate line item on an invoice.

As most exporting mining companies would agree, this is not used in practice. This interpretation by SARS has a material effect on the royalty liability mining companies need to pay: mineral royalty is calculated on the gross sales amount. Therefore, if the latter includes TIH costs, the mineral royalty liability stands to be significantly increased by its inclusion.

Careful scrutiny of the 2017 national budget shows that the only numbers SARS adjusted upwards are for mineral royalty, which indicates that it is looking to raise funds through mining royalties. It is, therefore, possible that SARS may seek to appeal against the judgment.

The high court found that UMK is entitled to calculate its gross sales for manganese transferred by deducting any TIH expenditure incurred after the mineral has been brought to the condition specified in schedule 2 of the Mineral and Petroleum Resources Royalty Act, as well as any TIH expenditure incurred to effect the disposal of the manganese.

These may be deducted irrespective of whether the TIH expenditure was specifically or consciously considered in determining gross sales and irrespective of whether these TIH costs are of a capital nature.

The dispute has its origins in the interpretation of the Mineral and Petroleum Resources Royalty Act, with SARS taking certain interpretational approaches to parts of the act that appear to contradict what was agreed on between the Treasury and the mining industry at the time that the act was being drafted.

To determine the mineral royalty liability, a mineral royalty percentage is calculated on a range. The minimum is 0.5% and the maximum is 5% for refined mineral resources or 7% for unrefined mineral resources. This percentage is applied to gross sales — as defined in the act, which may not necessarily be the actual price received  from customers.

On SARS’s interpretation, TIH costs are not deductible from the gross sales amount where they are not specifically recovered. Most export mining companies agree on the delivery terms set out in the Incoterms — for example, cost, insurance and freight — thus the price includes TIH costs to be incurred by the mining company.

This interpretation has costly consequences, as TIH costs can range from 30% to 50% of the revenue amount. For example, if a mining company’s revenue is R1bn for the year of assessment and the associated TIH costs are R500m, on SARS’s interpretation, the mining company would need to pay royalty tax on the full R1bn.

In its judgment this week, the court found in favour of UMK. It ruled that it had jurisdiction to hear the application for a declaratory order.

The intention of the Mineral and Petroleum Resources Royalty Act is to compensate South Africans for nonrenewable resources, with the state being the custodian of the compensation for the benefit of all South Africans. As such, the compensation is for nonrenewable resources and should not be calculated on the TIH costs. SARS’s interpretation unfairly penalises the taxpayer.

On our interpretation, with which the high court agreed, TIH costs actually incurred are always deductible, regardless of whether they are itemised or reflected as part of the total cost to customer, such as in cost, insurance and freight-and free-on-board transactions.

SARS has, however, been uncompromising and, notwithstanding the dispute resolution procedures set out by the Tax Administration Act, taxpayers have turned to other remedies to settle disputes.

In the UMK case, SARS disallowed the deduction of TIH costs incurred by UMK for mineral royalty purposes. At the outset, UMK pursued the lengthy tax administration procedure. During this process, the uncertainty over the interpretation of whether TIH costs can be excluded in calculating the mineral royalty created a knock-on effect for UMK.

It affected UMK’s income tax — whether the mineral royalty is allowed as a deduction — and had a severe effect on its medium-and long-term manganese sales plans. After five years of pursuing the tax administration procedure with no resolution, UMK took the matter to court.

SARS opposed the application for a declaratory order, arguing that the high court did not have jurisdiction to hear the application or make the declaratory order on the basis that UMK should have first exhausted the resolution procedure set out in the Tax Administration Act.

In its judgment this week, the court found in favour of UMK. It ruled that it had jurisdiction to hear the application for a declaratory order.

Notwithstanding that tax cases are generally reserved for the exclusive jurisdiction of the tax court in the first instance, it is settled law that a decision of the commissioner is subject to judicial intervention in certain circumstances like the current case, where the issue in question is turning on legal issues.

The declaratory order was granted, upholding UMK’s interpretation that TIH costs are deductible from gross sales when determining mineral royalty liability, irrespective of whether or not they are reflected as a separate line item on customer invoices. No matter which interpretation the court ultimately favours if taken on appeal, this case remains a victory for taxpayers.

The judgment will provide much-needed certainty, allowing taxpayers to effectively plan their royalty and income tax liabilities and, most importantly, accurately reflect their company’s tax liability.

• Myburgh and Van Rensburg are directors at ENSafrica’s tax department and represented UMK in this matter.

Please sign in or register to comment.