The debate on the nationalisation of mines seems to be heating up. Organised business is opposing it, while the ANC Youth League is adamant for it to go ahead. It will be interesting to note what tax changes will be brought about if this does happen or whether the government will introduce the mining super tax as in Australia ( which has the effect of discouraging foreign investments in the mining sector) and use it as a drive to take over the existing mines.
While we sit and watch the debate unfold, it would be prudent to give advice to entrepreneurs who are currently embarking on prospecting activities, about the tax implications of prospecting expenditure and preliminary expenses.
What is prospecting?
Before mining can commence, it is necessary to find payable mineral deposits. This is a time- consuming and costly exercise, often involving mineral exploration in underdeveloped and sometimes desolate areas. Prospecting has advanced technologically in many ways in the last century, but it is still very costly and full of risk.
Prospecting may involve exploration for minerals in territories as yet unexploited. There is no definition of prospecting in the Income Tax Act1. The fact that the definition of a mining operation in the Income Tax Act2 is very wide indicates that, in some circumstances, the term may include prospecting. Depending upon the intention of the prospector, the prospecting expenditure incurred may be either capital or revenue in nature.
These are expenses normally incurred prior to the commencement of prospecting operations. They could include the costs of the acquisition of land and obtaining prospecting rights. Where the initial costs as referred to above are incurred by an entrepreneur who intends to eventually carry on mining operations, the initial expenditure is of a capital nature. As such costs fall neither within the provisions of section 15(b) of the Income Tax Act (prospecting by a company carrying on mining operations) nor section 36 (mining capital expenditure) of the Income Tax Act, they cannot be deducted for tax purposes by the entrepreneur.In the case of the entrepreneur being a speculator, the deductibility of the initial expenditure depends upon how the speculator intends to turn the mineral deposits to account.
Nature of prospecting expenditure Having obtained prospecting rights, the entrepreneur can commence the actual prospecting operations. All expenditure incurred in exploration for minerals on the relative property constitutes prospecting expenditure. The nature of such expenditure depends upon the intention of the entrepreneur. Where the entrepreneur intends to mine any mineral deposits discovered, the prospecting expenditure will normally be of a capital nature. Similarly, the prospecting expenditure will be capital if the entrepreneur intends to enter into a royalty agreement in terms of which a third party will be permitted to exploit the deposits in return for a royalty. However, if an outright disposal of the mineral deposits to a third party is contemplated; the prospecting expenditure will be of a revenue nature.
Special deduction provision
A special deduction provision is granted by section 15(b) of the Income Tax Act in respect of prospecting expenses. The special deduction provision relates to prospecting expenditure as well as to any other expenditure which is incidental to the prospecting operations.
The deduction in respect of prospecting expenditure can only be allowed from the income derived by the taxpayer from mining operations.
In terms of section 15(b) of the Income Tax Act, expenditure incurred on prospecting operations includes expenditure on surveys, boreholes, trenches, pits and other exploratory work preliminary to the establishment of a mine. SARS may also include any other expenditure which in their opinion is incidental to prospecting operations under prospecting expenditure.
To qualify for deduction the expenditure must be: - incurred; - by the taxpayer; - during the year of assessment; and - in respect of any area within the Republic. Section 15(b) of the Income Tax Act imposes certain restrictions on the deduction of prospecting expenditure. They are the:
- (i) Installment restriction.
- (ii) Class of mining restriction.
- (iii) Capital redemption restriction.
Prospecting to establish a mine
In terms of section 15(b) of the Income Tax Act, the special deduction provision for prospecting expenditure permits a deduction only against income derived from mining operations. The entrepreneur may not have any income from mining operations against which to set off prospecting expenditure as it is prospecting in order to establish a mine. The prospecting expenditure incurred by the entrepreneur will also not be deductible in terms of the general deduction formula of section 11(a) of the Income Tax Act as projects of this type are of a capital nature. Before commencement of production, the prospecting expenditure incurred by the entrepreneur is accumulated as part of its unredeemed capital expenditure; after commencement of production, all prospecting expenditure is deductible as and when incurred.
Prospecting with a speculative purpose.
The entrepreneur’s objective is to find payable mineral deposits which can be turned to account by either selling them outright at a profit, or alternatively, allowing them to be exploited by a third party from whom the prospector derives income in the form of royalties. In the former case, the proceeds will be taxable, being of a revenue nature, while the prospecting expenditure (including that of an initial nature will consequently be deductible as expenditure incurred in the production of income under section 11(a) of the Act.
Where the speculator intends entering into an agreement whereby a third party is granted the right to exploit the mineral deposits in return for a royalty, that royalty will be taxable as non- mining income. In this case, however, both the initial and prospecting expenditure will be of a capital nature but will not rank for deduction under section 15(b) of the Income Tax Act, due to the fact that the entrepreneur is not carrying on mining operations. Unless the entrepreneur commences dealing in mineral deposits, any profit realised on a subsequent disposal of the rights to these deposits will also be of a capital nature and subject to Capital Gains Tax.
To prospect with a speculative intention is very complex and time consuming, as the Mineral and Petroleum Resources Development Act stipulates in section 11 that “a prospecting or mining right or any interest in such right or a controlling interest in a company ... may not be ceded, transferred, let, sublet, assigned, alienated or otherwise disposed of without the written consent of the minister, except in the case of change of controlling interest of a listed company”.
Section 100 of the MPRDA discusses the transformation of the minerals industry and states that the minister has to develop a broad-based socio-economic empowerment charter that will set the framework and targets for effecting the entry of historically disadvantaged South Africans into the mining industry. The minister will ensure the entity to which the right is disposed of is capable to comply with obligations and the terms and conditions of the right in question; the minister will also take into account the requirements of the Mining Charter before consent is granted for the disposal of a prospecting right.
Venture capital for junior exploration companies Junior exploration and mining companies in South Africa have repeatedly complained about the problems they run into in attaining finance, as local investors have little appetite for exploration risk. Government has acknowledged the need of greater access to equity finance for junior exploration companies and has introduced section 12J ‘Deductions in respect of expenditure incurred in exchange for issue of venture capital company shares’ into the Income Tax Act in January 2009. The intention of section 12J of the Income Tax Act is to provide a tax incentive for investors in small and medium-sized enterprises and junior mining exploration companies in South Africa. This section does not have tax consequences for the entrepreneurs currently embarking on prospecting activities, but provides a tax deduction for investors in junior exploration companies.
1 The Income Tax Act 58 of 1962, as amended (Income Tax Act) 2 Section 72 of the Income Tax Act
Acknowledgments Cronjé, C.J. & Sturdy, J. 2011. Course in mining taxation. Pretoria: Centre for Accounting Studies, UNISA.
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