JOHANNESBURG (miningweekly.com) – The bottoming of the resources market is presenting South Africa with a valuable opportunity to write a new exploration script that encourages investment ahead of all other mining jurisdictions.

“Catch this wave now so that when the market turns, we can be in a space that tells investors they should invest in South Africa rather than anywhere else,” KPMG corporate tax head Muhammad Saloojee urged on Tuesday. (Also see attached Creamer Media video)

At a Joburg Indaba breakfast debate chaired by mining luminary Bernard Swanepoel and a panel that included National Treasury’s Ismail Momoniat and Cecil Morden, Cadiz consultant Peter Major and Falcon & Hulme director Bruce Falcon, Saloojee presented a compelling case for the introduction of a flow-through share scheme similar to Canada’s and Australia’s, while Morden spoke of the possibility of modifying South Africa’s existing venture capital company (VCC) scheme in a manner that would attract significant exploration company uptake.

Saloojee reminded the meeting that the Citibank report continued to confirm South Africa as the country with the world’s richest resource base worth more than $2.5-trillion.

Against that background, the KPMG director saw the window of opportunity being wide open for the government to incentivise prospecting or face the prospect of a mining industry without a future.

Incentivising prospecting would be the first of a new cradle-to-grave approach.

“If you don’t start at the cradle level, you will not have new mines when the boom happens. If it means simply tweaking stuff, let’s do that. If it takes us out into a completely new regime, even better,” he added.

The flow-through share scheme is tax driven to facilitate equity finance for high-risk prospecting ventures.

Currently in South Africa, if an exploration effort fails, as happens with many prospecting ventures, that money goes into an abyss because that venture capital does not get any tax deduction.

In such instances, the investor who put money into this company, gets nothing out of it.

At best, he might get a deferred loss for capital gains tax purposes.

That is the mismatch that the Canadian flow-through share scheme addresses, by giving the deduction to the investor instead of giving it to the prospecting company.

In that way, the scheme reduces the cost of that investment and removes some of the risk associated with the exploration venture.

The scheme is a sweetener for the investor and clearly facilitates a much wider shareholder base.

In Canada, and more recently in Australia, the tax deductibility is removed from the prospecting company and given to the investor, who receives 100% of the tax deduction on all exploration expenditure.

“That’s the trick that we’re trying to play out here,” Saloojee told the Joburg Indaba breakfast, attended by Creamer Media’s Mining Weekly Online.

The scheme incentivises the most basic of exploration and to quality for the tax deduction, investors must put money into a prospecting company that is carrying out such basic exploration.

“It’s the cradle approach. You have to start off doing this basic work before you can ever get to build a mine, and this is what we’re trying to get some sort of funding for.

“In Canada, they say, if you do that, we’ll give you the deduction and we’ll give it to you upfront, as long as you spend the money within a 24-month period, so the deduction is not deferred for the investor,” Saloojee spelled out.

Interestingly, there is also a system in Canada, which actually gives investors an additional 15% credit for basic grassroots exploration, and also for siting exploration in certain municipal jurisdictions.

Canada’s federal tax credit plus the provincial tax credit can reduce a $1 000 investment to $519 or $319 and sometimes even less.

In times like today, when there is a squeeze on investors and the absence of liquidity in the markets to fund prospecting, the flow-through share scheme results in an uptake of investment.

Some 67% of all funding for prospecting ventures came through the flow-through share scheme in Canada in 2012/13 and 87% of the prospecting spend was from the flow-through model last year.

So it is clearly countercyclical. When the market is completely down and nobody wants to put money into exploration, investors say we’ll spend more money on the flow-through share scheme because that’s where we’ll take the least amount of risk.

With Australia introducing a similar model, it means that the parts of the world known for mining have recognised this model while South Africa has not.

The investor can be individual or corporate.

Aspirant explorers identify a project, set up a company and a $10-million investment will typically get the tax deduction for the investors in the year they make the expenditure.

THE STICKY SOUTH AFRICAN REGIME

In South Africa, a typical prospect miner and trader needs to claim his deduction under Section 15 (b) of the Income Tax Act.

“That section is unfortunately fraught with difficulties,” Saloojee pointed out.

One of the most difficult provisions is that prospecting expenditure can only be claimed against mining income.

Should a prospector invest the same $10-million and earn no income because the venture fails, that expenditure, according to 15 (b), will never benefit that venture because it never earned mining income.

That very same entity puts $10-million into a bank account and earns interest income, it will actually be taxed on the interest income and you won’t get the deduction on the prospect spend because interest in a company is not seen as mining income.

The VCC regime that the South African government has put in place and which is regulated under Section 12 (j), does cater for certain prospecting ventures as well as junior mining companies, but the difficulty is that it is very much structured on a fund model.

The legislature has lumped the prospecting deductions with the typical venture capital regime, which have very different needs more suited to the private equity industry.

For every R100 that the company receives, it is limited to taking R20 of that and putting it down to one new qualifying entity, which is unsuited to mining.

The other provision that is also a death knell for this regime is set out in Section 12 (j) 3A, which states that the investor making an investment in the VCC becomes a connected party to the VCC and no longer qualifies for the deduction.